We finally have tax legislation that answers the question of what will happen to the estate tax. The "Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010" ("2010 Tax Relief Act" or "Act") was signed into law on December 17 by President Obama. (For a detialed decription see They Call it a Tax Cut Part 1 and Part 2.) Now what?
Unfortunately, the Act provides only a temporary solution. The extension of the "Bush tax cuts" is for two years only, ending on December 31, 2012. That means in two years we will be going through this mess all over again.
Under the Act, retroactive for 2010 and for the next two years, there is $5 exemption for the estate tax. In 2011 and 2012 the exemption from the gift tax and the generation-skipping tax will also be $5 million. For amounts over the exemption, the top rate is 35%. As was the case at the end of 2010, if new legislation does not pass; the exemption in 2013 will go down to $1 million again.
2010 was the year with no estate tax. George Steinbrenner and other billionaires who died in 2010 got a complete free pass from the federal estate tax. However, in exchange for no estate tax, assets in these estates lost their automatic step-up to date of death value for income tax basis. Just to make life more interesting, the 2010 Tax Relief Act reinstates the estate tax retroactively to January 1, 2010, but gives the executors of these 2010 decedents an election to "opt out.". The executors can choose whether to have the 2010 law apply, that is, no estate tax and modified carry-over basis, or, apply the new 2011 law with the $5 million exemption and complete basis step-up to the 2010 estate. Get out your calculators, but there is no hurry. For decedents dying in 2010 before the date of enactment, the estate tax return is not due until September 17, 2011.
What does the new Act mean to you for your own estate plan? Let's break down planning into three scenarios:
Your estate is less than $1 million. If you have an estate plan that creates trusts to reduce estate taxes, you should have your plan redone. You don't need those complicated plans with trusts anymore. You don't want to leave your surviving spouse with a trust that is expensive and cumbersome to administer and that provides no tax advantage. Consider making a disclaimer plan that will allow the surviving spouse a choice of funding a trust if the exemption in 2013 falls below the level of your asset values. Taxpayers at all levels still need planning for insurance ownership, guardianships, digital assets, powers of attorney, medical directives, and other matters.
Your estate is between $1 million and $5 million. You need to pay attention to estate tax planning and using tax-saving trusts. In particular, if your plan includes a formula for allocating property to a trust based on the federal estate tax, the formula needs to be reviewed. Remember that the new exemption and rates only apply for two years. While it is unlikely that the 2012 Congress would allow the estate tax exemption to revert back to $1 million with a maximum 55% rate, they will certainly be looking for ways to increase revenue. During these two years consider making larger gifts to take advantage of the larger exemptions. Also consider planning techniques using insurance funded with large gifts.
Your estate is more than $5 million. Persons with substantial assets should use the large exemptions and lock in the benefits in the next year or so. We know the political process is unpredictable. Use the $5 million exemptions while they are available.
Make sure your plan and the way your assets are titled allow you to use both spouse's exemptions. The Act includes a provision that will (temporarily) allow the exemption to be "portable." If one spouse dies in 2011 or 2012 and part (or all) of his or her estate tax exemption is unused at his or her death, the executor can elect to permit the surviving spouse to use the deceased spouse's remaining estate tax exemption. This will produce a result similar to dividing the title of assets and creating trusts for each spouse to use the exemption. The election is available only for 2011 and 2012.
Portability applies to the unused exemption of one's last deceased spouse so remarriage
complicates planning as well. The deceased spouse's generation-skipping exemption isn't portable so trusts will still be necessary if it is intended to use both spouses' exemption from the generation skipping transfer tax. Thus, planning at this level is actually more complicated than before.
Traditional estate planning techniques are still alive and well. The new law did nothing to restrict valuation discount planning, such as family limited partnerships (FLPs), qualified personal residence trusts (QPRTs), charitable remainder and charitable lead trusts (CRATs and CRUTs), and grantor retained annuity trusts (GRATs). While the exemption is high for the next two years, taxpayers in this category should make aggressive use of the available exemptions with these and other planning techniques.