Tax Alert: New Estate and Gift Tax Law Offers Planning Opportunities
As a result of a compromise between President Obama and Congressional Republicans regarding the “Bush Tax Cuts,” the federal estate tax has returned for the years 2011 and 2012 with a higher exemption and a lower tax rate. In addition, the federal gift tax has been unified with the estate tax for the years 2011 and 2012 with the same exemption and tax rate as the estate tax.
The federal estate tax is imposed on transfers at death, but a specified dollar amount is exempted from the tax. This exemption amount continually increased in recent years up to $3.5 million in 2009 ($7 million for a married couple). The estate tax rate in 2009 was 45%. In 2010 the estate tax was temporarily repealed*, but the federal gift tax, which is imposed on lifetime transfers by gift, continued in effect. The lifetime exemption for the gift tax remained fixed at $1 million in 2010 ($2 million for a married couple), with a tax rate of 35%.
Under prior law, the estate tax was to have been reinstated automatically on January 1, 2011 at its 2001 level – with a $1 million exemption and a top tax rate of 55%.
However, under the “Tax Relief Act” enacted December 17, 2010, the estate tax is reinstated with an increased $5 million exemption and a lower 35% maximum tax rate.
In addition, in a particularly unexpected and surprising development, the Tax Relief Act also extends the generous estate tax exemption to lifetime gifts. Specifically, the new law unifies the estate and gift tax exemptions for 2011 and 2012, bringing them both up to $5 million ($10 million for a married couple). The gift tax rate is also 35% for 2011 and 2012.
Consistent with prior law, a taxpayer’s use of his or her gift tax exemption during lifetime will correspondingly reduce the amount that he or she may pass at death free of estate tax. The exemption amount of $5 million for both the estate tax and the gift tax will be indexed for inflation after 2011.
It is important to note that the new provisions relating to estate and gift taxes are applicable for only two years. After that time, unless Congress acts to amend the tax law again, the estate and gift tax provisions will revert to a much reduced $1 million exemption and a higher top estate tax rate of 55%. Therefore, a renewed discussion of the estate and gift tax laws prior to 2013 is virtually guaranteed.
The dramatic increase in the lifetime gift tax exemption from $1 million to $5 million ($10 million for a married couple) creates enhanced opportunities for tax-efficient lifetime transfers to the younger generation – creating an opportunity for taxpayers who previously used their $1 million gift tax exemption to now make additional substantial gifts in 2011 and/or 2012 without any gift tax liability. However, before a taxpayer decides to make any gifts, it is important to ensure that enough wealth is retained to maintain one’s standard of living and to meet any unexpected future needs.
Lifetime gifts can be particularly beneficial because they not only remove the gifted property from the taxable estate, but can also remove all future appreciation on that property from the taxable estate. A variety of wealth transfer techniques are currently available that can efficiently use a portion of the $5 million gift tax exemption. These include properly structured intra-family loans, sales to intentionally defective grantor trusts, and transfers to grantor retained annuity trusts or charitable trusts.
The new law also introduces the concept of “portability.” Effective for persons dying on or after January 1, 2011, a surviving spouse will be allowed to use any portion of estate and gift tax exemption that the spouse who dies first does not use. As a result, married couples may shield up to $10 million from federal estate tax, even if the first spouse to die fails to fully utilize his or her exemption.
Despite the introduction of portability, it will often still make sense to use trusts to shelter the estate and gift tax exemption of the spouse who died first. A trust not only provides significant asset protection and asset management benefits, but can also enable the appreciation earned on the trust assets during the period between the first spouse’s death and the second spouse’s death to pass to the next generation free of estate tax. In addition, because the provisions of the Tax Relief Act may expire at the end of 2012, there is the possibility that portability provisions may not exist when the second spouse dies, creating the risk that the first spouse’s unused exemption will be permanently lost without trust planning.
You should always periodically review your estate plan to make sure it is in line with your current objectives and personal goals. It is especially important that you implement this review now. The Tax Relief Act creates significant immediate estate planning opportunities. However, there remains considerable uncertainty about the future of the estate and gift tax. The time for planning is now.
If you have any questions about the new tax law or if you would like to review your estate plan, please contact one of the Estates attorneys at 215-661-0400.
* Under the new law, the estate tax repeal for 2010 is preserved, but in a roundabout way – estates wanting zero estate tax for 2010 must elect that option, along with the less favorable modified carryover basis rules that were set to apply for 2010. Otherwise, by default, the estate tax is revived for 2010, with a $5 million exemption, a top tax rate of 35%, and a step-up basis.