Federal Estate & Gift Tax: Opportunities and Uncertainties

The Tax Relief, Unemployment Reauthorization and Job Creation Act of 2010 was signed by President Obama on December 17, 2010.  This new law has increased the exemption amounts for estate tax, gift tax and generation‑skipping transfer tax, but to our great disappointment these changes expire after 2012, thereby perpetuating the uncertainties that we have faced since 2001.  Following are highlights of the law: 

Increased exemptions; lower tax rates.  The estate tax exemption will be $5 Million per person (which means it would be $10 Million for a couple) for estate, gift and generation-skipping transfer (“GST”) tax purposes for 2011 and 2012.  The exemption amount is increased for inflation in increments of $10,000 beginning in 2012.  The law also imposes a top tax rate of 35%.

Estates of decedents who died in 2010.  The increased $5 Million estate and generation‑skipping transfer tax exemptions and the 35% estate tax rate are effective January 1, 2010, meaning the change is retroactive for decedents dying in 2010, but a decedent’s executor can elect that there will be no estate tax and modified carry-over basis.  The generation‑skipping transfer tax rate for 2010 is zero percent.  For most estates, the law also allows until September 17, 2011 to make qualified disclaimers, but this is a federal law change, and qualified disclaimers must also comply with applicable state law. The due date for any estate and generation‑skipping tax returns for the estates of decedents dying after December 31, 2009 and before December 17, 2010 is September 17, 2011.

Gift Tax.  The new $5 Million gift tax exemption takes effect on January 1, 2011, so in 2010 the gift tax exemption is still $1 Million, with a 35% rate.  The $5 Million generation-skipping transfer tax exemption does apply to 2010, and there is a zero percent tax rate for 2010, so it is possible to make generation‑skipping transfers to grandchildren or other “skip persons” during the remainder of 2010 at no GST tax cost, although a gift tax would still be due at a 35% rate for gifts in excess of $1 Million. 

The reunification of the estate and gift tax.  The gift tax exemption and the estate tax exemption have been reunified, effective for gifts made after December 2010 and before 2013.  Assuming no prior taxable gifts, this means that a person can make $5 Million of gifts without gift tax liability.

Portability of Unused Exemption.  Under current law, in order to take full advantage of both spouses’ estate tax exemption amounts, the first deceased spouse’s exemption has to be held in a “Bypass” Trust.  The new law allows the executor of a deceased spouse’s estate to transfer any unused exemption to the surviving spouse without creating a trust.  This “portability” provision applies only with respect to the last deceased spouse of the surviving spouse, and it requires that an estate tax return be timely filed for the estate of the first deceased spouse, even though one would ordinarily not be required due to the deceased spouse having a taxable estate less than the estate tax exemption.  This increased exemption can be used both for gift and estate tax purposes.  However, remarriage and the death of the new spouse will cancel a prior portability election, and portability is not applicable to the generation‑skipping transfer tax. 

Charitable Gifts from IRAs.  Taxpayers may exclude IRA distributions to charitable organizations from income through 2011, up to a maximum of $100,000 per taxpayer per year.  The law allows taxpayers to treat such distributions made in January 2011 as if they were made on December 31, 2010, thus qualifying for the exclusion on their 2010 income tax returns.  Note that this is a federal law, not a California law.

Sunset.  These changed rates and exemptions will “sunset” at the end of 2012, so unless Congress again changes the estate tax law, the estate and gift tax exemption will revert to $1 Million and a 55% tax rate in 2013.  Following is a table summarizing this new law: 

Planning Points.  A person should not make a taxable gift in 2010, if possible, and instead defer the gift until 2011.  It might be advisable to make gifts to grandchildren or other “skip persons” in 2010, since such gifts will not be subject to the generation‑skipping transfer tax; however, they are still subject to the gift tax.

Despite the portability of the estate tax exemption, creating Bypass Trusts on the death of the first spouse to die still makes sense.  Aside from the non-tax benefits (for example, control over disposition and creditor protection) of holding assets in trust, funding a Bypass Trust on the first spouse’s death allows any increased value of the trust assets that occurred as between the first death and the second death to avoid estate tax.  Using the portability rule will not allow that increase between deaths to avoid estate tax.  In addition, if both spouses want to use their GST tax exemptions, recall that the GST tax exemption is not portable, so in order for the estate of the first deceased spouse to use it, a Bypass Trust should be used.  Finally, reliance on portability for estate and gift tax planning discourages a subsequent marriage.  If the “new” spouse dies first, the prior portability election is forever lost.  Bypass Trusts effectively preserve the first spouse’s exemption regardless of his or her spouse’s remarriage.

Please call one of our estate planners at (510) 834-6600 if you would like us to review your current estate plan in light of the new laws.