While no one was looking, and while no one seemed to care, something interesting and - dare I say - totally and utterly incompetent happened in Congress. The Estate Tax has been repealed!
From the time of the enactment of Bush's tax cuts in 2001 until Thanksgiving 2009, no estate planning professional thought this day would ever come. No one thought that we would ever reach repeal in the year 2010. I mean, the Estate Tax is repealed for 1 year in 2010 and then next year, in 2011, the tax law changes "sunset" and we revert back to the way the law looked 10 years ago - in 2001! Surely Congress would enact a law before 2010 that made some stable Estate Tax regime permanent! But no! Through either total incompetence or.... well, through just plain total incompetence, Congress did nothing before year end.
And now we have a mess!
For 9 years, estate planners and clients of estate planners have lived with uncertainty. What will happen when we get close to 2010? How will the estate tax laws look on a more permanent basis? How should we plan now for inevitable changes that will come? That uncertainty has turned into HUGE uncertainty and chaos.
In 2001 Bush's tax changes called EGTRRA were enacted that provided for a 1 year repeal of the estate tax in 2010, followed by a "sunset" of the law and a reversion back to the old laws of 2001 before EGTRRA.
During that 1 year of repeal, all kinds of crazy things are to happen. No more date of death step-up in basis. There are now complicated carry-over basis rules. People with estates of less than $3.5 million will actually be penalized by the change with income taxes that wouldn't have been imposed. You can no longer make a comleted gift to a nongrantor trust. There are some strange rules in place now that not many people have bothered to think about or understand, because no one in their right mind thought Congress would ever allow this to happen.
Now, no one knows what to do, or how to plan. Families who want to create a will or trust have no idea today how to structure those documents because no one knows what the law is or what it will be! On its face, the law currently provides that if Bill Gates or Warren Buffett were to die today, they would owe no estate tax. If they had died last week, they would have owed a 45% tax. This gives a whole new meaning to the phrase "throw momma from the train". If you have a rich grandmother that you love, you had better hire some guards to watch the plug to her life support machines, because right now hew heirs have a short term incentive to pull it.
Will Congress enact an estate tax soon in January? Will it be retroactive? If so, will that be unconstitutional? There are arguments that it wouldn't be. What if someone dies today with a taxable estate? Will they owe any estate tax? Is it fair to have people who die during the next few weeks to be the only people exempt from estate tax since the beginning of the 20th century and then start taxing decedents again in a few weeks? If Congress attempts to make an estate tax retro-active, it will surely draw a lawsuit from some decedent with a large estate.
EDIT - I have seen an peice circulated by one estates and trusts practitioner that states that John Buckley, Chief Tax Counsel to the House Ways and Means Committee, has reportedly stated that reinstituting the estate and GST taxes retroactively would be unconstituional. Representative Pomeroy reportedly said that it owuld not be applied retroactively. While there have been several U.S. Supreme Court cases that have upheld the unconstitutionality of retroactive changes to the transfer tax system, those cases have generally involved tax rate increases. If an estate and GST tax is enacted retroactively to January 1, 2010, there will undoubtedly be lawsuits of the constitutionality of the law.
SECOND EDIT:
Here is a link to a Wall Street Journal Article that verifies that repeal has taken effect and also describes another unintended consequence.
Wall Street Journal Article
Many trust documents provide that a credit shelter or generation skipping trust shall be funded with the maximum amount that can pass free from estate or GST tax (which has been the estate and GST tax credit (which was $3.5 million in 2009)). The balance of the trust fund (which is expected to be the majority fo the trust) will pass as a marital gift or into a marital trust for a surviving spouse. This allows the decedent to get the estate tax credit and use the unlimited marital deduction in order to defer the estate tax for years until the spouse's death. With repeal, it is possible that many estate planning documents will generate unwanted and unexpected results, as the gift or trust for a surviving spouse do not get funded at all. This is just one example of the problem.
This is clearly a display of gross incompetence on the part of Congress. Congress has thrown an entire tax regime into chaos, created confusion for millions of Americans (whether they know it or not), and caused a fissure in the U.S. transfer tax system that has been in place for almost a hundred years. Do you mean to tell me that sometime in the fourth quarter of 2009, they couldn't come up with a law that at least extended the state of the law then in effect in 2009 through the end of 2010, and punted the issue until next year?
THIRD EDIT:
The House of Representative tried to extend the 2009 law through 2010 to avoid this problem with House Bill HR 4154, which was passed by the House on December 3 without a single Republican vote. See here:
H.R. 4154
But the Senate failed to pass any measure.
This issue effects average Americans and not just rich people! This is really like a tax increase on average Americans because there is no more step-up in basis. Now we have carry over basis. When mom or dad dies, you will no longer get a date of death step up in basis. You will get their carry over basis and you will pay capital gains tax when you sell the assets. Repeal actually helps rich people and hurts poor people.
What a mess!