By Robert Moshman, Esq.

Plateau or Pinnacle?

Estate tax professionals, welcome to 2009, the promised land! We have made it through nearly the entire estate tax repeal phase-in from 2001 through 2009, the pinnacle of estate tax repeal.

Is this the fabled land of estate taxless nirvana?

A tabula rasa of zero tax zen? If we see a white light should be go into the light? Or no, bad idea, run from the light! Are there any good mantras that rhyme with "unrealized capital gains?"

No. Not exactly. In fact...not at all. Gentle readers, rest assured that estate tax repeal has not arrived and probably won't. We have fallen just short.

But aside from that little set back, we had best enjoy the new $3.5-million estate tax exemption because it may be as close as we ever get to estate tax repeal. So let us take stock of this penultimate phase that may actually be the final destination and review key limits and COLA adjustments for 2009.

Tax Magic, Tax Mischief

The estate tax repeal that a consensus of experts declared dead on arrival eight years ago has managed to stay on track and has actually made it to the final tax before repeal. Yet there is still an opaque ceiling of 45% estate tax with a $3.5-million exemption as a tax structure that imprisons mankind and blocks our view of the limitless heavens beyond--and it is probably here to stay. This penultimate plateau may be permanent.

Next year, instead of phasing out to zero estate tax, there will, most likely, be a last minute fix to continue the status quo of 2009 with an estate tax and with the same $3.5-million exemption, which happens to be spot on with President Obama's stated policy preference for the estate tax.

On the other hand, the fat lady of taxation is named Congress and it isn't singing just yet. Stranger magic and/or mischief than a repeal and then a return to 2001 estate tax rates in 2010 and 2011 respectively could be in store if Congress procrastinates and then fixes tax issues retroactively as it has in the past.

Estate Planning Pro?

You know you are an estate planner when a Q-TIP isn't about ears, it's qualified terminable interest property as part of a two-trust estate plan.

You know you are an estate planner when "BFF" doesn't mean "best friends forever" but "bundled fiduciary fee," under Knight v. Commissioner

You know you are an estate planner when estate tax repeal is not celebrated but ignored. Even a repealed tax could return; we still have to plan.

Bailing Out The Boat

Economists arguing all through 2008 about whether we were in a recession or not (we were and we are) whether the sub-prime mortgage mess would affect the general economy (it did) or if a perfect storm could unravel the economic fabric of the global economy (in progress).

For those of an academic bent, the technical definition of consecutive quarters of economic decline were not clearly demonstrating a recession. Recession? What recession? But hindsight is 20-20 and by the end of 2008 a variety of other reports indicated that we've been in a recession for the past year. Oh, THAT recession! It seems the economists were the last to find out.

Real estate softened first, going back prior to 2008. Analysts argued throughout 2007 that the real estate bubble was not going to burst ("it will just soften on a rolling cascade around the nation," they whistled in the dark.) But that analysis gave way to comments of analysts during 2008 which described the languishing real estate market as one of the byproducts of the sub-prime lending fiasco.

Loans gone bad contributed to the surplus of foreclosures.  In the second half of 2008, a new type of "short sale" emerged where lenders approved sales for below the value of the outstanding mortgage to cut their losses in lieu of foreclosures. Analysts ultimately set their sights to a more positive time, i.e., when values recover and sales resume in 2009 or beyond. 

As the stock market took a sudden vacation south of the 10,000 level of the Dow, a fearful nation put spending on hold and the bailout phenomenon began. Airlines, insurance companies, and lending institutions beat a path to Capitol Hill and by the end of the year, presidents of American auto makers were working for $1, driving themselves to Washington in American-made cars, and eating humble pie to secure their own bailout.

As an example of the roller coaster we have been riding, it was only a few years ago that economists feared that oil could reach $26 per barrel by 2025. During this year, crude oil spiked up to nearly $150 per barrel, speculation rose about breaking the $200 per barrel mark, but then prices fell to $37 per barrel toward the end of the year.

Practical Advice

On a practical level, this economic upheaval has diminished nest eggs intended for retirement or college tuition or purchasing a home, and there are some important lessons to be learned.

For starters, even a devastated portfolio can be addressed with sensible approaches. Gains and losses can offset one another. Remaining funds can be re-deployed based on current conditions. There are always opportunities and choices. Investors who previously employed benign neglect as a market strategy must make a point to periodically review investments rather than buying and holding forever.

For shell-shocked individuals planning an estate, the balance of assets being distributed may require adjustment. For instance, if one leaves real estate to one beneficiary and expects stock portfolios to even things up by benefiting other beneficiaries, a sudden devaluation of stocks may make such plans unbalanced and inequitable.

