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Changes To The Estate, Gift And Generation Skipping Transfer Taxes For 2010 Through 2012

02.17.2011

Summary

As you may be aware, under the recently enacted “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,” the federal estate tax, which disappeared for 2010, is reinstated for 2011 with an exemption for-the first $5 million of an estate’s value, and a top rate of tax of 35% applicable to all amounts over $5 million.  This article provides a brief overview of the new law relating to estate, gift and generation skipping transfer taxes.

Background

In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the first of the two large legislative packages that contain most of what are now commonly referred to as the“Bush tax cuts.” EGTRRA gradually lowered the maximum estate tax rate and substantially raised the applicable exemption amount over the years 2002 through 2009. The maximum tax rate fell from 55% under prior law in 2001 to 45% in 2007-2009. EGTRRA repealed the estate tax completely for decedents dying in 2010. You may be related to a person who died in 2010,or you may be aware of several of the well-publicized instances in which famous people died in 2010 leaving multi billion-dollar estates that will pass to their heirs without paying any federal estate tax. However, all of those provisions were scheduled to sunset on December 31, 2010, meaning that if Congress had not acted, starting January 1, 2011, the estate tax would have sprung back at a level where the exemption amount would have been $1 million ($2 million for couples) in 2011. The tax rate would also have risen,from a top rate of 45% in 2009, to a top rate of 55% in 2011.

Estate Tax

The new law brings back the estate tax, at least for the period from 2010 through 2012, however, with a significantly lower tax rate and higher exemption amount. During this period, the top tax rate will be 35%. For 2010 and 2011, the exemption amount will be $5 million per individual, and the exemption amount for 2012 will be this amount indexed for inflation.

For decedents dying in 2010, the new law gives a choice of which estate-tax rules to apply – the rules that used to apply for 2010 or the new rules for 2010 - 2012. This is important because although there was no estate tax under the old 2010 rules, some inherited assets were subject to higher capital gains tax, a situation that actually raises the tax burden for some heirs. Inherited assets under the 2010 rules have a tax basis equal to the price when they were purchased (subject to certain adjustments) rather than the price at death. That could lead to a significant tax burden for heirs who sell assets such as stock or real estate that had been held for many years and have greatly appreciated in value.

Under the new rules, by contrast, heirs will be allowed to inherit assets with a “stepped-up basis.” While most heirs would choose the new rules, which allow a $5 million exemption from both estate and generation-skipping tax and an unlimited step-up in the basis of assets to their current market value,the heirs of more wealthy decedents could find it more advantageous to elect the old 2010 law (no estate tax, but a limited step-up in the basis of certain assets). A federal estate tax return will be due by September 19, 2011 for the taxable estates of decedents dying on or before December 17, 2010,unless the executor makes an election to have the old 2010 rules apply.

The new law also includes a new rule with respect to the portability of the estate tax exemption between spouses. This provision allows any of a deceased spouse’s unused estate tax exemption to be used by his or her surviving spouse, providing the appropriate elections are made. In theory, this would allow the deceased spouse to leave more of his or her property to the surviving spouse directly. However, this provision may not be useful for the many married couples who want their estate plan to reflect their expectation that the distribution of each spouse’s respective property is distributed in a manner of that spouse’s choosing, such as keeping their property within the family line. We would be happy to discuss this with you as your individual circumstances will dictate the particular costs and benefits of exemption portability.

Gift Tax

For gifts made after December 31, 2010, the gift tax will be reunified with the estate tax, meaning that the $5 million estate tax exemption will also be available for gifts. The law in effect immediately prior to 2010 provided a $3.5 million lifetime exemption for estates, but only $1 million for gifts. The gift tax rate will continue to be 35%. We continue to advise our clients to take advantage of the $13,000 annual exclusion gifts every year, which will remain at the same level through 2011.

Generation Skipping Transfer Tax

The exemption from the generation-skipping transfer (GST) tax – the additional tax on gifts and bequests to grandchildren when their parents are still alive – will also rise to $5 million from the $1 million amount it would have been in the absence of the new law. The GST tax rate for transfers made in 2011 and 2012 will be 35%.

Some individuals made substantial GST gifts during 2010 to take advantage of the temporary repeal of the GST tax. Although the new law technically reinstates the GST tax for 2010, it sets the GST tax rate to 0% for that year in order to not retroactively invalidate these transfers. Therefore, there will not be any tax due for any GST gifts made during 2010.

The new law presents families with a number of wealth transfer opportunities that were not previously available. There are also additional opportunities available to estates of decedents who died during 2010. As you are probably aware, the new law also contains a great number of changes in the income tax arena which are not discussed in this letter. If you would like to review these opportunities or learn more about the new law, please give us a call.


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