Estate Planning After the 2010 Tax Act...What do we do now?

On December 17, 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“2010 Act”). As explained in more detail below, the 2010 Act increased the estate and gift tax exemptions and made other favorable extensions of the existing tax laws. Unfortunately, the 2010 Act expires at the end of 2012 and we will then revert to 2001 tax laws, unless Congress passes new legislation. This Newsletter is intended to advise you of the changes in the law and encourage you to reevaluate your estate plan in light of these changes.

Gift, Estate, and GST Tax Laws for 2011 to 2013.  The 2010 Act increased the gift, estate and generation-skipping transfer (GST)[1] tax exemptions to $5 million and reduced the estate, gift and GST tax rates to 35%. At the end of this Newsletter is a chart illustrating these tax exemptions and rates. You can now make lifetime gifts up to a maximum of $5 million without incurring a gift tax. Any gifts made during lifetime in excess of the annual exclusion (the $13,000 gift tax annual exclusion remains unchanged) reduce the estate tax exemption available at death. If you make no taxable gifts during lifetime, then you will have the full $5 million estate tax exemption available at death. The GST exemption now allows you to shield $5 million of gifts to grandchildren from the GST tax.

Unless Congress acts sooner, on January 1, 2013, the 2010 Act will be automatically repealed, resulting in $1 million estate, gift and GST tax exemptions and 55% estate, gift, and GST tax rates.

Review Wills and Revocable Trusts.  Now may be the time to review your existing Will or revocable trust. It is extremely difficult to predict what will happen to the tax laws in 2013; any number of changes may occur. Congress may do nothing. If so, there will be $1 million estate, gift, and GST tax exemptions and tax rates of 55%. On the other hand the $5 million exemptions could be increased or the estate tax could be repealed altogether.

An Unprecedented Opportunity to Make Gifts.  The gift tax exemption is significantly larger than it has ever been, and larger that it was ever expected to be. This may be the perfect time to make gifts. If you have a large enough estate that you expect to be paying estate tax when you die, then it is more tax efficient to use gift tax exemption while you are alive as opposed to estate tax exemption when you die. The benefit of a lifetime gift is that all of the future income and appreciation on the gifted assets passes estate tax free to the donee. For example, if you gave $5,000,000 to a trust for your children in 2011 and lived another 20 years, then you would exclude $11 million more from estate taxes than if you had waited until your death to use the $5 million exemption (assuming 6% annual growth). With a 35% estate tax rate, this $11 million excluded from your estate results in a tax savings of $3,850,000.

President Obama’s Budget Proposal.  Another reason to act quickly is that the President’s budget proposal calls for a reduction in the gift tax exemption from $5 million to $1 million. The budget proposal also reduces the estate tax exemption to $3.5 million, increases the gift and estate tax rates to 45%, requires a minimum 10 year term for a grantor retained annuity trust (GRAT), restricts discount planning, and limits the use of the GST exemption to 90 years. If enacted as currently written, the President’s proposal would be effective when signed into law.

It is possible that if you do not use your $5 million gift tax exemption soon, you may lose it forever. If you have been considering making a significant gift, or implementing a GRAT or installment sale to a grantor trust, then now is the time to act.

2010 Decedents.  Pursuant to the 2010 Act, the executors of estates of individuals who died during 2010 have a choice to make. They can do nothing and be subject to the 2011 estate tax laws with a $5 million estate tax exemption, 35% estate tax rate, and the traditional “step-up in basis”[2] rules. Or they can make an election out of the estate tax laws and be subject to the “carry-over basis” tax regime. Carry-over basis will usually be beneficial for estates substantially over the $5 million exemption. With carry-over basis, the beneficiaries of your estate receive a basis in your assets equal to the basis you had before death – in other words your basis “carries over” to the beneficiaries. However, the carry-over basis rules permit a step-up in basis of up to $1.3 million in assets, plus an additional $3.0 million for transfers at death to your spouse outright or in a qualifying “QTIP” trust (that pays all of the income to the surviving spouse and has no other beneficiaries during the spouse’s lifetime).

Estates of 2010 decedents with less than $5 million do not need to file a federal estate tax return or a carry-over basis election. The entire estate will automatically be GST exempt, unless the decedent used a substantial portion of GST exemption prior to death.

