Estate Planning & Tax Update - December 2010December 23, 2010
On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Act) into law. The following summary describes key provisions of the Act that relate to the Federal Estate Tax, the Federal Gift Tax and the Federal Generation-Skipping Transfer Tax.
Federal Estate Tax
The Federal Estate Tax is imposed on property transferred at death to the extent that the value of such property (other than property transferred to a surviving spouse or to charity) exceeds the unused portion of the decedent's Federal Estate Tax exemption amount (referred to as "Basic Exclusion Amount" under the Act). Lifetime taxable gifts are applied to the Federal Estate Tax exemption amount. Generally, the assets in a decedent's Estate also receive an adjustment in basis equal to the fair market value of the assets on the date of the decedent's death ("fair market value basis rules," which are sometimes referred to as the "step-up in basis rules").
Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the Federal Estate Tax was repealed in 2010. The Act (i) reinstitutes the Federal Estate Tax for 2010 and sets the Federal Estate Tax exemption amount at $5 million in 2010, 2011 and 2012 (indexed for inflation in 2012); (ii) sets the maximum Federal Estate Tax rate at 35 percent in 2010, 2011 and 2012; and (iii) reinstitutes the fair market value basis rules for individuals who died in 2010, although an election may be made to use the carryover basis rules, described in greater detail below.
Unfortunately, permanent Federal Estate Tax rules were not agreed to by Congress. The Act only extends the expiration of the so-called "Bush Tax Cuts" from December 31, 2010 through December 31, 2012. Consequently, the Federal Estate Tax exemption amount is scheduled to decrease to $1 million and the maximum Federal Estate Tax rate is scheduled to increase to 55 percent on January 1, 2013. As always, we will continue to monitor the tax law, although we suspect that we may find ourselves with last-minute tax legislation again after the 2012 elections.
Portability of Spousal Federal Estate Tax Exemption
In 2010 and in 2013 and thereafter, any unused Federal Estate Tax exemption amount of a deceased spouse expires upon his or her death and, therefore, cannot be used by a surviving spouse. Accordingly, the creation of trusts under the estate plan is often appropriate for married couples to ensure that both of their Federal Estate Tax exemption amounts are fully utilized. Generally, upon the death of the first spouse, one or two trusts are created as a means of protecting the Federal Estate Tax exemption of the deceased spouse.
In 2011 and 2012, however, the Act allows the Personal Representative of a deceased spouse's Estate to elect to allow his or her surviving spouse to use any unused Federal Estate Tax exemption amount of the deceased spouse in addition to the surviving spouse's Federal Estate Tax exemption amount (estate planners have referred to this as Federal Estate Tax exemption portability). Portability is only allowed where the election is made on a timely filed Federal Estate Tax return.
The effect of this new election may mean there is a reason to file a Federal Estate Tax return for deceased spouses' Estates that would otherwise be under the filing threshold in 2011 and 2012. In addition, while it could be argued that reliance on portability may lead to different recommendations regarding estate tax planning, the short-term applicability of the Act suggests that over-reliance on portability may be misguided.
Basis Adjustment for Decedents' Estates
Under EGTRRA, the Federal Estate Tax and the fair market value basis rules were repealed in 2010. Enacted in their place were carryover basis rules that applied to individuals who died in 2010. Under the carryover basis rules, assets in a decedent's Estate do not receive an adjustment in basis to fair market value at death, but rather the beneficiaries of the estate receive the decedent's basis in his or her assets. The beneficiaries are, however, entitled to a $1.3 million basis increase and an additional $3 million basis increase for property passing to a surviving spouse or certain types of Marital Trusts which may be added to the basis of appreciated assets at death.
Partly in response to likely constitutional challenges to the retroactive imposition of a Federal Estate Tax to 2010 Estates, the Act allows the personal representative of the Estate of a decedent who died in 2010 to elect to apply the carryover basis rules under EGTRRA rather than apply the Federal Estate Tax as provided under the Act. If such an election is made, the decedent's Estate is not subject to Federal Estate Tax. If you are acting in a fiduciary capacity for a decedent who died in 2010, please contact a member of our Estate Planning Practice Group to discuss whether such an election is appropriate.
Federal Gift Tax
The Federal Gift Tax exemption amount is the total amount of gifts that an individual may make during his or her lifetime in addition to annual exclusion gifts (currently $13,000 annually per donee) without incurring a Federal Gift Tax. Prior to EGTRRA, the Federal Gift Tax exemption amount was the same as the Federal Estate Tax exemption amount and was referred to as the Unified Credit. EGTRRA modified this by freezing the Federal Gift Tax exemption amount at $1 million and increasing the Federal Estate Tax exemption amount over time to a high in 2009 of $3.5 million.
