New Federal Estate And Gift Tax Legislation
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Act”) modified the federal estate, gift, and generation-skipping transfer tax laws.
ESTATE TAX
Prior to the enactment of the 2010 Act, there was no federal estate tax in place for individuals dying in 2010. Additionally, beneficiaries of individuals dying in 2010 generally took the basis of the decedent in the property inherited, except that an executor could allocate up to $1,300,000 to estate assets passing to non-spouse beneficiaries, as well as an additional $3,000,000 to assets passing to a spouse, to increase the basis inherited by the beneficiaries.
The 2010 Act reimposes the federal estate tax with a maximum tax rate of 35%, a $5,000,000 exemption, and a step-up in the basis of assets inherited by the beneficiaries to the fair market value of the assets on the decedent’s date of death. In addition, executors of estates of persons dying in 2010 have the option to have the law previously in effect for 2010 apply (i.e., no estate tax but limited basis adjustments). The executor of an estate of an individual who died in 2010 will need to analyze the estate plan of the decedent, as well as the tax consequences that will inure to the beneficiaries, before deciding which option to choose.
The federal estate tax and basis rules applicable in 2010 also apply in 2011 and 2012 (except for the ability of the executor to elect to have no estate tax apply). In other words, there is a federal estate tax in place, but there is a $5,000,000 exemption, a top tax rate of 35%, and the basis inherited in the assets is generally their fair market value at the decedent’s date of death. The federal estate tax remains in place after 2012 but the exemption is decreased to $1,000,000, and the top tax rate increases to 55%.
GIFT TAX
The 2010 Act did not change the gift tax previously applicable for gifts made in 2010. An individual could still make annual exclusion gifts of $13,000 per donee, have a lifetime gift tax exemption of $1,000,000, and the top gift tax rate remained at 35% for any taxable gifts (i.e., gifts that did not qualify for the annual gift tax exclusion).
Under the 2010 Act, the lifetime gift tax exemption is now “unified” with the estate tax exemption. Effectively, this increases the lifetime gift tax exemption for an individual from $1,000,000 to $5,000,000. However, the annual exclusion of $13,000 per donee is still available before any gifts “eat into” an individual’s lifetime gift tax exemption. The new $5,000,000 lifetime exemption afforded by the 2010 Act is required to be reduced to the extent that the $1,000,000 lifetime gift tax exemption (previously in effect) was utilized. By way of example, if prior to 2011, an individual had made lifetime gifts of $1,000,000, he could gift up to $4,000,000 in 2011 without paying gift tax.
GENERATION-SKIPPING TRANSFER TAX
The generation-skipping transfer tax is a separate tax that applies, on top of the estate or gift tax, to assets transferred to grandchildren or more remote generations (or to trusts for their benefit). The 2010 Act provides for an increase in the generation-skipping transfer tax exemption from $1,000,000 to $5,000,000 for transfers in 2011 and 2012. By increasing this exemption, a married couple could possibly gift up to $10,000,000 to grandchildren in 2011 or 2012 without paying gift tax or generation-skipping transfer tax. Additionally, individuals can take advantage of this increase in the generation-skipping transfer tax exemption by being more generous to their grandchildren in their estate planning.
PORTABILITY
Prior to the 2010 Act, to the extent that an individual did not have sufficient assets to fully utilize his estate tax exemption, the unused portion of his exemption was lost. Under the 2010 Act, a surviving spouse may utilize the unused portion of his deceased spouse’s exemption, provided that the deceased spouse dies in 2011 or 2012. For example, if a husband dies in 2011 and does not fully use his estate tax exemption, the unused exemption can be attributed to his surviving spouse, so that when she dies her estate can take advantage of both her estate tax exemption and her late husband’s unused exemption. This concept is referred to as “portability”.
Portability must be affirmatively elected by the deceased spouse’s executor on the deceased spouse’s federal estate tax return. In order for a surviving spouse to be able to utilize the unused portion of her deceased spouse’s estate tax exemption, the executor of the deceased spouse will be required to file a federal estate tax return even if it is not otherwise required. Portability only applies to the unused estate tax exemption of the “last” deceased spouse of the surviving spouse. In other words, if a widow remarries and survives the death of a second spouse, she only gets to use the unused estate tax exemption of the second spouse. Additionally, portability does not apply to a deceased spouse’s unused generation-skipping transfer tax exemption.
CONCLUSION
While the 2010 Act has greatly increased the federal estate, gift, and generation-skipping transfer tax exemptions, it is important to realize that the increases in these exemptions are only temporary. What rules may apply after 2012 are unknown. In that regard, gifting during the next two years may be advantageous. It is still important to have a well-designed estate plan in place and the use of trusts is still beneficial for many reasons, regardless of whether the value of one’s estate is less than the amount of the estate tax exemption.