The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Act), signed into law on December 17, 2010, has changed the law relating to estate and gift taxes. Over the past ten years, due to an earlier change in the tax law, the estate tax exemption was substantially increased and the tax rate was reduced, culminating in the year 2010, in which there was no federal estate tax. That same law would have reinstituted the estate tax in 2011, reduced the estate tax exemption to $1 million and increased the maximum tax rate to 55%. The 2010 Act provides at least temporary relief from those measures. The most recent changes in the law, some of which are summarized below, could affect your estate plan.
Estate Tax Exemption. For 2011 and 2012, every individual has a $5 million estate tax exemption. This means that every individual can pass up to $5 million dollars to his or her beneficiaries free of estate taxes. This also means that, with proper planning, a married couple can pass up to $10 million dollars to their beneficiaries without incurring any estate tax.
Estate Tax Rate. If an estate exceeds the available exemption, a maximum 35% estate tax rate will apply. Although this is a significant decrease in the rate from previous years, tax at this rate could still amount to a significant sum.
Gift Tax. The gift tax exemption and rate are once again unified with the estate tax exemption and rate. For lifetime gifts made after 2010, each individual has a combined $5 million gift and estate tax exemption. Lifetime gifts exceeding this exemption amount are taxed at a maximum 35% rate. Any gifts made during life will be counted against the estate tax exemption available at the time of death.
Basis Rules. Stepped-up basis rules are back! Once again, the basis of an asset passing to a decedent’s beneficiary is stepped up to its fair market value as of the date of death, thus avoiding capital gains tax.
Portability. The 2010 Act introduced a new estate planning concept. For a married couple, any estate tax exemption not used by the first spouse to die may be used by the surviving spouse, in addition to his or her own $5 million dollar exemption for gift and estate taxes. For spouses dying in 2011 and 2012, certain elections must be made to take advantage of this provision. Although this provision could make credit shelter trusts unnecessary in some cases, credit shelter trusts continue to be useful to protect against creditors and avoid estate tax on appreciation that occurs between the death of the first spouse and the surviving spouse. Also, the exemption amount transferred from the first spouse could be lost if the surviving spouse remarries and survives his or her new spouse.
Retroactivity to 2010. The 2010 Act allows estates of decedents who died in 2010 to choose whether to retroactively apply the 2010 Act ($5 million exemption, stepped-up basis) or to follow the rules in place in the year 2010 (no estate tax, modified carry-over basis). Before making this decision, the estate must carefully consider the tax advantages and disadvantages of each option. There also are time limits that apply.
Conclusion. Although the estate and gift tax relief in the new law is substantial, it is also temporary. Much less favorable tax treatment is scheduled to return after 2012. Incorporating flexibility into estate plans continues to be a high priority.
In accordance with the provisions of the United States Treasury Department Circular 230, the information contained in this article is not intended nor written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed by the Internal Revenue Service.