Estate Tax Changes
January 12, 2011
Estate Tax Changes in 2011 and Beyond
The tax bill passed recently by Congress and signed into law by President Obama on 17 December 2010 addresses important tax issues for 2010 through 2013. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 has several important aspects that affect the estates of decedents who died in 2010. The new law also has important provisions that may affect current estate plans. Several key changes and the impact on estate planning are summarized below.
The Estate Tax is Reimposed: The new law establishes that the estate tax rate is 35% beginning 1 January 2011 and continuing to 31 December 2012. The applicable exemption from the estate tax is $5 million, and is indexed to adjust for inflation after 2011. On 1 January 2013, absent further action by Congress, the estate tax rate will reset to the pre-2001 level of 55%, with a $1 million applicable exclusion amount.
New Choices for 2010: Generally, the estates of decedents who died after 31 December 2009 and before 1 January 2011 are subject to the estate tax at the current rate of 35% with the $5 million exclusion and stepped-up basis for estate assets. For smaller estates of under $5 million, this rule is beneficial because it allows stepped-up basis of the assets in the estate. Property with a stepped up basis generally receives a basis equal to the property’s fair market value on the date of the decedent’s death.
For larger estates over $5 million, however, the Personal Representative may elect not to apply the current estate rules. If this election is made, estate taxes are zero, but the estate assets receive a carry-over basis instead of a stepped-up basis. Under the carry-over rules, property generally receives a basis equal to the lesser of the decedent’s basis in the property or the property’s fair market value at the time of decedent’s death. Additionally, under the carryover basis rules that apply for 2010, Personal Representatives can increase the basis of estate property by $1.3 million.
Personal Representatives should consider several factors before making such an election, such as the amount of estate taxes otherwise payable compared to the capital gains taxes on the anticipated sale of estate assets.
Portability to Surviving Spouse: For 2011 and 2012, the Personal Representative may make an election so that if one spouse did not fully utilize his $5 million applicable exclusion amount, the unused portion can be transferred to the surviving spouse. This means the executor can increase the possible estate tax exemption for the surviving spouse by the amount the first spouse did not use.
This provision was enacted to avoid the need for credit shelter trusts in estate planning documents. Unfortunately, because it expires on 31 December 2012, in order to benefit from this portability feature, both spouses must die before 2013. For this reason, and because credit shelter trusts provide additional benefits beyond just the use of each spouse’s applicable exclusion amounts, most clients should continue to use estate plans that incorporate credit shelter trusts.
Credit shelter trusts ensure that assets contained in the trust pass to children of the couple and not to any new spouse of the surviving spouse. Appreciation on assets contained within the credit shelter trust, which may be more than the applicable exclusion amount, are not subject to the estate tax upon the surviving spouse’s death. Assets in credit shelter trusts are also protected from creditors of the surviving spouse, including any marital claims of future spouses.
Extension of Current Gift Tax Rates: The new law extends the 35% maximum rate for gift taxes from now through 2012, after which the rate resets to 55%, absent further action by Congress.
Increased Lifetime Applicable Exclusion from Gift Taxes: Starting on 1 January 2011, the lifetime exclusion from gift taxes is increased to $5 million per person from $1 million ($10 million per married couple). This means that individuals may transfer up to $5 million ($10 million for a married couple) free of gift tax. This increased exclusion amount is set to expire and reset at $1 million in
2013, absent further action by Congress.
This increased applicable exclusion provides an unprecedented opportunity to move substantial amounts of wealth out of individuals’ estates. For example, the increased gift tax applicable exclusion amount increases the amount of assets that individuals can transfer via an installment sale to a dynasty/grantor trust. Under this estate planning technique, individuals can now make an initial gift of as much as $5 million ($10 million per married couple) to a dynasty trust, in exchange for an installment note. This technique works especially well for family businesses that are expected to grow significantly in value over time.
Because this provision will expire in 2012 absent further action by Congress, it would be prudent to implement estate planning techniques utilizing lifetime gifts before the 31 December 2012 sunset date.
