How the (Temporary) Repeal of the Estate Tax Could Affect You

Ronald P. Adams

The recent (and likely temporary) repeal of the federal estate tax carries at least one consequence that you may have overlooked: Married people who don't update their estate plan could unintentionally disinherit a surviving spouse.

It's become common for married couples to use estate tax funding formulas in their estate plans to place in a Trust the maximum amount of assets not subject to the estate tax, often to benefit children. The remaining assets go to the surviving spouse.

But this year, you can pass to your heirs an unlimited amount of assets without triggering the estate tax. An unintended result is that all of your assets might automatically move into a Trust, and your surviving spouse could be out of luck.

Avoid Unintentionally Disinheriting Your Spouse. Most states allow surviving spouses to claim part of an estate even if disinherited, but it can be costly.

To avoid this dilemma, you might be wise to update your estate plan to remove any estate tax funding formulas for 2010. Instead, you can use dollar amounts or a percentage to designate where assets should go. Alternatively, you should consider transferring some assets to a spouse's name now to ensure sufficient funds are available to him or her.

How Did This Repeal Happen? Most experts believed that Congress would carry the 2009 estate tax exemption of $3.5 million through 2010 and address the estate tax this year. Instead, the House failed to act on a one-year extension and sent the Senate a bill to make the 2009 law permanent.

However, the Senate was so tied up debating health care reform and disagreeing over what to do with estate taxes that it did not act on the estate tax issue at all. Thus, the repeal took effect.

Congress's failure to adopt any estate tax legislation for 2010, as well as the possibility that no changes will be enacted at all this year, dramatically affects the estate planning considerations for many clients.

What will happen? Here are some possibilities:

• Congress will again do nothing in 2010, in which case there is a nominal step-up in basis and no estate tax for those who die in 2010. In 2011, the estate tax exemption automatically reverts to $1 million.

• Congress will enact legislation to carry the 2009 exemption over to 2010 and make the legislation retroactive to January 1. So if a client dies before the enactment, his or her estate could still be taxed.

Act Now. To determine whether updates are needed, it may be prudent for you to check with your estate planning attorney.

Congress can reinstate the estate tax, retroactive to January 1, 2010. Also, the Obama administration has included a new estate tax bill ($3.5 million exemption per person, $7 million per married couple) as part of its proposed budget. White House spokesmen have expressed confidence that there will be a new estate tax – but they have not specified an effective date.