On December 17, the President signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Act”). This Client Alert summarizes major estate, gift and generation-skipping transfer (“GST”) tax provisions of the Act and 2010 year-end planning opportunities. As this is only a partial summary, we encourage you to contact us to discuss your specific situation in detail, and you should not take any planning actions without seeking the advice of a tax professional.
EXECUTIVE SUMMARY OF THE ACT’S ESTATE, GIFT & GST TAX PROVISIONS
- Federal estate, gift and GST tax rates will be 35% in 2011 and 2012
- Federal gift & estate tax exemptions “reunified” in 2011 and 2012 to permit aggregate transfers of $5 million per person; GST tax exemption in 2011 and 2012 increased to $5 million per person
- Surviving spouse can use, for both gift and estate tax purposes, a deceased spouse’s unused Federal estate (but not GST) tax exemption in 2011 and 2012
- Estates of persons who died in 2010 may elect tax treatment under the Act or under prior 2010 law
- Provisions expire December 31, 2012 absent new legislation
- Existing estate plans will still be valid, but should be reviewed in light of the Act
MAJOR PROVISIONS
FEDERAL ESTATE, GIFT AND GST TAXES WILL BE 35% IN 2011 AND 2012
Federal estate and GST taxes will be reinstated January 1, 2011 with a higher per person exemption ($5 million) and a lower tax rate (35%) than were in effect in 2009 ($3.5 million exemption and 45% rate). The exemption amounts are indexed for inflation beginning 2012. The Federal gift tax rate, which was lowered to 35% in 2010, will remain 35% in 2011 and 2012. The Federal gift tax exemption will be “reunified” in 2011 and 2012 to allow aggregate transfers by gift or at death of $5 million per person.
PORTABILITY OF EXEMPTIONS BETWEEN SPOUSES
Effective 2011, the surviving spouse can use a deceased spouse’s unused Federal estate and gift (but not GST) tax exemptions if the executor for the deceased spouse makes an election to that effect.
GST PROVISIONS
The Act sets the GST tax exemption amount at $5 million per person and the rate at 0% for 2010. For clients who are willing to make significant gifts outright to grandchildren, this allows for substantial tax savings for gifts made in 2010 (see “Outright Gifts to Grandchildren” below). Please contact one of us immediately if you are interested.
NEW YORK TAX
New York State’s estate tax regime is not affected by these developments. New York’s estate tax exemption amount will remain capped at $1 million, and New York’s estate tax rate will remain 16%. Any New York estate tax paid continues to be deductible for purposes of the Federal estate tax. There is no New York gift tax.
ESTATES OF DECEDENTS WHO DIED IN 2010
The Act allows the executor for an individual dying in 2010 a choice in tax treatment. The estate can either (1) be subject to the estate tax described above ($5 million exemption and 35% rate) and get a “stepped up” (i.e., date-of-death) basis for income tax purposes for includible estate assets, or (2) have no estate tax apply, but receive only a “carry over” basis for income tax purposes for includible estate assets, with the ability to “step up” a limited amount of assets. Executors should consult a tax professional to determine which option is of greater overall benefit to the estate.
YEAR-END PLANNING STILL APPLIES
NONTAXABLE GIFT AMOUNTS FOR 2011
Each year, you can make annual gifts to an unlimited number of recipients of up to a certain amount – for 2010 and 2011, $13,000 per donee (or $26,000 if you are married and your spouse consents to “split” gifts). These gifts will not reduce and are in addition to your lifetime gift tax exemption, but are on a “use or lose” basis. If you have not yet made your 2010 annual gifts, you should consider doing so now, and again in early January to cover your annual gift for 2011. In addition to annual gifts, payments (in any amounts) for tuition or medical care for other individuals will not reduce your lifetime gift tax exemption, provided that the payments are made directly to the educational institution or health care provider.
In 2011, the amount that you can give annually as a nontaxable gift to a spouse who is not a U.S. citizen has been increased to $136,000.
CHARITABLE GIVING FROM IRAS IN 2010
In 2010, an individual over age 70½ is allowed to give up to $100,000 directly to certain eligible charities from IRA funds and exclude the amount from taxable income. Additionally, any contribution to an eligible charity from IRA funds in January 2011 may be treated as being made in 2010.
