Abstract: There’s been much speculation as to what Congress would do about the 2010 estate tax repeal and the scheduled 2011 return of the tax at higher rates and a lower exemption. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 have finally given us our answer. Signed into law Dec. 17, the act provides some good news for those concerned about estate tax liability. This article examines the estate, generation-skipping-transfer and gift tax law changes under the act.
How will the Tax Relief act affect your estate plan?
There’s been much speculation as to what Congress would do about the 2010 estate tax repeal and the scheduled 2011 return of the tax at higher rates and a lower exemption. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 have finally given us our answer.
Signed into law Dec. 17, the act provides some good news for those concerned about estate tax liability. Rather than simply extending the 2009 rates and exemptions, as many expected Congress would do, the act reduces rates and increases exemptions. It also provides some flexibility for the families of people who died in 2010.
But the outlook isn’t completely rosy. The act provides only temporary relief, so we again face the prospect of much higher rates and lower exemptions in the near future.
The 2010 Tax Relief act retroactively brings back the estate tax for 2010, but with a $1.5 million exemption increase (to $5 million) and a 10 percentage point rate reduction (to 35%) compared to 2009. It extends these levels to 2011 and 2012, with an inflation adjustment on the exemption for the latter year. Then in 2013, the exemption and top rate will return to levels prescribed by pre-2001 tax law — the levels that would have gone into effect in 2011 without the 2010 Tax Relief act.
While what for 2010 is essentially a repeal of the estate tax repeal may sound unattractive, it actually may prove beneficial to many families with loved ones who died this year. Why? Because the estate tax repeal was accompanied by a limit on the step-up in basis, which could have caused many heirs to face significant income tax liability on the sale of the inherited assets.
Still, for some families the step-up in basis is less of an issue than the estate tax. So the Tax Relief act provides an option to elect the pre-act estate tax regime for 2010. (This is discussed further under “Election for 2010,” below.)
The generation-skipping transfer (GST) tax was also repealed for 2010, and the Tax Relief act brings it back for 2010 as well, with the same exemption amounts as the estate tax through 2012. However, the act sets the GST tax rate for 2010 at 0%.
This is probably because, unlike the estate tax where the elimination of the step-up in basis limitation could be provided to essentially offset liability from the return of the estate tax, there was no such offset that could make up for tax liability due to the return of the GST tax in 2010. Such a retroactive tax would likely have brought lawsuits.
That’s not an issue after 2010, so the GST tax rate goes back up to 35% to match the top estate tax rate in 2011 and 2012.
The gift tax was never repealed for 2010, so the 2010 Tax Relief act provides no change to the gift tax regime for 2010. The exemption remains at $1 million and the top rate at 35%.
But, like the GST tax, the gift tax will follow the estate tax exemptions and top rates for 2011 and 2012.
Election for 2010
For anyone who dies in 2010, as mentioned above, the estate may either follow the new rules under the 2010 Tax Relief act or elect to follow the pre-act regime.
First some background on step-up in basis:
- Generally, the income tax basis of most inherited property is “stepped up” to its date-of-death fair market value. This means that recipients of the property can sell it immediately without triggering capital gains tax. Even if they hold on to it, they typically will pay less capital gains tax whenever they do sell it than they would have if the basis hadn’t been stepped up.
- Under the estate tax repeal, the automatic step-up in basis is eliminated. Instead, estates can generally allocate only up to $1.3 million to increase the basis of certain assets plus up to $3 million to increase the assets inherited by a surviving spouse.
So, if the estate of someone who died in 2010 doesn’t exceed the new $5 million exemption (less any gift tax exemption used during life), then following the new rules will likely be more beneficial: No estate tax will be due anyway, and the deceased’s heirs don’t have to worry about any limits on the step-up in basis.
If the estate exceeds the deceased’s available estate tax exemption, the decision becomes more complicated. Factors such as the extent of the possible estate tax liability, the extent to which assets have appreciated beyond the deceased’s basis and the extent to which the assets are going to a surviving spouse vs. other heirs will need to be considered.
Fortunately, the Tax Relief act does give families some time to make this decision. It extends the estate tax filing deadline for estates of those dying after Dec. 31, 2009, but before Dec. 17, 2010, generally to nine months after Dec. 17, 2010.
More flexibility for married couples
The 2010 Tax Relief act includes a provision that will (temporarily) provide significant estate planning flexibility to married couples. 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 estate can elect to permit the surviving spouse to use the deceased spouse’s remaining estate tax exemption.
Similar results can be achieved by making asset transfers between spouses during life and/or setting up certain trusts at death. But making this election will be much simpler and provide flexibility if proper planning hasn’t been done before the first spouse’s death.
Still, this election is currently available for only two years unless Congress extends it. So married couples can’t depend on the election being available to ensure that they take full advantage of both spouses’ exemptions.
Also be aware that the provision doesn’t allow the deceased spouse’s remaining GST tax exemption to be used by the surviving spouse.
Charitable giving is an important part of many people’s estate plans, and the 2010 Tax Relief act extends a couple of valuable charitable giving breaks through 2011:
- Tax-free IRA distributions for charitable purposes. You can make a direct contribution from your IRA to a qualified charitable organization without owing any income tax on the distribution. If you’re subject to required minimum distributions, the contribution can be used to satisfy that requirement. The maximum allowable distribution for charitable contribution purposes is $100,000 per tax year.
- Contributions of capital gains real property for conservation purposes. You can make such a contribution and take a larger deduction than is allowed for most other capital gains property contributions. Specifically, your deduction for a contribution of capital gains real property for conservation purposes generally can be up to 50% of your adjusted gross income (AGI) rather than the 30% of AGI limit that normally applies to contributions of capital gains property.
Other estate, GST and gift tax changes
The 2001 tax act that established the reductions in the estate, GST and gift taxes over the last several years, as well as the 2010 estate tax repeal, “sunsets” after 2010. This is why the significant estate, GST and gift tax increases were set to go into effect in 2011.
While the 2010 Tax Relief act defers those increases until 2013, there are several sun-setting provisions related to these taxes that it doesn’t address. Fortunately, the old provisions that will be going back into effect generally are beneficial, such as the return of the estate tax credit for state estate taxes paid.
Time to review your estate plan
With the many changes going into effect and the uncertainty about what will happen with the estate, GST and gift taxes in 2013, it’s critical to revisit your estate plan. If you don’t, the changes could result in your assets not being distributed according to your wishes or your family paying unnecessary taxes.
The law is complex and there are many contingencies to consider. We’d be pleased to work with you and your attorney to review your estate plan and update it as needed in light of the 2010 Tax Relief act.
|Transfer tax exemptions and rates for 2009–2013|
|Gift tax exemption||$1 million||$1 million||$5 million||$5 million2||$1 million|
|Estate tax exemption1||$3.5 million||$5 million3||$5 million||$5 million2||$1 million|
|Generation-skipping transfer (GST)|
|$3.5 million||$5 million||$5 million||$5 million2||$1 million2|
|Highest gift and estate tax rates and GST tax rate||45%||35%3|
0% for GST tax
1 Less any gift tax exemption already used during life. For 2011 and 2012, these amounts are “portable” between spouses.
2 Indexed for inflation.
3 Estates can elect to follow the pre-2010 Tax Relief act regime (estate tax repeal + limited step-up in basis).
4 The benefits of the graduated gift and estate tax rates and exemptions are phased out for gifts/estates over $10 million.