The Economic Growth and Tax Relief Reconciliation Act that was signed into law by President Bush on June 7, 2001, provided for a reduction in the maximum federal estate, generation-skipping and gift tax rates for the years 2002 through 2009. This new law also increased the unified credit amount which exempts assets from the federal estate tax during those years. On January 1, 2009, the unified credit that exempts assets from the payment of the estate tax will increase from $2,000,000 to $3,500,000. This federal law also states there will be no estate tax in the year 2010. Unless new legislation is enacted, the unified credit will return to $1,000,000 on January 1, 2011. 

This drastic increase in the federal estate tax exemption equivalent from $2,000,000 to $3,500,000 for the year 2009, may be a reason for a person who has established of a credit shelter bypass trust to amend his or her present estate plan. The reason that an amendment to such an estate plan may be necessary relates to the fact that when the exemption equivalent increases to $3,500,000, the amount available outright for the surviving spouse may be nothing. For instance, it is common for an estate plan with a credit shelter bypass trust to state, “I leave to my spouse my property qualifying for the marital deduction after first taking into consideration the maximum amount that can pass free of estate tax due to the applicable credit amount.” If a person does not change his or her estate plan and dies in the year 2009 with an estate of $3,500,000, the surviving spouse will receive nothing. This is because the entire estate will be allocated to the credit shelter bypass trust, which will be $3,500,000 in 2009. The credit shelter trust traditionally provides for the surviving spouse to only receive income from these trust assets for his or her life. The balance at the death of the surviving spouse is distributed to the children of the first spouse to die.

Consideration should accordingly be given to capping the amount that will be assigned to the credit shelter bypass trust regardless of the increase in the exemption equivalent. Thus, the estate plan can be amended to state that the amount that is to fund the credit shelter bypass trust is to be limited to a certain amount, such as $1,000,000. This would assure that the surviving spouse in the above example will receive in trust or outright the remaining $2,500,000.

Spouses who understand this change in the law, but decide to not cap the credit shelter amount, may wish to consider signing a postnuptial agreement. This will confirm that it is the surviving spouse’s intention to not subsequently claim the elective estate that is now 30% of the fair market value of all of the deceased spouse’s assets and to only receive what is provided in the credit shelter trust. Repeal of Step-Up in Basis Presently, the federal income tax laws assign to inherited property a basis equal to the fair market value of that property on the date of the decedent’s death or six months.

Repeal of Step-Up in Basis

Presently, the federal income tax laws assign to inherited property a basis equal to the fair market value of that property on the date of the decedent’s death or six months later if the alternate valuation date is selected. This step-up or step-down in basis eliminated the recognition of income on the increase in the value of the property that occurred before the death of the person devising the property, and eliminated the tax benefit from any unrealized loss. This exclusion of the gain from income taxation was due to a concern that a double tax existed when a beneficiary was subject to an estate tax and an income tax on inherited property.

Since beneficiaries receiving property due to inheritance are presently not subject to a federal estate tax after 2009, the current law’s step-up in basis rule is to be replaced with a modified carryover basis rule. Beginning in 2010, inherited property will have a basis equal to the lesser of its fair market value on the date of death or the decedent’s adjusted basis in the property. However, a modified carryover basis rule will apply to these assets. The first modification to the new cost basis rule is that the basis in each asset will be increased proportionately so that the basis of all the estate’s property will be increased to an aggregate basis of $1,300,000. In addition, the basis in property left to a spouse outright or in a qualified terminal interest trust for a surviving spouse will increase to an aggregate of $3,000,000. This means that the basis of property transferred to a surviving spouse can be increased by as much as $4,300,000.

The new law states that the basis in property will not increase if the property is received by the decedent by gift or transfer for less than adequate and full consideration during the three-year period ending on the date of the decedent’s death. An exception will be when the property is acquired from the decedent’s spouse, provided the spouse did not within this three year period acquire the property by gift or for less than adequate and full consideration.

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