January 28, 2010

Dear Clients and Friends,
A NEW LAW has taken effect on January 1, 2010 that affects the vast majority of our clients. Changes to the federal estate tax will affect our estate planning clients, while changes to the way capital gains will be calculated will affect all of our clients, including our elder law clients.

As of January 1st, 2010, the federal estate tax in this country has been repealed for one year. As of January 1st, 2011, the federal estate tax is scheduled to return with a vengeance. While this possibility has been on the books since 2001, the overwhelming conventional wisdom was that it would never happen. It simply did not make sense to eliminate the federal estate tax for just one year!
So what is going on? Over the last decade, the federal estate tax has been phasing out, first by increasing the exclusion, then by full repeal this year. The exclusion meant that a decedent’s estate would pay no federal estate tax unless the total estate exceeded the exclusion in the year of death. The tax would only be assessed on the excess. The exclusion got as high as $3.5 million in 2009. In 2011, the federal estate tax is scheduled to return with about a $1 million exclusion. This will have a devastating effect on the middle class. Nevertheless, it is currently the law.
The overwhelming prevailing thought in our profession was that our Congress would never let this happen and would either fix the exclusion at a certain level or repeal the tax. This still may happen at some point this year, perhaps retroactively.
Many estate plans were written in such a manner as to shelter the exclusion at the first death, usually by placing such excluded amount into a trust (called a “by-pass” or “credit shelter” trust) and having the balance either pass outright or in trust (called a “Q-Tip” trust) to the surviving spouse (or to the children of a first marriage).
The language of the new law as applied to these plans may cause assets to pass in ways that were wholly unintended. For example, the “by-pass” trust may either be under or over funded, or perhaps not funded at all because no exclusion amount applies in 2010. Several problems could arise if the “by-pass” trust is not funded.

1. With the return of the estate tax in 2011, failure to shelter assets at the first death will cause more assets to be taxed at the second death, for both federal and state purposes. (New York currently has a $1 million exclusion).

2. Some estate plans (especially with second marriages) were written so that the exclusion amount would go to one set of beneficiaries (usually the spouse) and the balance to another set of beneficiaries (usually the children). If zero is allocated to the first set of beneficiaries, then all will go to the second set of beneficiaries, which certainly was never intended, and can be quite disruptive to an otherwise properly planned estate.

A “disclaimer plan” may be an appropriate response to this new law and its inherent problems. A disclaimer plan is one where the beneficiary is the surviving spouse, but the surviving spouse can disclaim (divert) the estate (or part) to a “by pass” trust. This allows for last minute fine tuning. While not right for everyone, a disclaimer plan may be something to consider at this uncertain time.

The trade off for the elimination of the federal estate tax, was the elimination of the “step-up” in tax basis. In simple terms, your basis is the amount of money you paid for an asset over time. For example the purchase price of real property or stock is the basis. Any amount you sell your real property or stock above the basis is subject to capital gains tax (about 15% federal and 7% New York State). The step-up in tax basis meant that at death, the basis of all assets automatically rose to the value upon the date of death, essentially wiping out all capital gains. However, in 2010 upon death, the basis will remain the same or go down (if the fair market value of the asset on death is less than the basis before death). For most clients this means that your basis will remain the same, before and after death, guaranteeing capital gains tax when the property is sold.
There is some relief. A decedent’s estate is permitted to increase the basis of assets transferred by up to a total of $ 1.3 million plus an additional $3 million for assets passing to a spouse. Actually, the decedent’s Executor has the power to allocate the increase in basis to any particular eligible asset or the decedent’s will can so provide.

Lastly, if you protected your assets with the use of a life estate or an irrevocable Medicaid family trust, this new law may have a negative impact. Previously, homes transferred with a retained life estate or any assets held in our irrevocable Medicaid family trust would enjoy a complete step-up in tax basis at death thereby eliminating all capital gains at death. Today, if you were to die in 2010, this may no longer be the case.
The bottom line is that your situation should be immediately reviewed, especially if you are concerned about your short term health. Please call our office immediately for a consultation to address your current options and/or attend our SPECIAL CLIENT SEMINAR on Tuesday, March 2nd at The Islandia Marriott, 3635 Express Drive North, at either 10am or 7pm. Please call JoAnn at 631-234-3030 or email her at to reserve a seat for yourself and a friend. The seminar is FREE but reservations are required.

We shall continue to post updates regarding this matter and other pertinent issues
throughout the year on our website at

I am,

Very truly yours,
Davidow, Davidow, Siegel & Stern LLP

Lawrence Eric Davidow
Managing Partner