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Estate and Gift Tax Provisions under the 2010 Tax Act

    Client Alerts
  • December 22, 2010

As we advised in our November Estate Planning Update, the Federal estate tax was repealed for 2010. The “flip side” of this coin was the limited basis adjustment for assets inherited in 2010; under the tax provisions in effect prior to January 1, 2010, the basis of inherited assets was equal to the fair market value of such assets (the so-called “step up”). With the repeal of the estate tax, the step-up was limited to $1.3 million, plus an additional $3 million for qualifying transfers to a surviving spouse. However, the estate tax and exemption were scheduled to be reinstated (at a maximum rate of 55% and with a $1,000,000 exemption) effective as of January 1, 2011, along with the basis step up provisions. Additionally, for the current year, the Federal generation skipping transfer tax (“GST tax”), which tax is applicable to transfers made to persons more than one generation below the transferor, had been repealed, but also was to be reinstated effective as of January 1, 2011.

While the estate and GST taxes had been repealed for 2010, the gift tax had not. However, the top gift tax rate in 2010 is 35% and the gift tax exemption is $1 million per person. As with the scheduled reinstatement of the estate and GST taxes, in 2011 the gift tax rates were scheduled to be unified with the estate tax rates (with the top rate scheduled to be 55%).

Although Washington has had almost nine years to address the sunset provision contained in the Economic Growth and Tax Relief Reconciliation Act in 2001 (the “2001 Act”), which sunset resulted in the reinstatement of the estate and GST taxes on January 1, 2011, it was not until December 17, 2010 (a mere two weeks before the effective date of the sunset) that we have new legislation, the 2010 Tax Act, addressing the estate, gift and GST taxes.

The estate, gift and GST tax provisions of the 2010 Tax Act are complex and lengthy and affect transfers by gift and at death occurring during 2010, as well as for 2011 and 2012. Following is a summary of the key provisions:

  • For estates of decedents who died in 2010, the 2010 Tax Act retroactively reinstates the estate and GST taxes as of January 1, 2010 at the rates and exemption amounts as provided under the 2010 Tax Act (as described below), but allows the personal representative of the estate to “elect out” of such application so that the provisions that were in effect under the 2001 Act (the repeal of the estate and GST taxes and the limited step up in basis provisions) would apply. This may be an attractive opportunity for estates that will not be subject to estate and/or GST taxes under the 2010 Tax Act, but for which a full step up in basis cannot be achieved under the repeal. A detailed analysis and calculation should be performed in this regard. The time period for making this election is yet undetermined, but likely will be within nine months of the date of enactment of the 2010 Tax Act (i.e., September 17, 2011).
  • Estate and GST tax exemptions increased and maximum rates reduced effective January 1, 2011. For decedent’s dying after December 31, 2009 (except with regard to decedent’s dying prior to December 31, 2010 where a qualifying election is made, as discussed above), the estate tax exemption amount is $5 million and the maximum rate is 35% .
  • Gift tax provisions for 2010 remain the same, but significant changes become effective as of January 1, 2011 making taxable gifts in excess of the current $1 million exemption in the current year (2010) tax inefficient. For taxable gifts made after December 31, 2010, the gift tax exemption amount is unified with the estate tax exemption at $5 million. For taxpayers who have previously made taxable gifts and used a portion (or all) of their then available gift tax exemption, they should be aware that their available exemption as of January 1, 2011 will be reduced accordingly. For example, a taxpayer who previously fully utilized their $1 million gift tax exemption amount will be able to make additional taxable gifts beginning in 2011 of $4 million ($5 million exemption effective as of January 1, 2011 less $1 million used in prior years) without the imposition of gift tax. For taxable gifts exceeding the $5 million exemption, the maximum rate is 35%.
  • Estate and gift tax exemption remains unified in so far as use of the exemption during life will reduce the amount available at death. Thus, the $5 million exemption may be used to make transfers during life and at death of an aggregate $5 million.
  • The 2010 Tax Act reinstates the GST tax provisions retroactively to January 1, 2010 but sets the GST tax rate at zero (0%) percent and the GST tax exemption at $5 million in 2010. There is still time to take advantage of the lack of a GST tax liability on transfers to skip-persons (i.e., grandchildren or trusts for their benefit), although transfers in excess of the $1,000,000 gift tax exemption would be subject to gift tax (at the current 35%). This still represents an excellent opportunity to fund a trust for the benefit of grandchildren without incurring a GST tax currently or on future distributions from the trust. Taxpayers may fund a trust for the benefit of grandchildren without incurring any GST tax and without using any of the taxpayer’s GST exemption if done prior to December 31, 2010.
  • The 2010 Tax Act provides that the estate tax exemption amount is portable as between spouses meaning that any unused exemption may be used by the surviving spouse at his or her death. The portability of the exemption between spouses should make it easier for spouses to effectively use both of their exemptions to shelter a combined $10 million of assets from estate and gift taxes. This provision is effective only for decedents dying after December 31, 2010.
  • Impact of increased exemption and portability is that the structure of many estate plans may result in the over-funding of the credit shelter trust and significantly reducing, if not eliminating, the amount a surviving spouse is entitled to receive while unnecessarily retaining assets in trust.
  • The estate, gift and GST tax provisions of the 2010 Act expire at the end of 2010. Yes, that means in two years we likely will again be waiting for new legislation to be passed to address the estate, gift and GST taxes – and 2012 is a Presidential election year.

We hope that this information is helpful to you and we encourage you to contact us if you have any questions or would like to discuss your personal estate planning matters in light of these important changes to the estate, gift and GST tax provisions.