Lawyers serving you and your family . . . Tax Law Update
Posted December 21, 2010: We now have “certainty” regarding the estate tax law. Congress has passed legislation that makes several important changes to the estate, gift and generation-skipping tax provisions. The exemption amount, i.e., the estate value that may pass free of estate and gift taxes, has been increased to $5 million and indexed for inflation. Additionally, this exemption is now portable between spouses, meaning that the surviving spouse may use any unused estate tax exemption of the first to die spouse. The new provisions are effective for only two years, and therefore, everyone will have important decisions to make regarding gifts and revisions to existing plans, taking into consideration not only tax issues but also the non-tax reasons for estate plans. Here are the highlights: Gift Tax: As of January 1, 2011, individuals can make up to $5 million in aggregate lifetime taxable gifts (i.e., exclusive of annual gift tax exclusions) free of gift tax. Couples may double that amount through “gift splitting.” Gifts in excess of $5 million are subject to a 35% tax rate. Estate Tax: The estate tax is retroactively reinstated for decedents dying after December 31, 2009, with a 35% rate, a $5 million exemption and stepped-up basis for all assets included in the estate for estate tax purposes. For decedents dying in 2010, however, the estate may elect instead to apply the law as it was in 2010, i.e., no estate tax BUT with carryover basis for capital assets and only limited basis step-up on $1.3 million (plus an additional $3 million for assets passing to a spouse). Portability: For those dying on or after January 1, 2011, the surviving spouse may use any unused portion of his or her deceased spouse’s exemption. To do so, an estate tax return must be filed for the deceased spouse and an election affirmatively made by the surviving spouse. As the law now reads, however, both spouses must die within the next two years for the provision to apply since the provisions of the Act are effective for only two years. We can only speculate as to whether Congress will continue the portability provision when the two-year term of this temporary law ends. Note that portability does not apply to any unused GST exemption of the predeceased spouse. GST Taxes: The Generation Skipping Transfer tax is reinstated for 2010 with a $5 million exemption, but with a tax rate of 0% for that year. Effective January 1, 2011, the GST tax rate will increase to 35%. The disparity in tax rates and higher exemption amount than in years past provide for some planning opportunities in the remainder of 2010 as well as 2011 and 2012.
Estate Tax Update: The New Law
Posted January 25, 2010:
Estate Tax 2010 – Temporary Repeal
Background of the Transfer Tax Law Changes
In 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), which contained a wide range of tax law changes. Included among those changes were gradual increases in the federal estate tax exemption amount from $675,000 in 2001 to $3,500,000 in 2009, reductions in the maximum federal estate tax rate from 55% in 2001 to 45% in 2009, and elimination of the federal estate tax and generation skipping transfer (“GST”) tax in 2010.
Because EGTRRA did not receive the vote of at least 60 senators, legislative procedural rules require that the law is required to expire (or “sunset”) after a 10 year period. This means that the federal estate tax laws that were in effect in 2001 will be restored unless new legislation is passed. In 2011, therefore, the federal estate and gift tax exemption will be $1,000,000, the GST exemption amount (which is indexed for inflation) will drop to around $1,350,000, and the maximum federal estate and gift tax rates will increase to 55% (plus a 5% surcharge for estates between $10 million and $17,184,000).
At the time EGTRRA was passed, few would have predicted that we would reach 2010 without changes to the transfer tax laws. Nevertheless, the House of Representatives and the Senate have not been able to agree on estate tax reform, and did not address the issue prior to the end of 2009 as anticipated. The timing and nature of any Congressional action going forward remains uncertain, as does the question of whether the estate tax could be constitutionally reinstated retroactively.
Because of the inaction of Congress, there currently is no federal estate tax and no generation-skipping transfer tax. There is still a gift tax, although the top tax rate is now 35% instead of 45%. Because there is no federal estate or GST tax in 2010, there may be uncertainty how the provisions of a decedent’s estate plan will be interpreted and applied.
An important corollary to estate tax repeal is that the cost basis of a decedent’s assets no longer would receive a “step up” in value to fair market value on date of death, and, as a result, the basis of property inherited from someone who dies in 2010 would be the same as the decedent’s basis (a “carryover basis”), unless the fair market value is less than the decedent’s basis, in which case the fair market value is used as the new basis. This basis would then be used to calculate capital gains when the inherited property is eventually sold. (EGTRRA does, however, provide for some additional basis allocation – generally, up to $1.3 million of property passing to anyone, and up to $3 million of property passing to a surviving spouse either outright or in a qualifying trust.)
The term “repeal” gives a false sense of simplicity, when in fact the complexity of interpreting the provisions of existing documents and the record-keeping requirements of the modified carry-over basis rules will increase the record-keeping burdens and administrative costs associated with administering estates. One of the most significant problems caused by the temporary 2010 repeal is that many previously-drafted estate plans may no longer work in the manner intended. Provisions in wills and trusts are often written in terms of tax-related concepts, such as the estate tax exemption amount, the marital deduction, and the GST tax exemption, and become meaningless without the estate tax in effect. As a result, if a death occurs in 2010, beneficiaries could find themselves inadvertently disinherited, and, because repeal is not permanent, the amount of transfer taxes ultimately paid in the future could be greater due to unused credit sheltering.
The uncertainty of interpretation may well lead to an increase in legal actions in future years regarding construction of the provisions of wills and trust and intra-family litigation. In an attempt to address this concern, legislation has been introduced at the current session of the Virginia General Assembly to provide that until new legislation is passed by Congress, or January 1, 2011, whichever occurs first, if a person dies after January 1, 2010 their documents will be interpreted as if that person died on December 31, 2009. While this Virginia law may help in the interpretation of many documents, it may not produce optimal tax results for every decedent.
We believe that the current uncertainty in the transfer tax laws may create potential planning opportunities for some individuals in certain situations. While we anticipate the Virginia General Assembly will pass legislation to address interpretation issues, there is no across-the-board fix for everyone. Individual situations vary and the planning opportunities, along with the associated risks, are not appropriate for everyone. We would be happy to meet with you to discuss your estate plan and to work with you to determine whether there are possible planning opportunities that would be suitable for your situation.