As you may have heard, the 2010 Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Estate and Gift Tax Law”) was signed into law on December 17, 2010, by President Obama. The new law has far-reaching ramifications for our clients and opens an unprecedented window of opportunity over the next two years for families to consider significant transfers of wealth without incurring any estate or gift taxes. However, for some clients there may be negative implications embedded in the interplay between the new law and state inheritance tax law. Accordingly, we urge you to revisit your estate plans during the next two years, ending December 31, 2012 to determine a course of action appropriate for your situation.
The following is a summary of some of the key Estate and Gift tax provisions under the new law which should be in place through 2012:
1. Increase in Estate Tax and Generation Skipping Tax Exemption Amounts and Decrease in Maximum Tax Rate. Under the terms of the new law, the estate tax exemption for decedents dying between January 1, 2011 and December 31, 2012 will be increased to $5,000,000, and the maximum federal estate tax rate will be reduced to 35%. The generation skipping tax (“GST”) exemption amount during this period is also increased to $5,000,000, with a maximum federal tax rate of 35%. Existing wills with formula based credit shelter trust provisions may have to be changed. If not changed, the surviving spouse could wind up with much less outright and more going into the trust than the family desires. The increased estate tax exemption under the new law does not apply to non-resident aliens. Such individuals should refer to the prior law.
2. Gift Tax Exemption is reunited with the Estate Tax Exemption and Increases to $5,000,000. Under the terms of the new law, an individual may apply his or her entire estate tax exemption amount to lifetime gifts. In 2009, a donor could apply only $1,000,000 of the donor's lifetime $3,500,000 estate tax exemption amount to gifts made during the donor's lifetime. However, under the new law, a donor may apply his or her entire $5,000,000 estate tax exemption amount to lifetime gifts with a maximum gift tax rate of 35% on gifts in excess of the exemption. This is a significant beneficial change in the law. The annual gift tax exclusion for 2011 remains at $13,000 per person per calendar year, or $26,000 for married couples, as gift splitting is still permitted. Additionally, there remains an unlimited exclusion for transfers made for medical or educational purposes, if the transfer is made directly to the medical service provider or educational institution.
3. Portability of the Estate Tax Exemption between Married Couples. The new law permits an executor to elect to transfer a deceased individual's unused estate tax exemption amount to the individual's spouse who, thereafter, may combine this unused amount with his or her own estate tax exemption amount but this portability provision is scheduled to expire at the end of 2012. . This will effectively allow married couples to pass up to $10,000,000 on to their heirs free from estate taxes even if the first to die spouse fails to utilize a full $5 million exemption. The exemption from the GST, however, is not portable.
4. Implications for New York New York must remember there has been no change in the New York New York New York New Jersey ’s exemption from state inheritance tax is only $675,000 and Connecticut
5. Election possibilities for 2010 Estates.. Under the prior law enacted in 2001, there was no federal estate tax due on the estate of an individual dying in 2010, regardless of the size of the estate. While this rule was incredibly generous for federal estate tax purposes, it carried with it some negative income tax consequences, as it provided for a limited ability to increase or “step-up” the basis in inherited property to date of death values for income tax purposes. Accordingly, heirs would incur capital gains tax upon the sale of inherited property having to use the cost basis of the decedent, which quite often would be difficult to determine. More importantly, on January 1, 2011, the tax law in effect prior to 2001 would have brought about a revival of the federal estate tax, with an estate, gift and GST exemption amount of $1,000,000 per individual and estate tax rates of up to 55%. Only the GST exemption amount would have been adjusted for inflation since 2001. By contrast, the 2010 Estate and Gift Tax Law gives estates of decedents who died in 2010, the ability to opt-out of the revived estate tax. It gives those estates the option to elect to (1) apply the estate tax based on the new 35% top tax rate and $5 million exemption, with a full step-up in tax basis or (2) opt-out of the revived estate tax resulting in no federal estate tax due, but a limited ability to step-up the estate beneficiary’s tax basis in inherited property to date of death values for income tax purposes. The basis adjustment is limited to $1,300,000 plus an additional $3 million passing to a surviving spouse. Once made, any election would be revocable only with the consent of the IRS.
6. Some planning possibilities. Among the planning opportunities for individuals with assets in excess of $5 million or couples with assets in excess of $10 million, is the use of leverage in structuring transfers to take advantage of the new exemption amount for Gift, Estate and Generation Skipping Transfer Taxes. Planning might include outright gifts to trusts, or more sophisticated planning like GRATs, sales to intentionally defective Grantor Trusts, CLATs and Freeze Partnerships. Although, proposed legislation in the past threatened to limit the use of entity discounts and short-term GRATs, the new laws do not adversely affect either. These tools are ideal for transferring assets that are expected to appreciate in value over time, e.g., interests in family businesses, real estate investments and works of art. Since the Act expires at the end of 2012, it seems quite logical and even imperative that clients begin to consider planning how to take advantage of what appears to be an abbreviated two-year window of opportunity.
7. Tax free IRA/charitable rollovers. A portion of the law with perhaps the most immediate impact on charitable giving, is the extension of the ability for those over 70½ to make tax-favored gifts to charity directly from a traditional or Roth IRA. This presents some interesting charitable planning opportunities with IRAs. The expired 2009 law is extended for 2010 (retroactively to January 1, 2010) and 2011. An individual age 70½ or older can make direct charitable gifts from an IRA, including his or her required minimum distributions of up to $100,000 per year to public charities, and not have to report the IRA distributions as taxable income on his or her federal income tax return. A taxpayer needs to check carefully for any ineligible donees such as donor advised funds! The tax-free rollover is for direct gifts only. No charitable deduction is allowed for the IRA distributions, but not paying tax on otherwise taxable income is the equivalent of a charitable deduction. It is important to remember that this provision only applies to gifts from Individual Retirement Accounts and NOT from 401(k) plans or other tax-favored retirement planning vehicles.
Since the Act expires at the end of 2012, it seems quite logical and even imperative that clients begin to consider planning how to take advantage of what appears to be an abbreviated two-year window of opportunity.
2009 (OLD law) | 2010 (Retroactive under NEW Act) | 2011 (Under NEW Act) | 2012 (Under NEW Act) | |
Estate Tax Exemption | $3.5 million | Election between: $5 million or no estate tax | $5 million and portability | $5 million, indexed for inflation since 2010 and portability |
Maximum Estate Tax Rate | 45% | 35% | 35% | 35% |
Basis Adjustment at Death | Unlimited | Election between Unlimited or $1.3 million general and $3 million spousal | Unlimited | Unlimited |
GST Tax Exemption | $3.5 million | $5 million | $5 million; No portability | $5 million, indexed for inflation since 2010; No portability |
Maximum GST Tax Rate | 45% | 0% | 35% | 35% |
Maximum Gift Tax Rate | 45% | 35% | 35% | 35% |
Lifetime Gift Tax Exemption | $1 million | $1 million | $5 million (with portability) | $5 million, indexed (with portability) |
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