December 31, 2010
Dear Clients and Friends:
On December 17, 2010, President Obama signed a significant package of tax legislation. (It’s officially called “The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010”.)
The primary feature of this legislation is a two-year extension of the Bush-era income tax cuts. However, the Act also addresses the repeal of the estate tax for 2010 and its reinstatement in 2011. The legislation reenacts the estate tax for 2010 (but grants an option to elect back into the repeal) and provides increased estate and gift tax exemptions and lower tax rates for 2011 and 2012. Unfortunately, the Act is only a temporary measure — in 2013, the pre-2001 estate and gift tax provisions will return, with the potential to impose a much greater tax burden on estates and gifts.
Following is a summary of the estate, gift and generation skipping tax provisions of the new Act.
Estate and Gift Taxes in 2011 and 2012
For decedents dying in 2011 and 2012, the Act greatly reduces the reach of the estate tax by granting estates a $5.0 million exemption for property subject to the tax. In 2009, the last year in which there was an estate tax, the exemption was $3.5 million, so this is a significant increase. In addition, the Act introduces the concept of exemption “portability” between spouses — if one spouse does not use all of his or her $5.0 million exemption, it may be used by the estate of the surviving spouse, effectively creating a $10.0 million exemption for married couples. The few estates that exceed this $5.0/$10.0 million threshold will be subject to a new 35% tax rate, considerably lower than the 45% rate that prevailed before 2010.
A major change also applies with respect to gift taxes. Since 2001, taxpayers have had only a $1.0 million lifetime exemption for gift tax purposes. That exemption is increased to $5.0 million for gifts made in 2011 and 2012, and the tax rate on 2011 and 2012 gifts in excess of that amount is 35%. NOTE: The gift tax exemption and the estate tax exemption are unified, meaning if you use some or all of your gift tax exemption during your life, your estate tax exemption is reduced as well by the same amount.
Generation-Skipping Transfer Tax
The Act makes a number of changes to the generation-skipping transfer (GST) tax, which is an additional tax imposed on gifts and bequests to grandchildren and great-grandchildren. The 2001 legislation repealed the GST tax for 2010 only, but there was a lack of clarity as to the effect of that repeal. The recent Act should eliminate that uncertainty, because it provides that the GST tax was in effect in 2010, but with a 0% tax rate. This means that any generation-skipping transfers that occurred in 2010 were tax-free, but that taxpayers could still take advantage of the various GST tax exemptions that could reduce or eliminate the tax in future years.
Going forward, the Act aligns the GST tax with the reformed estate and gift taxes. In 2011 and 2012, the GST exemption is increased to $5.0 million and the tax rate is 35%.
2013
Unless new Congressional action is taken, in 2013 the estate, gift and generation skipping tax exemptions will all revert back to $1.0 million and the 55% tax rates will return.
Planning Opportunities
These changes mean that most estates of people passing away in 2011 and 2012 will not be subject to estate or generation skipping taxes. They also mean that the planning opportunities for larger estates are greater than they have been in many years. We don’t know what the law will be after 2012. But, we do believe that those of you with large estates should take advantage of this 2 year window and plan accordingly.
For those of you whose estates are under the new thresholds, consideration should be given to drafting changes in your documents that eliminate automatic bypass provisions[1] that may exist and that add language to provide greater flexibility given the probability of future changes in estate and gift tax law. However, the tax implications are not the only driving factors. It will be important to discuss the specific objectives and implications of changes before revising your documents. (Please see the footnote below if you are not sure if you have an automatic bypass provision in your trust or not.)
[1] “Automatic bypass” provisions are ones that require a bypass trust to be created on the passing of the first spouse. These should not be confused with “disclaimer” provisions that allow the surviving spouse the option to create a bypass trust but do not require it. An automatic bypass trust should be removed from your documents if your estate is significantly below the $5 million/$10 million threshold discussed above and the estate tax was the only reason for having an automatic bypass provision.