New Estate Tax Law: The Good, the Bad & the Ugly

The Good

Congress has passed and the President has signed into law the deal extending the Bush tax cuts and added some additional tax law changes.

As it relates to estate tax planning, the key elements of the legislation are the following:

• Restoration of the federal estate tax, which was to have been “repealed” for the calendar year of 2010 (based upon legislation past in 2001!).
• Reduction of the tax rate from a range of 41% to50% to a flat 35% tax rate
• Increase of the estate size which is exempt from estate tax from $1 million up to $5 million ($10 million for couples).
• The law makes the estate tax exemption “portable” between spouses. This means that if the first spouse to die does not use all of his or her $5 million exemption, the estate of the surviving spouse could use it, but how this is to be tracked or reported is yet unclear.

The legislation also makes several significant changes which affect wealth transfer/gift tax planning:

• The law unifies the estate, gift and generation-skipping transfer tax exemptions at $5 million, raising the amount you can gift during your lifetime without paying gift taxes from $1 million to $5 million.
• A 35 percent tax rate will apply to gifts or transfers over the $5 million threshold.
• There is no change in the $13,000 annual exclusion amount for gifts.

What does this mean in terms of gift planning? For those inclined, these high exemption levels mean that you have a two-year window in 2011 and 2012 to protect large amounts of your estate from taxation for generations by transferring it before you die (or before 1/1/2103). This could be especially beneficial for persons with estates greater than $1 million, if the estate tax exemption reverts back to $1 million in 2013, as it is scheduled to do (see discussion below).

The Bad

In 2001 (yes – ten years ago) Congress enacted a ten year phase out (what they called a “repeal”) of the federal estate tax, with the full repeal occurring in the tenth year – 2010. However, to make that “repeal” permanent, they had to take legislative action by December 31, 2010. They didn’t.

After ten years of waiting, the repeal of the death tax was not made permanent. Instead, the new law revives the estate tax, although increasing the amount exempt from federal estate taxes.

In addition, the new legislation is being applied retroactively (yes retroactively) back to January 1, 2010. The heirs of those dying in 2010 will have a choice between applying the new rules (no complete estate tax repeal) or electing to be covered under the rules that have applied in 2010 — no estate tax but only a limited step-up in the cost basis of inherited assets. That is, pick your poison, pay an estate tax or a pay a capital gains tax.

But it gets worse….

The Ugly

Not even this new legislation is permanent. If Congress does not change the law in the interim, on January 1, 2013 the estate tax will revert to what it was scheduled to be in 2011 – a 55 percent rate and a $1 million exemption. The gift tax rules also revert back.

Thus, from planning perspective, we would be back to where we were late last year.

What This All Means

Unless you know you are going to die before January 1, 2013, if you have or will have an estate over $1 Million (for a married couple – combined assets over that amount) by that date you should plan to protect your assets with trust (dual) based plan, with provisions that adjust should these legislative changes be made permanent. If you have a trust plan that has estate tax protection provisions in it, perhaps modify them to provide maximum flexibility in light of this changing legislative landscape. To do otherwise, could cost your loved ones thousands of dollars in taxes.

For those of you who would like to begin gifting assets for tax reasons, the next two years present some tremendous opportunities. However, please consult with your attorney (and CPA) first, as there are considerations other than tax implications that dictate whether gifting is advisable (i.e. – need for long term planning).

As the we become more familiar with the new, lengthy legislation, we will provide more planning suggestions in the future.