Under the Act, the Federal Gift Tax exemption and the Federal Estate Tax exemption amounts are unified again. Beginning January 1, 2011, both the Federal Gift Tax exemption and Federal Estate Tax exemption amounts will be $5 million. A surviving spouse's Federal Gift Tax exemption amount could be more than $5 million if portability applies (see discussion above). The Act does not change the Federal Gift Tax exemption amount for gifts occurring in 2010 - the Federal Gift Tax exemption amount remains at $1 million for gifts in 2010. The Act sets the maximum Federal Gift Tax rate at 35 percent in 2010, 2011 and 2012.
Because the Act extends the sunset that was to occur after December 31, 2010 to December 31, 2012, the Federal Gift Tax exemption amount is scheduled to decrease to $1 million and the Federal Gift Tax rate is scheduled to increase to 55 percent on January 1, 2013. Accordingly, if you are considering significant gifts to transfer wealth, you may want to contact a member of our Estate Planning Practice Group to evaluate a gifting program that takes advantage of the higher Federal Gift Tax exemption amount and the lower Federal Gift Tax rate.
Federal Generation-Skipping Transfer Tax
The Federal Generation-Skipping Transfer (GST) tax applies to transfers made to skip persons - grandchildren or more remote descendants or unrelated individuals who are more than 37.5 years younger than the donor.
Under EGTRRA, the Federal GST Tax was repealed in 2010. The Act, however, retroactively reinstates the Federal GST tax for transfers made to skip persons after December 31, 2009 and sets the Federal GST Tax exemption amount at $5 million in 2010, 2011 and 2012 (indexed for inflation in 2012). The Act sets the Federal GST Tax rate at 0 percent in 2010, but increases the Federal GST Tax rate to 35 percent in 2011 and 2012.
The 0 percent Federal GST Tax rate in 2010 allows for potentially significant opportunities to make transfers directly to skip persons or to make distributions to skip persons from trusts that are not otherwise exempt from the Federal GST Tax. Such transfers must occur by December 31, 2010. After that date, the higher Federal GST Tax exemption amount (from $3.5 million in 2009) and lower Federal GST Tax rate (from 45 percent in 2009) may provide significant opportunities as well - particularly for transfers in trust. Consequently, clients may find they are able to accomplish many of their goals without having to complete transactions by the end of the year.
Because the Act extends the sunset that was to occur after December 31, 2010 to December 31, 2012, the Federal GST Tax exemption is scheduled to decrease to $1 million (plus an adjustment for inflation) and the Federal GST Tax rate is scheduled to increase to 55 percent on January 1, 2013.
What This All Means to You
While we have attempted to provide a general description of the Act, we recognize that our clients and friends are most interested in knowing what the tax changes mean to them and their particular situations. Certainly, tailored advice will be most appropriate, but here are a few general thoughts to help you apply the above discussion to your circumstances:
- If your family has larger trusts, the beneficiaries of which include grandchildren or more remote descendants (measured from the donor's perspective), distributions from such trusts that are not exempt from the Federal GST tax to such beneficiaries should be evaluated before year end.
- If you wish to make gifts in excess of $13,000 ($26,000 if you are married and your spouse consents to split the gift) to your grandchildren or more remote descendants, you may wish to make these gifts before year end.
- If you are involved in a 2010 decedent's estate or trust, you should discuss with your Godfrey & Kahn attorney, prior to September, 2011, whether an election should be made to have the carryover basis rules apply to the decedent's assets or whether the new Federal Estate Tax law should apply.
- If your estate is over $5 million (or over $10 million for married couples who do joint planning), you should consider making GST-exempt transfers in 2010, 2011 or 2012 to "lock in" the benefits of higher exemptions and lower rates than you have had available to you in the past.
- If wealth transfer planning is important to you, some of the positive aspects of the current estate planning environment (i.e., low interest rates, continued viability of Grantor Retained Annuity Trusts and valuation discount planning) should be considered in the short term.
- Federal Gift Tax reporting for gifts made in 2010 should be evaluated - although no change in past practice may be required.
- In all other cases, during 2011 you may wish to contact a member of our Estate Planning team to verify that your estate plan is in accordance with your wishes.
|Federal Estate Tax Exemption||$3.5 million||$5 million* ||$5 million ||$5 million**||$1 million|
|Federal Gift Tax Exemption||$1 million||$1 million||$5 million||$5 million**||$1 million|
|Federal Gift and Estate Tax Rate||45%||35%||35%||35%||37% - 55%|
|Federal Generation-Skipping Transfer Tax Exemption||$3.5 million||$5 million||$5 million||$5 million**||$1 million**|
|Federal Generation-Skipping Transfer Tax Rate||45%||0%||35%||35%||55%|
*election available to make exemption unlimited at the cost of applying carryover basis rules
** plus indexing for inflation