A sudden drop in the market may alter overall estate valuations for transfer tax purposes. For example, someone interested in utilizing the lifetime gift tax exemption of $1 million could transfer stocks while they are at a lower value, with lower capital gains, and more potential for future appreciation. 

Management of trust and retirement funds becomes a critical consideration that many have taken for granted--with emphasis on providing total return flexibility, maximizing long-term gains and setting fiduciaries free to employ greater discretion as opposed to the more conservative historic role of trusts to safeguard funds. Long-term investments have time to recover while those with retirement and college funding needs have a more restricted time frame and need a portfolio balance that reflects those needs.

Tax Thresholds for 2009

INCOME TAX BRACKETS: Top individual rates remain at 35% for 2009. For individuals, a 33% rate applies to income over $171,550. The 35% rate kicks in at $372,951 for individuals as well as married filing jointly. For estates and trusts, the income tax ranges from 15% for amounts under $2,300 and 35% for amounts exceeding $11,150 (up from $10,700 in 2008).

SOCIAL SECURITY WAGE BASE: The first $106,800 of income is subject to Social Security tax withholding (up from $102,000 in 2008) and the rate remains 7.65% for employees and 15.3% for self employed. Cost-of-living increases of 5.8% apply to Social Security and SSI for 2009.

TOP ESTATE TAX RATE: We are in the eighth and final year of the phase out of the estate tax. The top estate tax rate remains at 45% this year and applies to taxable estate assets in excess of $1.5 million.

ESTATE TAX EXEMPTION: We have reached an exemption of $3.5 million up from the $2-million exemption of the past three years. This may be the final exemption level if Congress freezes the status quo and avoids the final repeal of the estate tax. As things now stand, the estate tax will be repealed in 2010 and then reverts to 2001 rates in 2011 unless Congress takes action. (See chart.)

GENERATION-SKIPPING TRANSFER TAX: Also unchanged. Both the tax rate and exemption for estates continue to apply to the GST tax, i.e., 45% and $3.5 million.

GIFT TAX EXCLUSION: The annual gift tax exclusion has risen to $13,000 for 2009, up from $12,000 over the previous two years. The top gift tax rate remains at 45%. With gift splitting, a married couple can give each beneficiary $26,000 free of gift tax each year. Increases come in $1,000-increments based on cumulative inflation adjustments. The next jump, to $14,000, will probably arrive in 2012.

GIFT TAX LIFETIME EXEMPTION: The lifetime exemption for gift taxation remained at $1 million, and will remain at that level through 2011.

SPECIAL-USE VALUATION: The aggregate decrease in value of an estate using §2032A for estate tax purposes is $1 million for 2009.

NON-CITIZEN SPOUSES: The exemption under sections 2053 and 2523(I)(2) for gifts to non-citizen spouses increased from $128,000 in 2008 to $133,000 for 2009.

QUALIFIED FUNERAL TRUST: The limit had been at $9,000 for 2008, up from $8,800 for 2007. But for 2009 the limits were repealed as part of the Hubbard Act. So there are no known limits, but a reasonability test may end up evolving.

CAPITAL GAINS: A top rate of 15% continues to apply and those in low tax brackets pay 0% in 2008 through 2010.

ATTORNEY FEES: For fees incurred in calendar year 2009, the attorney fee award limitation under IRC §7430(c)(1)(B)(iii) is $180 per hour, up from $170 per hour for the past two years.

ELECTIVE DEFERRALS: For 2009, 401(k) and certain other plans will have a contribution ceiling rising to $16,500, up from $15,500.

CONTRIBUTION LIMITS: Limits for SIMPLE accounts increase to $11,500 for 2009, $14,000 for those over age 50. Limits increase from $45,000 in 2008 to $46,000 in 2009 for defined contribution plans, with higher limits of $51,000 for those over 50. Roth IRA eligibility limits for 2009 are $105,000 of income for an individual, $166,000 for spouses filing jointly. Regular IRA contribution limits for 2009 are the same as 2008, i.e., $5,000 for those 49 and younger and $6,000 for those 50 and older (the "catch up" limit).

COMPENSATION LIMITS for eligibility in SEPs and other plans increase to $245,000 for 2009.

Sources:  For 2009 rates, see  IR-2008-117 and 118 and Rev. Proc. 2008-66. For 2008 rates, see: Revenue Procedure 2007-66.

Estate Tax Phase Out 2001 -- 2011

  + = In addition to the 55% rate, a 5% surtax applied to certain estates exceeding $10 million.

  * = In 2011, item reverts to 2001 level unless Congress enacts further legislation.

  ** For carryover basis in 2010 (and beyond if extended by Congress) a limited stepped-up basis      would continue to apply to the first $1.3 million of capital gains transferred to a non-spouse and the first $3 million of capital gains transferred to a spouse.

   (c) KS 2009.1