Donors continue to be able to use the annual gift tax exclusion before having to use any part of their applicable exclusion amount. For 2010 and 2011, the annual exclusion amount is $13,000 per recipient. Married couples may continue to “split” their gift and may make combined gifts of $26,000 to each recipient.
Extension of Time to File Estate Tax Returns, Pay Estate Taxes, and Disclaim Property: The new law provides that for decedents dying after 31 December 2009 and before the date of the enactment, the due dates for filing returns, paying taxes and making disclaimers of property are extended.
The due date for filing an estate tax return and for payment of the estate tax is no earlier than nine months following the date of enactment. Because the law was enacted on 17 December 2010, the earliest date estate tax returns and payments are due will be 19 September 2011 for decedents who died in 2010 before 17 December 2010.
Similarly, the time for making a disclaimer of property is extended in the case of decedents dying after 31 December 2009 before the enactment of the law on 17 December 2010. The time for making a disclaimer of property is extended to nine months following the date of enactment, so 19 September 2011.
Income Tax Provisions
Alternative Minimum Tax: the Alternative Minimum Tax (AMT) exemption will continue to be adjusted for inflation through 2011. This provision is, however, set to expire in 2012.
Required Minimum Distributions from IRAs: Individuals over age 70 ½ who still need to make a required minimum distribution (RMD) from an IRA for tax year 2010 may choose to donate up to $100,000 of the RMD to a qualified charity. Donors pay no income taxes on the amount of their RMD (up to $100,000) donated to a qualified charity. Donors have until 1 February 2011 to direct their 2010 RMD to a qualified charity. However, individuals who have already taken their RMD without directing it to a charity may not “undo” or redirect those distributions to charity. Taxpayers will also be allowed to direct their 2011 RMDs to qualified charities because the new law extends this provision through tax year 2011.
Reduced Income Tax Rates Extended: The new law extends the “Bush tax cuts” of 2001 for two additional years. The top marginal income tax rate will stay at its current level of 35% for 2011 and 2012 but is set to increase to 39.6% in 2013.
Payroll Taxes: the new act provides for a one year reduction in an employee’s social security taxes, to 4.2% from 6.2%. This reduction is effective for 2011 only, and applies to all income up to $106,800 (the cap for Social Security taxes). Self-employed individuals also receive a 2% reduction in their Social Security tax rates, from 12.4% to 10.4%.
Capital Gains and Qualified Dividend Income: The 15% rate on long-term capital gains and qualified dividend income is extended through 2102. Absent further action by Congress, these rates are set to increase to 20% for long-term capital gains and 39.6% for qualified dividend income on 1 January 2013.
The provisions of the new law are temporary and will expire by January 2013, although some (like the Alternative Minimum Tax relief and payroll tax reduction) will expire even earlier. In 2013, absent Congressional action, top marginal income tax rates, estate and gift tax rates, and long-term capital gains rates will reset at their pre-2001 levels. Additionally, the estate tax and gift tax exemptions will decrease to $1 million each.
In light of the changes in the new law, current estate plans may need to be reviewed to be sure that formula calculations in wills and trusts are compatible with the new rates and exemption amounts. Clients may desire to reassess their estate plans to ensure their intentions are met.
As always, we recommend that clients review their estate plans periodically and whenever a significant life event occurs (e.g., birth of a child, death of a spouse, purchase of a new home). Please do not hesitate to contact us with any questions you might have or if you would like to discuss your estate plan in light of the new changes.
IRS Circular 230 Disclosure: Any discussion of U.S. tax matters contained herein is not intended, and cannot be used, for the purpose of avoiding U.S. tax-related penalties, or in connection with the promotion, marketing, or recommendation by anyone unaffiliated with Becker & House, PLLC of any of the matters addressed herein.
The views and strategies discussed herein may not be suitable for everyone. This information is provided for educational purposes and distributed with the understanding that we are not rendering legal, accounting or tax advice. You should consult with an independent advisor concerning such matters.