In 2001 EGTRRA substantially reduced the amount of estate tax paid by all Americans. The good news is that for this year, 2010, the estate tax goes away. The bad news is that the estate tax is replaced by a brand new income tax. All trusts needs to include language to deal with this income tax.
The Brand New Income Tax
Under the previous version of the Internal Revenue Code (IRC), there was a tax on all assets that a taxpayer owned on the day of death. One major benefit from the estate tax is there is generally no income tax on the assets if they were sold. The reason there is no income tax is the basis or cost of the asset was stepped up to fair market value. For example, if you bought a building for $100 and sold it before you died for $500, you would pay capital gains tax on $400. $100 is your cost or basis. $500 is the value of the asset. $500 (FMV) less $100 (cost) equals a gain of $400. If the personal representative sold the building the day after death, there is no capital gains tax. The basis or cost of the property is stepped up after death to $500. So $500 (FMV) less $500 (stepped up basis) equals $0 capital gains tax. Well the new law gets rid of the stepped up basis rule. The result is an income tax on the taxpayer’s property at death.
Most Trusts Don’t Deal With the New Income Tax
When EGTRRA was passed it was designed to last through 2010. In 2010 the estate tax went away and the income tax was put in its place. The law says it sunsets (ends) in 2010 and in 2011 we go back to the law we had before EGTRRA. The estate planning community believed that we would never see EGTRRA sunset. The literature said Congress would change the law so we would not have to deal with the new income tax. As of the day this guide is first published, the literature is wrong. The income tax is here and we have to deal with it. Most trusts are written to help to reduce estate tax. Very few trusts are written to help reduce the new income tax. So trusts need to be reviewed and amended to take help taxpayers avoid the new income tax.