|Highlights of the new Estate Tax Legislation
On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Tax Act”). In a nutshell, it did five things: extended current unemployment benefits to 99 weeks, extended current income tax rates (the Bush tax cuts) for all taxpayers for two more years, made significant changes to the estate tax applicable to those dying in 2010, 2011, or 2012, modified the gift tax for 2011 and 2012, and modified the Generation Skipping Transfer Tax for 2010, 2011, and 2012.
Estate Tax Exemption and Tax Rate
Planning Tip: To determine your current taxable estate, add the value of all your assets, including your home, business interests, bank accounts, investments, IRAs, retirement plans and death benefits from your life insurance policies, and then subtract all of the debts you owe.
It’s important to remember two things: These changes are only effective for the next two years. If Congress does not act again before the end of 2012, on January 1, 2013, the estate tax exemption will drop to $1 million (adjusted for inflation) with a top tax rate of 55%. Also, some states have their own death tax, so your estate could be exempt from federal estate tax but still have to pay a state death tax.
Optional Retroactive Planning for Estates of Those Who Died in 2010
The “basis” of an asset is the value used to determine gain or loss for income tax purposes when the property is sold. If you give someone an asset while you are alive, it keeps your basis (what you paid for it) so the recipient gets what is called a “carryover” basis.
For 2010, under the pre-2010 Tax Act law, limits were placed on the amount of asset basis that could be stepped up in a decedent’s estate: only $1.3 million in asset value increases were allowed, plus an additional $3 million of basis increases for assets passing to a surviving spouse. In effect, the law substituted paying capital gains taxes for paying estate taxes. Under the 2010 Tax Act, there is a choice for those who died in 2010.
Planning Tip: Executors have until September 17, 2011, to decide if the option is better for the estate, file an estate tax return, pay taxes and make any disclaimers. Electing the “no estate tax/modified basis option” would generally be good for those with large estates that would not be covered by the $5 million exemption. However, each case must be evaluated individually, considering, for example, the amount of estate tax that would be payable now versus income tax that would be due on the gain when the assets are sold at some point in the future; the expected sale date of the assets; and what the capital gains and ordinary income tax rates might be in the future.
Portability of Estate Tax Exemptions between Spouses
For those couples in which both spouses die between January 1, 2011, and December 31, 2012, the Congress tried to fix this problem with something called “portability.” Under the 2010 Tax Act, if one spouse dies in 2011 or 2012, the Executor of the deceased spouse’s estate may transfer any unused federal estate tax exemption to the surviving spouse by so electing on a timely filed estate tax return. But, the transferred exemption must be used before December 31, 2012, or it is lost. Also, only the most recent deceased spouse’s unused exemption may be used by the surviving spouse, which could impact the surviving spouse’s decision to remarry.
For example, let’s say that after Jack dies, Jill marries Bill. If Bill dies before Jill does, Jack’s unused exemption would no longer be available to Jill. And Bill may have little or no unused exemption to transfer to Jill.
Even with temporary portability, relying on the unlimited marital deduction can cause other problems. For example, by leaving everything to Jill, Jack has no control over how his share of their estate is managed or distributed. Jill can do whatever she wants with the assets, including disinheriting any children Jack may have from a previous marriage. Also, any growth on the assets will be included in Jill’s estate when she dies and will be taxed at the rate in effect at that time. (Remember, the estate tax exemption will be just $1 million with a 55% maximum tax rate in 2013 unless the Congress acts.)
If Jack and Jill plan ahead, they can make sure they use both of their exemptions. Their wills or living trusts could include a provision that splits their $10 million estate into two trusts of $5 million each. When Jack dies, his trust uses his $5 million exemption and when Jill dies, her trust uses her $5 million exemption. This reduces their taxable estate to $0, letting them leave the full amount to their beneficiaries. (This tax-planning provision is often called an A-B trust or credit shelter trust.)
