It all depends on how your current estate plan was structured and how much flexibility you have built into your estate plan to anticipate the possibility of a federal estate tax repeal.  And, of course, if you don’t believe you will die this year, perhaps no changes will be needed.

Thanks to delays in Congress, the temporary federal estate tax repeal for 2010 has actually happened, at least for now. The failure of Congress to act in a timely manner has created an unprecedented uncertainty in the world of estate planning.  Although many believe that Congress will reinstate the estate tax in early 2010 and make it retroactive to January 1, 2010, nothing is definite.   Besides, there is also a constitutional issue to apply any estate tax retroactively.   The issue would most likely have to be answered by the Supreme Court if challenged by the families of some wealthy people dying prior to any 2010 legislation.

With the repeal of the federal estate tax law in 2010, gone is the $3.5 MM in estate tax exemption, the 45% top rate, and the step-up in cost basis of estate assets as under the old 2009 tax law.  In 2010, and for one year only, we have no federal estate tax, no generation skipping tax (GST), but also no step-up in cost basis at death either.  Instead, inherited estate assets will get a “modified carryover basis” which may require cumbersome cost basis tracing and substantiation.

So, what should you do?

If you believe you will survive the 2010 year or Congress will reinstate the estate tax retroactively, you may choose to do nothing.  However, if you have any doubt about that or want to reduce the risk, you may want to consider reviewing your current estate plan with your estate planning advisor to see whether the intent of your estate plan can still work under the 2010 federal estate tax repeal.

The current uncertain future of the federal estate tax law also creates a window for some unusual estate planning opportunities.  You may want to explore them with your estate planning advisor to take advantage of this short window.  However, be prepared to be flexible in your new estate plan since no one knows what Congress might do for the rest of 2010.

Here are some observations to share with you...

• Many of you may have your current estate plan that references the unified credit ($3.5MM under the old 2009 tax law) or uses some formula clauses to control the disposition of estate assets.  With the 2010 federal estate and GST tax repeal, the above approach might unintentionally pass estate assets all to the surviving spouse or all to the children and grandchildren, depending on how the planning document reads, since there is no federal estate or GST tax per se in 2010.  Although some of the post-mortem planning techniques such as disclaimers and spousal elective share may remedy the situation to certain extent, those techniques should only be used as a last resort.  Advance planning is always better.
• The 2010 federal estate tax repeal allows no step-up in cost basis at death.  However, it does provide a $1.3MM in income tax basis adjustment on estate assets and a $3MM adjustment for estate assets passing to a spouse.  Nobody has paid much attention to this issue until now.  Proper planning and guidance to the executor in basis adjustment allocation may become necessary to deal with the issue in order to maximize the tax benefit and/or to keep most, if not all, of the beneficiaries happy.
• Some have speculated that the repeal of the federal estate tax is not a good thing for small business owners if their businesses are worth less than $7MM.   With the $7MM in combined exemptions for a couple as under the old 2009 tax law, there would be no federal estate tax to pay.   However, with the loss of step-up in cost basis at death in 2010, there would be potentially large capital gain tax to be paid by heirs on the inherited estate assets.
• The 2010 estate tax repeal is federal only.   Like some other states, DC and MD still have an estate tax.  Estate planning to avoid or minimize the state estate tax now takes on a new dimension, and old planning techniques might not work anymore.
• The 2010 federal estate tax repeal is only temporary.  The estate tax will return in 2011 at the pre-2002 law with 55% top rate and $1MM exemption under the sunset rules.  Most believe that the return to the pre-2002 rate and exemption is considered unpopular, but we will have to wait and see what Congress does to bring some certainty and permanence back to the federal estate tax law and the world of estate planning before the end of 2010.
• Finally, we hope Congress will act quickly this time around.  We cannot imagine devising estate plan that must address federal capital gain tax combined with a state estate tax, if the current estate planning documents are not already complicated enough.

For more information about how this temporary federal estate tax repeal may affect you, please contact Aronson & Company’s Tax Services Group at 301.231.6200.