 

Missouri Estate Tax Laws.  Missouri’s estate tax is equal to the federal credit for state estate taxes paid (referred to as “pick-up tax”). As there is currently no federal credit for state estate taxes (there is only a deduction), there is currently no Missouri estate tax.

Illinois Estate Tax Laws.  For Illinois residents dying on January 1, 2011 or after, Illinois has reinstated their estate tax with a $2 million exemption. If you use a traditional credit shelter trust to take advantage of the full $5 million federal estate tax exemption in 2011, then, assuming the trust is fully funded, there will be an Illinois estate tax on $3 million (the value of the credit shelter trust that exceeds the Illinois $2 million exemption). The Illinois estate tax on a $5 million estate is $352,158. However, Illinois law allows your executor to make an election to defer the Illinois estate tax on any portion of your estate passing to a QTIP credit shelter trust. The value of the QTIP trust will be subject to Illinois estate tax at the surviving spouse’s death.

To take advantage of this Illinois election, consider implementing a QTIP credit shelter trust. Many credit shelter trusts would not qualify for the election, such as those that permit income or principal to be paid to the spouse and descendants.

Portability.  For spouses dying on or after January 1, 2011 and before January 1, 2013, the executor of a deceased spouse’s estate may transfer any unused estate tax exemption to the surviving spouse. Some clients have heard that this estate tax “portability” means they can now leave their entire estate to the surviving spouse, outright, and forego the use of a credit shelter trust. This portability feature of the new tax law should not be relied on in most cases. First, it is set to expire at the end of next year. Second, utilizing a credit shelter trust will allow you to shield more of your assets from estate taxes (as the future income and appreciation on the assets of the credit shelter trust will escape estate taxes).

Income Taxes in 2011.  The 2010 Act extended the 2010 income tax brackets – 10%, 15%, 25%, 28%, 33%, and 35% - for another two years. In addition, we retain the 15% top rate for long-term capital gains and the 0% rate for those in the 10% and 15% brackets. The tax rate for qualified dividends remains at 15% (0% for those in the 10% and 15% brackets, subject to the “kiddie tax”).

 

 

Estate Planning After the 2010 Tax Act 


 Year

 Estate Tax Exempt

 GST Exempt Amount

Estate, Gift and GST Tax Top Bracket

Gift Tax Exempt Amount

Annual Exclusion

 2001

$675,000

$1,060,000

55%

 $675,000

$10,000

2002

$1,000,000

 $1,100,000

50%

 $1,000,000

$11,000

 2003

 $1,000,000

$1,120,000

 49%

$1,000,000

$11,000

 2004

 $1,500,000

$1,500,000

 48%

$1,000,000

$11,000

 2005

 $1,500,000

$1,500,000

 47%

$1,000,000

$11,000

 2006

 $2,000,000

$2,000,000

 46%

$1,000,000

$12,000

 2007

 $2,000,000

$2,000,000

 45%

$1,000,000

$12,000

 2008

 $2,000,000

$2,000,000

 45%

$1,000,000

$12,000

 2009

 $3,500,000

$3,500,000

 45%

$1,000,000

$13,000

 2010

 See 2010 Decedents, above

$5,000,000

 See 2010 Decedents, above

$1,000,000

$13,000

 2011

 $5,000,000

$5,000,000

 35%

$5,000,000

$13,000

 2012

 $5,000,0003

$5,000,0003

 35%

$5,000,0003

$13,0003

 2013

 unknown ($1,000,000 if no action by Congress)

unknown ($1,000,0003 if no action by Congress)

 unknown (55% if no action by Congress)

unknown ($1,000,000 if no action by Congress)

unknown ($13,0003 if no action by Congress)

 

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[1]  The GST is a tax on transfers to grandchildren or other individuals two or more generations younger than you.

[2]  Under the step-up in basis rules the beneficiaries of your estate receive an income tax basis on the property they inherit equal to the fair market value of the property at the time of your death. This eliminates any built-in gain on the property that would otherwise be subject to income tax upon the sale of the property.

[3]  This amount may be increased based on a cost of living adjustment.

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