Tax & Estate Preservation Legal Update

Federal Estate Tax – Gone, But For How Long?

   Gregory D. Willett

2010 has brought with it with several changes in Federal estate tax law – the temporary repeal of the Federal estate and generation-skipping transfer (GST) taxes, the imposition of modified carry-over cost basis for assets held by a decedent, and the reduction in the gift tax rate to 35%. 

Though these one-year tax changes were part of the Economic Growth and Tax Relief Reconciliation Act of 2001, most tax practitioners expected the passage of estate tax reform in 2009 that would have avoided the one-year repeal and set the Federal estate exemption and estate tax rates at or near their 2009 levels ($3.5 million exemption and 45% top marginal tax rate).  Under the current law, if the estate tax structure is not modified by Congress, the Federal estate tax will return on January 1, 2011 to a $1 million exemption and marginal tax rates as high as 60%.

Congress’s one year repeal of the Federal estate tax law has created uncertainty in the estate planning community.  Discussions on Capitol Hill have included the possibility of a retroactive imposition of the estate tax when finally passed.  Constitutional challenges to the passage of a retroactive estate tax can be expected from estates of those dying in 2010.   

The uncertainty is especially acute for some married couples.   Many couples’ wills divide the estate of the first spouse to die into two broad portions.  One portion is equal to the deceased spouse’s unused Federal estate tax exemption amount.  The other portion is equal to the balance of the deceased spouse’s estate.  This balance is called the “optimum” marital deduction.  In most cases, neither portion will be subject to Federal estate tax when the first spouse dies even if there is a Federal estate tax.  The Federal estate tax exemption portion (sometimes called the “credit shelter” portion) escapes tax because it passes into a trust in order to take advantage of the Federal estate tax exemption of the first spouse to die. This “credit shelter” amount also escapes Federal estate taxation when the surviving spouse dies, though a portion of the “credit shelter” amount may be subject to state inheritance or estate taxes.  The marital deduction portion is not subject to Federal estate tax when the first of spouse passes on, but is subject to estate tax when the surviving spouse dies.

We continue to believe that this approach is appropriate for most couples with taxable estates.  However, the temporary repeal may change the calculation of these two portions, based on the formulas contained in an individual’s will, and result in unforeseen consequences.  These consequences could include over or underfunding the credit shelter or marital portion.  Therefore, we suggest that both individuals in poor health as well as those whose estate planning documents utilize a formula based on the Federal estate tax exemption review their estate planning documents immediately with an attorney to determine if the documents should be modified in the near term.

If you have any questions about these changes in the Federal estate tax, please contact one of the members of our Taxation and Estate Preservation Section.

Converting a Traditional IRA to a Roth IRA

    Bryson M. Kirksey

Starting in 2010, taxpayers can now convert a traditional IRA (including those that have been rolled over from a qualified employer-sponsored retirement plan) to a Roth IRA, regardless of the taxpayer’s income level. 

Benefits of converting a traditional IRA to a Roth IRA include:

• Tax-sheltered income similar to that of a qualified employer-sponsored plan or traditional IRA;
• Tax-free distributions for contributions made after a 5-year holding period and after the account holder reaches age 59 ½ ;
• No required minimum distributions to the account holder upon reaching age 70 ½.

Converting a traditional IRA to a Roth IRA requires the taxpayer to include the amount converted to the Roth IRA in his taxable income.  However, for conversions occurring in 2010, taxpayers have the option to report all of the income from the conversion in 2010, or to average the income over 2011 and 2012, paying the tax over two years.  Deciding when to report the conversion income should be carefully considered based on anticipated income and applicable tax rates.

Generally, converting a traditional IRA to a Roth IRA should be considered by individuals who:

• Can pay the income tax on the conversion with non-retirement-plan funds;
• Anticipate paying taxes at a higher tax rate in the future than what they are paying now (many observers believe that tax rates for upper-middle income and high income individuals will trend higher in future years); and
• Are willing to pay a tax price now for the opportunity to receive income tax-free distributions in the future. 

There are many details to consider before converting a traditional IRA to a Roth IRA.  If you are interested in obtaining more information about this conversion process, please contact a member of our Tax and Estate Preservation Section.