There are other benefits to this planning. For example, Jack can keep control over how his share of their estate is managed. He can choose his own beneficiaries, which may or may not be the same as Jill’s. The assets in his trust are valued and taxed only when he dies, so any growth on these assets will not be included in Jill’s estate when she dies. And even though the assets remain in Jack’s trust, they still can be available to provide for anything Jill needs.
Planning Tip: The portability provision may work fine for some couples. But you may still prefer the benefits of the A-B (credit shelter) trust, especially if you have a “blended” family. Also, if you use a living trust and properly fund it (transfer your assets to it), you will avoid probate which, depending on where you live, could save your family thousands more.
Gifting in 2011 and 2012
You can still make annual tax-free gifts of $13,000 ($26,000 if married) to as many individuals as you wish each year. (This amount is tied to inflation and is adjusted from time to time.) If you give more than this, the excess is considered a taxable gift and goes against your lifetime gift/estate tax exemption. ($5 million through 2012, $1 million thereafter.)
Generation Skipping Transfers in 2011 and 2012
Skipping a generation can cause the inheritance to be subject to the “generation skipping transfer” (GST) tax. The onerous GST tax is equal to the highest federal estate tax rate in effect at the time of the transfer and is in addition to the federal estate tax. This tax exists because Uncle Sam wants the estate tax to apply when assets are transferred at every generation. So, if you skip a generation, you don’t skip the taxes that would have been paid.
For 2010, the GST tax exemption was $1 million with a 0% tax rate, because there was no estate tax. In 2011 and 2012, the GST tax exemption is $5 million ($10 million if you are married and you plan ahead) with a 35% tax rate.
Planning Tip: Remember, there is a possibility that Congress will not act before the end of 2012, and the GST tax exemption will decrease in 2013 to $1 million with a 55% tax rate. With this in mind, if you have a large estate, you may want to use a good portion (or all) of your $5 million GST tax exemption ($10 million, if married) in 2011 and 2012.
Planning Opportunities in 2011 and 2012
Leveraging Transfers through Discounts
Other Items of Interest
* Tax on long-term capital gains and qualified dividends remains at 15% for two more years. If no action had been taken, capital gains would have been taxed at 20% and dividends would have been subject to the individual ordinary tax rates.
Planning Tip: The danger of the Congress not extending those tax rates beyond 2012 is significant. Remember that the justification for not allowing income tax rates to increase at the end of 2010 was the state of the economy. If the economy is improved as the end of 2012 approaches, those reasons will not exist.
* The AMT (alternative minimum tax) exemption for a married couple was increased from $45,000 to $72,450.
The 2010 Tax Act provides tremendous planning opportunities to transfer vast amounts of wealth for families with estates of all sizes, but it is a limited time opportunity that expires on December 31, 2012. At the same time, individuals with estates of less than $5 million and married couples with estates of less than $10 million can focus on planning that concentrates on family goals and objectives without, at least for the next two years, having to jump through hoops to avoid federal estate taxes. Of course, state death taxes and income taxes must still be considered.
We are ready to help you define your personal and financial goals and desires, and take advantage of these unique planning opportunities. Contact our office for a consultation.
Test Your Knowledge
1. Everyone has to pay estate taxes when they die. True or False
2. The estate tax exemption was set permanently at $5 million with a 35% tax rate.True or False
3. Basis is the value used to determine estate taxes. True or False
4. If an estate does not have to pay federal estate taxes, it will not have to pay any state death tax. True or False
5. If Congress does not act by the end of 2012, the current estate tax exemption and rate will stay in effect. True or False
6. For those who died in 2010, their estates did not have to pay any federal estate tax or capital gains tax, and all of the assets received a stepped-up basis. True orFalse
7. The new provision for portability of the estate tax exemption between spouses occurs automatically; nothing needs to be done. True or False
8. The unlimited marital deduction lets you leave everything to your spouse and no estate taxes will ever be due. True or False
9. I can leave my grandchildren an unlimited amount of assets when I die completely tax-free because the IRS considers grandchildren to be special. True or False
10. The top income tax rate and long-term capital gains tax rate increased to 39.5% for 2011. True or False
Answers: All of the above are false.
|To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.
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