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Estate Tax Limbo

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Important changes to the federal transfer tax regime became effective on January 1, 2010. These changes have their roots in the Economic Growth and Tax Relief Reconciliation Act of 2001, which contained a nine-year phase down of the federal estate tax that culminated in the repeal of both the federal estate tax and the generation-skipping transfer tax as of January 1, 2010. The federal gift tax remains in effect, but the highest tax bracket on gifts made in 2010 is reduced from 45% to 35%.

Under current federal law, if Congress takes no action before the end of this year, the federal estate and generation-skipping transfer taxes will return on January 1, 2011, but at the higher rates that applied prior to 2001 (when the highest marginal bracket was 55% versus the 45% rate in effect in 2009) and with a much lower exemption amount ($1 million versus the $3.5 million exemption in effect in 2009).

Although it was widely believed that Congress would attempt to pass legislation before the end of 2009 to prevent the repeal of the federal estate tax, it failed to do so. Many commentators and congressional observers now speculate that Congress may pass legislation reinstituting the federal estate and generation-skipping transfer taxes and make it retroactive to January 1, 2010. While the constitutionality of any such retroactive legislation is likely to be challenged, most of the constitutional law experts who have offered opinions on the subject believe it will be upheld. Of course, it is also possible that Congress may do nothing at all about the estate tax in the near term, in which case 2010 might really be an estate and generation-skipping tax free year.

Prior to the (temporary) repeal of the estate tax, many properly drawn estate plans included trust funding formulas that were keyed to the size of the federal estate tax exemption. For example, a married couple may have created a plan under which an amount equal to the federal estate tax exemption would pass to a “credit shelter trust” for the benefit of the children -- and possibly also for the surviving spouse -- while everything else (basically the amount necessary to eliminate the federal estate tax) would pass to a trust for the surviving spouse. If there is no federal estate tax, this type of funding formula may result in essentially everything passing to the credit shelter trust. This result may not pose a problem if the surviving spouse is a beneficiary of the credit shelter trust but, if not, the repeal of the federal estate tax could alter the desired division of property among the beneficiaries of the plan. 

Our estate planning attorneys are continuing to monitor developments relating to the federal estate tax. In the interim, we suggest that you contact your estate planning attorney at Nutter McClennen & Fish and ask for a review of your estate planning documents to ensure that your documents work to accomplish your goals in light of the recent changes to the tax laws.    

Peter R. Brown               

Natalie B. Choate

Julia Satti Cosentino             

Thomas P. Jalkut             

Deborah J. Manus

Susan L. Repetti                     

Circular 230 Disclosure: To ensure compliance with IRS Circular 230, we inform you that any federal tax advice included in this communication is not intended or written to be used, and it cannot be used,  for the purpose of (i) avoiding the imposition of federal tax penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered advertising.

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