2010 Tax Relief Act: Key Estate, Gift and Generation Skipping Transfer Tax Changes
In addition to income taxes, the Act also impacts estate, gift and generation skipping transfer (“GST”) taxes for 2010, 2011 and 2012. As under the law prior to 2010, estate, gift and generation skipping transfer taxes will return as they existed in 2001 beginning on January 1, 2013, unless Congress passes further legislation prior to 2013. Thus, the new Act has limited applicability.
Prior to the passage of the Act, for decedent’s dying in 2010, the federal estate and GST taxes were repealed, and were scheduled to return in 2011 with an estate tax applicable exclusion amount and a GST tax exclusion amount of $1 million and a top estate and GST tax rate of 55%. Moreover, for deaths in 2010, the tax basis of inherited property would generally be the basis of the property in the hands of the decedent (i.e., carryover basis) with a limited step-up in basis at the election of the personal representative (generally, $1.3 million plus an additional $3 million for surviving spouses).
Under the Act, the estate tax applicable exclusion amount has been set at $5 million per decedent and indexed for inflation in $10,000 increments (the inflation adjustments begin in 2012). The top estate tax rate is now 35%. Moreover, for estates of decedents dying in 2010, the Act allows a choice between applying the new estate tax regime with a $5 million exemption, a 35% top tax rate and a full step-up in basis for inherited assets OR electing out of the estate tax and applying carryover basis (plus the limited basis step-up) to inherited assets. The default rule under the Act is that the estate tax will apply for decedent’s dying in 2010. As a result, if a personal representative does not want the federal estate tax to apply to the estate of a decedent dying in 2010, the personal representative must opt out of the estate tax and will have to file an information return detailing the decedent’s basis in his or her assets and applying, where applicable, the limited step-up in basis to those assets.
For generation skipping transfers, the GST tax is retroactively reinstated for 2010 with an exemption amount of $5 million indexed for inflation. Thus, for deaths in 2010, an exemption amount of up to $5 million may be allocated to a trust created or funded during 2010. It should be noted, however, that while the GST tax is applicable in 2010, the GST tax rate for generation skipping transfers made during 2010 is 0%. For GST taxable transfers or terminations in 2011 and 2012, the GST tax rate will be 35%.
In addition to the above, effective for estates of decedents dying after December 31, 2010, the personal representative of a decedent’s estate may transfer any unused portion of a predeceased spouse’s federal estate tax exemption to the decedent at the time of such decedent’s death. Thus, the Act makes the predeceased spouse’s applicable exclusion amount “portable” to the surviving spouse (at the surviving spouse’s death). However, because the Act’s portability provisions are only applicable for deaths in 2011 and 2012, the provisions will impact a decedent’s estate only if the decedent and his or her spouse die after 2010 and before 2013.
With respect to the federal gift tax, the Act reunifies the gift tax with the estate tax for 2011 and 2012. Therefore, the gift tax lifetime exemption amount will be $5 million (indexed for inflation) with a top gift tax rate of 35%. Lastly, with respect to tax and information return filings, for a decedent dying after December 31, 2009 but before the enactment date of the Act, the due date for filings (such as an estate tax return) will be not earlier than the date that is nine months after the enactment date of the Act.
The passage of the Act brings many planning opportunities. The following are a few for consideration:
1. Year-End Gifts to Grandchildren and Distributions from Non-Exempt GST Trusts. Since during 2010 the GST tax rate is 0%, grandparents may make gifts to their grandchildren before the end of 2010 free of GST tax (and without using any GST tax exemption). Similarly, a Trustee may distribute trust assets from a non-exempt GST trust to another generation without GST or gift tax before the end of 2010.
2. Simple Gifts and Gifts to Grantor Trusts. Due to the reunification of the federal gift and estate tax exceptions, beginning in 2011 and through 2012 ($5 million per individual and $10 million per couple), individuals should consider making simple gifts during these years to take advantage of the increased gift tax exemption. In addition, if the gift is made to a grantor trust, this will not only take advantage of the increased gift tax exemption but should allow the donor to continue paying income tax on the transferred assets, thereby increasing the after-tax value of the gifted assets over time.
3. Sales to Grantor Trusts. The increase in the gift tax exemption for 2011 and 2012 increases the effectiveness of a sale to a grantor trust. This type of planning opportunity allows the donor to shift appreciation to the beneficiaries of the trust (a younger generation) and remove such appreciation from the donor’s estate. The increased gift tax exemption will allow a donor to initially fund the trust with a large seed gift free of gift tax thereby increasing the amount of assets that may be sold to the trust.
4. Life Insurance Transfers. The increase in the gift tax exemption will increase the effectiveness of life insurance trusts by allowing an insured to transfer a greater amount to the trust to pay premiums and/or acquire a life insurance policy gift tax free. This, in turn, will allow a greater death benefit to pass free of estate tax to younger generations.
Please contact a member of our tax group if you would like to discuss any of the Act’s provisions.