LOW-INTEREST PLANNING TECHNIQUES
Because interest rates are at historically low levels and valuations on nonmarketable assets are relatively low, this is an excellent time to consider taking advantage of estate planning techniques that transfer potential upside and work well in low-interest environments. These include GRATs, sales to “grantor` trusts,” intra-family loans, charitable lead trusts and other techniques we would be happy to discuss with you.
ISSUES TO CONSIDER & PLANNING OPPORTUNITIES
ESTATE PLANS SHOULD BE REVIEWED
Many estate plans contain so-called “credit shelter” bequests to use the decedent’s full Federal estate tax exemption. If your estate plan contains a “credit shelter” bequest, no immediate changes are required. However, your estate plan should be reviewed during the course of 2011 in light of the Act.
If your estate plan leaves a “credit shelter” bequest to different beneficiaries than the people or organizations who receive the rest of your estate, then the Act will change the economic effect of your estate plan. The increased Federal estate tax exemption amount means that the “credit shelter” bequest is now $5 million, rather than $3.5 million as in 2009, transferring a larger amount to the beneficiaries of the “credit shelter” bequest than may have been anticipated. The same issue affects bequests of the unused GST exemption amount. Finally, married couples should also review how assets are held (jointly or individually) to maximize each individual’s ability to transfer property free of GST tax, since under the Act the amount of property exempt from GST tax is not portable between spouses.
TIMING OF GIFTS – IN 2010 OR LATER?
Many planners encouraged clients to consider gifts when the 35% lower gift tax rate appeared to be effective only for 2010. The Act continues that rate, for both gift and estate tax purposes, for 2011 and 2012. For clients with sufficient means and a desire to transfer assets currently, gifts still make sense from a tax perspective and still save a family overall amounts of transfer tax under many circumstances. Moreover, gifts escape New York transfer tax altogether (there is no New York gift tax, while there is a New York estate tax). However, clients may wish to consider delaying gifts they plan to make (other than annual gifts) until 2011, so that they may both utilize the higher lifetime gifting limits ($5 million per person or $10 million per couple, rather than $1 million per person or $2 million per couple) and delay until the following year (2012) the need to pay any gift tax due.
OUTRIGHT GIFTS TO GRANDCHILDREN – CONSIDER MAKING IN 2010
Gifts to grandchildren are an exception to the general rule above. Because the rate of GST tax during 2010 is 0%, outright gifts in 2010 directly to grandchildren or more remote descendants (or some unrelated young donees) will avoid a GST tax that otherwise would be payable on such gifts beginning in 2011. (It is not clear whether this also would be true of gifts in trust for grandchildren.) Gifts in 2010 in excess of any unused $1 million lifetime Federal gift tax exemption may still trigger gift tax. If you are interested in making significant current gifts outright to grandchildren, please contact one of us immediately. Keep in mind that, as with any lifetime estate planning technique involving payment of any gift tax, you could be in a worse-off position financially if subsequent to your gift the estate, gift and GST taxes are repealed, and are not re-instituted by the time you later dispose of your assets (by later gift or at your death).
USE OF GRATS
For many years, Grantor Retained Annuity Trusts, or GRATs, a special type of trust (explained in more detail here), have been one of the most effective techniques for transferring wealth down generations in a tax-free or tax-advantaged manner, with limited risk to the client. Several recent tax (and non-tax) legislative bills contained new provisions that would have placed significant limits on the GRAT technique (including imposing a minimum 10-year term to prevent the “overlapping” or “rolling” use of GRATs). While the Act contains no provisions that address GRATs, subsequent legislation (including eventual tax legislation dealing with the expiration of the Act, or even unrelated non-tax legislation where this provision could be used as a revenue offset) may yet impose such limitations. If you are interested in GRATs, please contact one of us to discuss timing issues.
USE OF VALUATION DISCOUNTS
For many years taxpayers have been able to obtain transfer tax benefits by transferring assets that receive discounts for valuation purposes in the gift and estate tax areas. There was some concern that the new bill might attempt to limit the use of valuation discounts within the family context, but no provision regarding discounts is included in the Act. The use of various techniques employing valuation discounts remains for now an effective means of reducing overall estate and gift taxes.
CIRCULAR 230 NOTICE
Pursuant to U.S. Treasury Department Circular 230, we are informing you that this memorandum (including any enclosures) is not intended and was not written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties under the Federal tax laws that may be imposed on the taxpayer.