The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the "Tax Act" or the "Act") was signed into law on December 17, 2010. We are pleased to provide you with a summary of the estate, gift and generation skipping transfer (GST) tax changes under the Tax Act.
Background on Prior Law
Under prior law, the estate and GST taxes were phased out, over a period of years from 2002 through 2009, and fully repealed in 2010. The gift tax exemption amount remained at $1 million per person with a top gift tax rate of 35% for 2010. For 2011 and thereafter, the "sunset" of prior law resulted in the estate, gift and GST tax exemption amounts reverting to $1 million per person and top tax rates of 55%. The new Tax Act now provides for a generous $5 million exemption amount and a reduced top tax rate of 35% for the estate, gift and GST tax as detailed below.
Summary of Estate, Gift and GST Tax Rules under the Tax Act
The Tax Act includes the following provisions:
- 2010 Provisions: An estate tax exemption amount of $5 million applies to decedents dying in 2010. The Executor may elect out of the estate tax regime and the carry over basis rules will apply. The gift tax exemption amount for 2010 remains at $1 million and a top rate of 35%. The GST exemption amount is $5 million, and the GST tax rate is reduced to 0% for 2010.
- Exemption Amounts for 2011 and 2012: The estate, gift, and GST exemption amounts are increased to $5 million for 2011 and 2012. This amount will be indexed for inflation in 2012.
- Tax Rates for 2011 and 2012: The top rate for the estate, gift, and GST tax is reduced to 35% for 2011 and 2012.
- Portability: The Executor of a decedent dying in 2011 or 2012 may elect to transfer any unused portion of the decedent's estate or gift tax exemption to the decedent's surviving spouse.
- Two Year Extension: The provisions of the Tax Act are effective for two years only. In 2013, the exemptions revert back to $1 million and a maximum rate of 55%.
The exemption amounts and tax rates for 2010 through 2013 are summarized below:
| 2010 | 2011 | 2012 | 2013 | |
| Estate Tax Exemption/ Top Estate Tax Rate | $5,000,000/ 35% (unless an election is made to forgo application of estate tax regime) | $5,000,000/ 35% | $5,000,000*/ 35% | $1,000,000/55% |
| Gift Tax Exemption/ Flat Gift Tax Rate | $1,000,000/ 35% | $5,000,000/ 35% | $5,000,000*/ 35% | $1,000,000/ 55% |
| GST Exemption/ Flat GST Tax Rate | $5,000,000/ 0% | $5,000,000/ 35% | $5,000,000*/ 35% | $1,000,000*/ 55% |
*Indexed for inflation.
Planning Recommendation: Many estate planning documents use a formula to set aside an amount equal to the estate tax exemption amount to pass to a bypass trust upon the death of the first spouse, with the balance of the assets passing to the surviving spouse (either outright or in a marital trust). The dramatic increase in the estate tax exemption amount may now cause the bypass trust to be funded to a larger extent than anticipated by the decedent. This may unintentionally result in fewer assets (or no assets) passing solely to the surviving spouse. We recommend a review of your estate plan to ensure that your estate plan continues to reflect your wishes considering the impact of the Tax Act. We can provide you with an illustration detailing how your assets will pass to your beneficiaries based on your current estate plan, your financial situation and the increased exemption amount.
Planning Opportunity: An individual who had previously used his or her entire $1 million lifetime gift tax exemption may now gift an additional $4 million gift tax free. This increased exemption amount is applicable only for 2011 and 2012. In 2013, the revised transfer tax provisions will "sunset" and (absent further legislation) will return to a $1 million exemption amount with a top tax rate of 55%. This two year window provides us with an unprecedented opportunity to make tax-free gifts and lock-in the benefits of the current law. A lifetime gift can be particularly advantageous since it removes the asset, as well as all future appreciation on the asset, from the donor's estate. We recommend a review of your estate plan to determine whether it makes sense to take advantage of this limited opportunity.
For Decedents Dying in 2010: The estate tax provisions of the Tax Act are retroactively applicable to decedents dying in 2010. The 2010 estate tax will be calculated using a $5 million exemption amount (less any exemption used during the decedent's life) and at a top estate tax rate of 35%. In addition, the estate assets (other than retirement plan assets and other income in respect of a decedent) will be entitled to a step-up in basis equal to their fair market value at the time of death.
However, if more advantageous, the Executor may elect out of the new estate tax regime. If the election is made, there is no estate tax and the carry-over basis rules apply. Under the carry-over basis rules, the basis the decedent had in the asset carries over to the recipient with a limited step-up of $3 million for assets passing to a surviving spouse and $1.3 million for assets passing to non-spousal beneficiaries (plus the amount of the decedent's capital loss and passive activity loss carry forwards).
Planning for this election is fairly straightforward. For estates of $5 million or less (including the value of any prior taxable gifts), the estate is better off with the application of the estate tax provisions since the estate will be entitled to a full step-up in the basis of the assets without actually paying any federal estate tax. For estates over $5 million, the Executor should carefully consider electing out of the application of the estate tax. The Executor should run a calculation of the total federal estate taxes that would be payable compared to the potential capital gains tax that may be due upon the later sale of the estate assets.
Portability of Unused Exemption Amount
Under prior law, a married couple would be advised to review ownership of their assets (and, if necessary, re-title assets) so that each spouse owned assets in his or her own name equal to the estate tax exemption amount. For 2011 and 2012, a decedent's unused portion of his or her estate tax exemption amount may be added to the surviving spouse's exemption amount. For example, if the wife predeceased her husband but had no assets in her individual name, her Executor may elect to transfer her $5 million exemption amount to her surviving spouse, so that the surviving spouse would have a $10 million exemption amount available to him (for use during his lifetime or at his death).
This ability to transfer the unused estate and gift tax exemption amount was intended to eliminate or reduce the need for retitling assets between spouses and to reduce the need for tax planning at the first death. However, there is no provision under the Massachusetts estate tax laws for the portability of the exemption amount. Further, federal law provides for portability only in 2011 and 2012. In general, we recommend that our clients continue to structure their estate plan and their assets regardless of the ability to transfer one's exemption amount to his or her spouse.
Other Highlights of the Tax Act
There are a number of other important provisions in the Tax Act. Some of the highlights include:
- For 2011 and 2012, the long term capital gain tax rate and qualified dividend tax rate will remain at 15%.
- The income tax rates for individuals will remain at the highest income tax rate of 35%.
- The Child Tax Credit, Earned Income Tax Credit and American Opportunity Tax Credit are all extended for 2011 and 2012.
- The Alternate Minimum Tax (AMT) has been raised for 2010 to $47,450 for individuals and $72,450 for married couples filing jointly. This exemption increases in 2011 to $48,450 for individuals, and $74,450 for married couples filing jointly.
- Employees and the self-employed will have their portion of FICA (Social Security) reduced by two percent for 2011.
- The repeal of the limitation on itemized deductions will be extended for two more years. The personal exemption phase-out does not apply for an additional two years.
- The IRA Charitable Rollover provisions were extended for 2010 and 2011. This allows individuals 70½ and older to make direct transfers of their Individual Retirement Accounts (IRAs) to qualified charities up to $100,000 per year.
- There are no provisions under the Tax Act which set a minimum term for Grantor Retained Annuity Trusts (GRATs), so short-term GRATs continue to be a viable option.
If you have any questions regarding the new Tax Act, would like more information regarding the provisions of the Tax Act, or would like to discuss your estate planning needs in light of the revised tax provisions, we are ready to assist you. Please feel free to contact any one of our estate planning attorneys at Seegel Lipshutz & Wilchins LLP.
