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January 2010

2010 estate tax update
Although the tax has been repealed for now, it could be retroactively reinstated

Under the terms of the In this report, we will briefly address the following questions:
Economic Growth, Tax Relief • Can Congress change tax rules retroactively?
and Reconciliation Act of 2001 • What does this mean for planning?
(EGTRRA), federal estate taxes • What rules apply during repeal under current law?
are repealed for 2010 only. • What are the implications for deaths that occur before Congress acts?
However, Congressional leaders • What might a reinstated 2010 estate tax look like?
have indicated that they expect
to reinstate this tax for 2010 Can Congress change tax rules retroactively?
and may make the reinstatement Yes. It’s fairly common for tax provisions to have an effective date that precedes the
retroactive (possibly to Jan. 1). enactment date (that is, the date the President signs a bill). Sometimes this benefits
taxpayers (for example, when a tax break has expired but is retroactively reinstated),
and sometimes it does not.

There are Supreme Court cases indicating that retroactive tax laws do not necessarily
violate the Constitution. Nevertheless, if the estate tax is retroactively reinstated, we
can expect litigation on the issue that will not be resolved for years.

What does this mean for planning?
For most of us, estate planning is not something we think about frequently. But
the current uncertainty about estate tax rules may be unsettling and frustrating,
especially if you are beginning the estate planning process or are dealing with the
death of a family member. Here are some points that may be helpful for individuals
in different situations:

• If you are relatively young, in good health and have an estate plan that you
don’t expect to become effective for many years, it may not be urgent to act now.
This uncertain period will pass, and you may be able to wait until Congress acts.
However, this time of political confusion may be a good time to clarify your
personal goals and objectives. Think about:
– How do you want your financial success to affect your children and
grandchildren?
– If there were no estate tax, what would be your ideal estate plan?
– If there is an estate tax, how would your goals change?

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– What do you think would have a more positive effect on your children —
receiving an outright, lump sum inheritance or a lifetime of supplemental
income?
– Is increasing the amount transferred to your family members by minimizing
their potential estate tax liability a priority for you? Or is your goal to take care
of your financial needs first and to give only what’s left to your family? Or do
your wishes lie somewhere in between?

Waiting is not without risk. In the event of an untimely death, existing documents
could lead to unexpected results because even recently drafted wills and trusts were
probably not designed to take the possibility of estate tax repeal into account. Talk
to your attorney about whether the risk of waiting outweighs the cost of amending
Now is the time to have an
your estate planning documents today.
in-depth conversation with
Now is the time to have an in-depth conversation with your Financial Advisor
your Financial Advisor about about these topics. If you have clear goals, this will help you be prepared to evaluate
these topics. your estate plan once the tax picture clears up.

• If you are currently putting basic planning documents — wills, revocable trusts,
durable powers of attorney and health care directives — in place, you probably
should proceed. It’s important to have these documents, regardless of what happens
to the estate tax.

• If you are a married couple considering or in the process of instituting credit
shelter trust planning to help reduce your family’s potential estate tax liability, it
probably makes sense to proceed even with the current uncertainty about tax law.
Your attorney can design a plan so that if there is an estate tax (which appears
likely), you can still take maximum advantage of whatever the federal applicable
exclusion (the value an estate must exceed before it’s subject to estate taxes)
happens to be.

• If you are currently evaluating advanced tax planning strategies, work closely
with your legal and tax advisors to evaluate the respective risks of planning vs. not
planning. For example:
– If you proceed with planning but die during a period when there is no estate tax,
you may have paid for an “unnecessary” strategy, but if the strategy still delivers
property to your family, your family’s financial loss may not be great.
– If you delay planning and Congress retroactively reinstates the estate tax for
the period in which you die, your family may lose large amounts due to a 45%
or greater estate tax rate.

• If you (or a family member) face a significant risk of death due to advanced age,
illness or any other reason, it may be wise to have an attorney review existing wills
and trusts to clarify what will happen if death occurs during a period when the
estate tax is repealed. Many wills and trusts contain references to tax laws or
concepts that were in effect at the time of writing and include provisions to create
credit shelter or marital trusts after death. However, the language used to create
those trusts could have unintended consequences if death occurs during the period
when there is no estate tax. For example, how would references to the “applicable
exclusion” or “marital deduction” be interpreted while the estate tax is repealed
and there is no applicable exclusion or marital deduction in effect?

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In some cases, it might be appropriate for wills or trusts to set out two different
distribution outcomes. One plan might go into effect if it is later determined that
estate and generation-skipping taxes were repealed as of the date of death. The
other plan would go into effect if those taxes are reinstated or otherwise in effect
at the date of death.

Work closely with your attorney to determine whether changes to your estate plan
are necessary.

• If you currently have advanced estate planning strategies in place, you may be
tempted to dismantle existing planning structures or forgo making life insurance
premium payments during the period when the estate tax is repealed. However,
doing so may be unwise given Congressional leaders’ stated intention to reinstate
estate and generation-skipping taxes and the fact that these taxes are scheduled
to come back in 2011 even without Congressional action.

