Washington Sources indicate that Congress finally may be getting serious about acting to amend the federal estate tax.  A House and Senate negotiating committee has been working to achieve a compromise among various bills proposed in the House and Senate, all aimed at preventing the scheduled repeal of the estate tax next year and replacing it with permanent reform.  The recent compromise would freeze an individual’s exemption at $3.5 million and the top tax rate at 45% (the current 2009 levels).  Based on the alternatives, this may be good news indeed.

Recent proposals would have set the tax rates on decedent’s estates considerably higher.  H.R. 2023 was offered by Democrat Jim McDermott.   That bill would have lowered the applicable exclusion amount available to an individual (the amount that would pass free of estate tax at the death of an individual if not utilized during lifetime for gifting) (the “exclusion”) from $3.5 million to $2 million.  It would have made the exclusion portable between spouses.  (Portability means that a surviving spouse would have the use of any remaining exclusion not utilized during life or at death by the first spouse to die — not currently permitted).  However, that would have limited a married couple to $4 million in total combined exclusion, down from the current $7 million. 

Worse, Representative McDermott’s proposal would have eliminated the current deduction for state death taxes.  An estate currently can take a deduction from the federal estate tax for estate taxes paid to any state.  Most states that have an estate tax still use similar systems based on the old credit from the estate tax for death taxes paid to a state.  This would have meant a substantial estate tax increase — combining the federal estate tax rate with an assumed rate equal to the old state death tax credit, taxable estates of $4,040,000 would have paid a combined tax rate of over 56%, with taxable estates exceeding $10,040,000 owing combined federal and state taxes at a rate of 71%! 

Other bills would have set the limits at far more sane levels.  A recent budget passed by the Senate would have increased the exclusion to $5 million per person and lowered the top estate tax rate to 35%.

Other related issues to watch with concern include what Congress will do with the current step-up in the income tax basis for assets passing from a decedent, the use of discounts in valuing lifetime gifts of closely-held stock and other property, and the lifetime gift tax exemption of $1million, to name a few.  Watching Congress attempt to reach final passage of a permanent amendment to the estate and gift tax portion of the Internal Revenue Code may well resemble a good NBA or NHL playoff game — unpredictable at best.  We will do our best to keep you informed.

A recent U.S. Supreme Court decision illustrates the importance of making sure that clients properly designate the beneficiaries of their retirement plans. In Kennedy v. Plan Administrator for DuPont Savings and Investment Plan 129 S. Ct. 865 (2009) a unanimous Supreme Court determined that the plan administrator acted properly in paying benefits to the divorced spouse of the deceased plan participant.

In Kennedy, the decedent, William Kennedy was an employee of DuPont and participant in its savings and investment plan (the “Plan”). William later married Liv Kennedy and named her the beneficiary of the Plan. William later divorced Liv, but did not change the beneficiary designation. The divorce decree did specify however, that Liv waived any rights to any retirement plan, pension plan or like benefit program. When William later died, DuPont paid the Plan benefits to Liv, in accordance with its obligations under ERISA. The estate of William sued DuPont alleging that Liv had waived her benefits in her divorce and that DuPont had violated ERISA by paying the Plan benefits to Liv. 

The Estate was successful in the District Court; however, the Fifth Circuit Court of Appeals reversed.  The Supreme Court affirmed the Appellate Court decision, noting that the Plan provided a simple way for William to change the beneficiary designation.  

This is a nice lesson in human nature and the importance of properly reviewing beneficiary designations after a divorce or other important life event.  Liv knew that equitably, she was not entitled the Plan benefits, because she had waived them in the divorce. Her argument prevailed however, because of the specific requirements that ERISA imposes on plan administrators to pay plan benefits to the designated beneficiaries.  Kennedy is a sad reminder to always review beneficiary designations after a divorce or other important event.