Be warned. If you serve high-net-worth individuals, they might want to consider hiding in a safe house during 2010. Their enterprising heirs have the potential to increase their inheritance by 45% or more due to the current "one-year-only" repeal of the estate tax.

On the other hand, it might just be easier to remind them that Congress could always reinstate the estate tax retroactively.

The federal transfer tax system consists of an estate tax and a gift tax. The estate tax applies to assets passing at death. The gift tax applies to assets transferred during life. The two systems have an overlapping exemption and similar tax rates.

The traditional estate tax has an exemption amount that has varied from $1 million (in 2001) to $3.5 million (in 2009). The exemption returns to $1 million next year. Likewise the estate tax rate has varied from 55% (in 2001) to 45% (in 2009). The maximum estate tax rate returns to 55% in 2011.

Meanwhile, the gift tax exemption amount has remained at $1 million since 2001. The gift tax rate, though, has varied from 55% (in 2001) to 35% (in 2010), and back to 55% (in 2011).

Another special rule applies to assets transferred to grandchildren; the so-called generation-skipping transfers. This special tax had carried rates ranging from 55% (in 2001) to 45% (in 2009). It returns to 55% in 2011. The purpose of this tax was to prevent multi-generational transfer of assets free from the estate tax. These multi-generational trusts are also known as dynasty trusts.

Estate Tax Holiday

Under the current law, this year there is no estate tax and no generation-skipping tax (but remember there is still a gift tax). This is the estate tax "loophole" that has been the subject of derision since it was passed in 2001. Wealthy families can save millions and millions of dollars in estate tax and generation-skipping tax if the parental generation dies in 2010.

Professional advisors have been dreading the approach of 2010 for years. At one time, it seemed a long way away. A single year of no estate tax was sure to be changed before 2010 arrived.

In 2008 and 2009 it looked as if Congress would extend the 2009 rates through 2010 and make the holiday rule inapplicable. Unfortunately, Congress was distracted by other major legislation and never got around to fixing the one-year holiday.

So now it is 2010. And we have no estate tax and no generation-skipping tax that applies (unless Congress changes it retroactively, which might be unconstitutional).

If Congress does nothing, the IRS will have to design and release a 2010 estate information return (as opposed to an estate tax return).

Carryover Basis

The usual rule is that the cost basis of assets is stepped-up to fair market value at death. This is much like a capital gain forgiveness card.

Heirs and professional advisors do not need to worry about the original cost or purchase data for assets because everything is refreshed on the date of death. The estate tax return, Form 706, is designed to capture asset values and calculate a transfer tax. It doesn't apply in 2010.

For this year only, all assets have a basis that carries over at death. Heirs and advisors must now unearth original cost and purchase data for every single asset.

There is also a step-up provision that can be used for up to $3 million in assets passing to a surviving spouse and a separate $1.3 million for assets passing to other heirs. Under the step-up, heirs only have to pay capital gains on the increase in the value of the asset from when they inherited it to when they sell it (not the increase in value from when the asset was purchased). The executor chooses on the estate return which assets get the step-up. The estate tax return will now become simply a listing of all assets with original purchase prices and how much "step-up" will be applied.

As with the existing estate tax, certain assets are not eligible for step-up. These include assets that would generate ordinary income and include IRAs, annuities, 401(k) plan accounts, certain stock options and other employee benefit plans. Will Congress Act?

The cynics have already calculated the last possible moment for reasonable retroactive enactment of the traditional estate tax. That date is Oct. 1, 2010. That's the first possible date that one of the "new" estate information returns would be due to be filed.

Retroactive reinstatement before that date would prevent the need to file amended returns for those dying early in 2010. Retroactive reinstatement could take place even into 2011, but it could require amending or refiling returns for those dying in 2010.