What rules apply during repeal under current law?
The following rules theoretically apply today. Of course, it is very possible that
these rules will become irrelevant if Congress enacts different rules and makes
them apply retroactively.

• The estate tax and generation-skipping tax are repealed in 2010 only.

• A 35% flat-rate gift tax applies to gifts of more than $1 million in 2010.

• During 2010, assets transferred at death no longer get an automatic “step up”
in cost basis. As a result, beneficiaries may incur capital gains taxes when they
sell inherited assets. However, a limited amount of assets could still receive a cost
basis step up under the carryover basis rules. Keep in mind that these rules are
very complex; the following is just a rough summary.
– For assets passing to a nonspouse, up to $1.3 million in gains could receive a
step up. This can be increased by unused losses and loss carryovers.
– For assets passing to a spouse, an additional $3 million could receive a step up.
(In other words, spouses can avoid a total of $4.3 million in gains.)
– If the date-of-death value is lower than the decedent’s basis, heirs get a
“step-down” to date-of-death value.
– The estate’s executor has the power to determine which assets get a step-up
and which do not.

• These rules “sunset” and are automatically repealed at the end of 2010.

• In 2011, the estate tax will return with a $1 million applicable exclusion and a 55%
top rate. The rules providing a cost basis step-up (or step-down) at death will also
be restored.

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What are the implications for deaths that occur
before Congress acts?
For families that lose a loved one in 2010, uncertainty about estate and income taxes
may add additional frustration and grief. It is entirely understandable that surviving
spouses and other family members may be angry about the position they are placed in
because of Congress’s failure to act. However, financial decisions should not be made
on the basis of anger or frustration. Take a careful, “wait and see” approach. Don’t
assume that the outcome will be what you want to or think should happen.

It may be prudent for executors and trustees to manage assets for larger estates or
trusts as though estate tax will still be due in case Congress does retroactively reinstate
the tax. This means providing liquidity for potential estate taxes.

Determinations about funding certain trusts may need to be delayed. For example, a
decedent’s will or living trust may contain provisions stating that a subsequent trust
should be funded with any of the following:

• The largest possible amount that results in no estate tax

• The minimum amount necessary to reduce federal estate tax to zero

• The applicable credit amount

How are such directions to be interpreted in the absence of an estate tax?

To add to the confusion, remember that some states have their own estate taxes, which
often are “decoupled” from federal rules.

Individuals, estates or trusts that acquire property from someone who dies in 2010
may be unable to determine their cost bases for capital gains tax purposes until
Congress acts. (Remember, however, that under the 2010 carryover basis rules, limited
amounts of step-up are still available.) Keep in mind that the fiduciary duty to preserve
Until Congress acts, it’s assets and diversify investments is still effective. Even if there is uncertainty about
impossible to know what the the tax consequences of any sales, executors and trustees may still have a fiduciary
responsibility to make adjustments to portfolios if they determine that nontax benefits
estate tax will look like if, indeed, outweigh the potential tax costs.
it’s reinstated for 2010.
It’s very important to rely on your CPA and attorney for guidance. In many cases,
executors and trustees may be stuck in a holding pattern until Congress acts. Waiting
for Congress to act may be frustrating for executors or trustees who would prefer to
settle estates promptly and for beneficiaries who are awaiting distributions. However,
it may be the right thing to do.

What might a reinstated 2010 estate tax look like?
Until Congress acts, it’s impossible to know what the estate tax will look like if, indeed,
it’s reinstated for 2010 or later years. Legislative chemistry is volatile right now, so it’s
difficult to make predictions about what Congress will do. However, here are some
possibilities:

• Congress could reinstate estate taxes at 2009 levels (or using a new set of rules
altogether), retroactive to Jan. 1, as though repeal had never happened.

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• Congress could reinstate estate taxes at 2009 levels (or using a new set of rules
altogether), retroactive to the date the bill is introduced. This scenario could mean
that during a particular time period, some estates would actually escape estate
taxes (but beneficiaries would be saddled with the carryover basis rules).

• Congress could enact a temporary “patch” for a year or two and put off decisions
about the estate tax’s long-term future. If there is a patch, it could be retroactive to
Jan. 1, or it could have a different effective date.

• Different provisions could have various effective dates. For example, the step-up in
basis rules could be made retroactive to Jan. 1, but the reinstatement of the estate
tax could have a different effective date.

• Congress could fail to agree on anything, let 2010 go by and just let the estate tax
return in 2011 with rules similar to those in effect prior to 2001.

Most of the (unsuccessful) legislative activity at the close of 2009 was based on the
idea of simply extending 2009 exclusions and rates – either indefinitely or temporarily.
But there were not sufficient votes lined up to make this happen. It appears that some
legislative “horse trading” may be necessary to get a bill passed. Since 2010 is an
election year, pre-election posturing could also impede any potential compromise
solution. If the process drags out, it will become more likely that the outcome will
include unexpected provisions.

Wells Fargo Advisors does not provide legal or tax advice. Be sure to consult with your own tax and legal
advisors before taking any action that could have tax consequences. Any estate plan should be reviewed by
an attorney who specializes in estate planning and is licensed to practice law in your state.

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