On December 17, 2010, Congress enacted and on December 18, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“2010 Tax Relief Act”), legislation that extends the 2001 tax cuts for two years, temporarily increases estate, gift and generation skipping tax exemption amounts, and temporarily reduces the estate tax rate. The 2010 Tax Relief Act comes just thirteen days prior to the scheduled expiration of the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), which, but for the 2010 Tax Relief Act, would have resulted in increased taxes for most Americans.
Exemptions and Rates in 2011 and 2012
The much anticipated and long overdue legislation provides for a $5,000,000 unified estate and gift tax exemption in 2011 and 2012, and a 35% tax rate for estates and gifts exceeding the $5,000,000 exemption. The generation skipping transfer (“GST”) tax exemption amount is also set at $5,000,000 and a 35% rate for the next two years. The reunification of the gift and estate tax exemptions provides planning opportunities for clients who may have used all of their $1,000,000 gift tax exemption who desire to make additional large lifetime gifts, but who didn’t want to pay gift tax.
For deaths occurring in 2011 and 2012, stepped up income tax basis of assets received from a decedent is reinstituted. Stepped up basis allows for a cost basis adjustment of a decedent’s assets to date of death fair market value. Alternatively, under the modified carryover basis system that was in effect for deaths in 2010, a decedent’s cost basis in an asset carries over to the beneficiary, potentially resulting in significant capital gains upon subsequent sale of the asset.
Portability of Unused Exemption on First Death
The 2010 Tax Relief Act also provides for portability of a deceased spouse’s unused estate tax exclusion amount. Under prior law, the estate tax exemption of the first to die was a “use or lose it” proposition. For deaths occurring in 2011 and 2012, a surviving spouse may add their deceased spouse’s unused exemption amount to the surviving spouse’s estate tax exemption without the use of the traditional credit shelter trust.
However, portability alone should not be relied upon for utilization of the first to die’s estate tax exemption because the portability may be lost if the surviving spouse remarries and is later widowed again. In addition, the creation of a credit shelter trust at the first spouse’s death protects appreciating assets from estate tax at the second spouse’s death; it will also provide protection of those assets from the reach of the surviving spouse’s creditors. Finally, portability does not apply to the GST tax, so in order to fully leverage the GST exemptions of both spouses for GST trust planning, it will still be necessary to create a trust at the first spouse’s death.
Exemptions, Rates and Deaths in 2010
For all deaths occurring in 2010, the estate tax exemption is $5,000,000 and the top estate tax rate is 35%. But, estates may elect to be subject to the regime in effect for most of 2010, which was the modified carryover basis system and no estate tax. For deaths occurring after December 31, 2009 and before December 17, 2010, if estates do not elect the no estate tax regime, estate tax returns will be due on September 17, 2011, and heirs have nine months from December 17, 2010 to disclaim an interest in property passing to them from a decedent who died during that period. For deaths occurring in 2010, the GST exemption is $5,000,000 and the tax rate is zero percent. Finally, the lifetime gift tax exemption in 2010 remained at $1,000,000 and the top gift tax rate remained at 35%.
Other Planning Techniques Still Allowed
The 2010 Tax Relief Act does not contain restrictions on the Grantor Retained Annuity Trust (“GRAT”), a highly effective wealth transfer planning technique that takes advantage of the current historically low interest rates to make gifts of appreciating assets. It also did not remove the ability to utilize valuation discounts for transfers of closely held family businesses.
The 2010 Tax Relief Act also includes several already highly publicized changes:
- Extension of current income tax rates (with a top rate of 35% on ordinary income and 15% capital gains)
- AMT patch for 2011 and 2012
- Reinstatement of many business tax breaks that expired at the end of 2009
- Reinstatement of ability to make tax free distributions from an IRA to a charity of up to $100,000 per year, per taxpayer for taxpayers age 70 ½ or older (for 2010 and 2011)
Although the higher exemption amounts and lower tax rates may appear to simplify wealth planning, the complexities of the new law require careful review of each estate plan to ensure it is appropriate in light of the new rules and individual circumstances. The changes are also temporary and will once again change if no action is taken by Congress prior to December 31, 2012.