Temporary Opportunities For More Favorable Estate and Gift Taxes
Posted April 29, 2011
Temporary Opportunities for More Favorable Estate and Gift Taxes
A two-year window opened with the passage of the Tax Relief Act of 2010. Thanks to the historic tax legislation, families and individuals of wealth may now have temporary but significant opportunities to reduce the bite of federal estate and gift taxes.
For two years, those with large estates will be able to plan for larger tax-free transfers of assets to their heirs. They will also have greater latitude in the transfer of assets before they die and in reducing the size of their taxable estate.
Some are predicting the largest transfer of wealth ever in the next two years.
How We Got Here
To put the change in context you have to back to 2001, when the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) began to gradually increase the estate tax exemption level and lower the tax rate from 2002 to 2009. Then on Dec. 31, 2009, the estate tax was automatically eliminated.
As a result, there was no federal estate tax in 2010. But the same law that repealed the tax for a year required that, unless lawmakers passed some new legislation, the estate tax would return in 2011 with an individual lifetime exemption of just $1 million and a 55 percent rate.
The gift tax, which at the time was not tied to the estate tax, had a $1 million lifetime exemption limit in 2010, and a 35 percent rate on gifts over the limit.
Estate and Gift Taxes, Together Again
Under the Tax Relief Act of 2010, federal estate and gift taxes are once again unified at the same level for the next two tax years (2011 and 2012), and the estate tax rate has been reduced.
The estate tax exemption level is $5 million ($10 million for married couples), with a 35 percent rate.
The maximum lifetime gifting amount is also $5 million (likewise doubled for married couples), with a 35 percent rate.
Portability
Another key feature of the new law is portability, which allows a surviving spouse to acquire all or part of the $5 million lifetime estate and gift tax exemption of their deceased husband or wife, even if the deceased spouse did not leave a will or trust.
For example, assume John dies in 2012 after he and his wife have each transferred $2 million in assets to their children. This means that their total joint lifetime limit of $10 million in tax-free gifts is reduced to $6 million. Under previous law, at John’s death, his remaining estate tax exemption, $3 million, would be wasted unless he created what is known as a credit shelter or family trust before his death, or through his estate planning documents. Under the new law, John’s wife has the ability to “inherit” John’s unused $3 million of estate tax exemption and will be able to reduce her estate by $6 million if she were to transfer those assets before Dec. 31, 2012.
Of course, this assumes that the terms of the Tax Relief Act will remain unchanged until it expires. Unfortunately, no one knows how gift and estate tax laws will evolve between now and then, or if the current rules will be renewed or extended.
What to do Right Now
What do these changes mean to someone with a sizable estate?
- Estates of up to $5 million will at least temporarily be sheltered from any federal estate tax. Some state estate or inheritance taxes may still apply.
- Substantially more assets can be gifted to heirs free of transfer tax in order to reduce the size of the estate upon death.
- Those who had reached the $1 million gift limit under previous law will now be able to give an additional $4 million ($8 million for couples where both had reached the limit) without paying transfer taxes currently.
- There is a significant opportunity to reduce or even eliminate an estate tax liability through careful planning in the next two years.
Options for 2010 Estates
There are options for the estates of those who died in 2010. They can elect to apply the new estate tax rate of 35 percent and the exemption of $5 million with stepped-up basis on assets transferred at death, or they can choose no estate tax and apply modified carryover basis rules.
If an asset receives a “step-up” in basis when it is part of an estate, then the beneficiary’s income tax basis is equal to the asset’s fair market value. Depending on which estate tax rules are applied, 2010 or 2011, an asset’s income tax basis may be different in the hands of the beneficiary. Which option is best depends on the size of the estate and other factors that should be discussed with financial, tax and legal advisors.
New Clouds of Uncertainty
While this two-year window is being welcomed by estate planning professionals, legal advisors and their clients, the estate tax issue is still not permanently settled. The same clouds of uncertainty that hung over the last decade will almost certainly return as the deadline for change approaches in 2012.
Few are willing to predict now whether estate and gift tax rates, exemptions and limits will be allowed to revert to pre-2001 levels, continue at 2011 levels, or fall somewhere in between. What is certain at the moment is that the opportunities available now should be explored and a flexible plan put in place as soon as possible.
Contact us for assistance with your estate planning needs.
