Observations Regarding Estate Tax Aspects of 2010 Tax Act

On December 17, 2010 President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010.  The Act significantly changes the federal estate tax and presents significant estate planning opportunities.

Summary of the Act

·         The estate tax exclusion amount increases to $5 million per person for 2010 through 2012.

·         The maximum estate and gift tax rate is reduced from the 55% maximum rate under prior law to a maximum estate and gift tax rate of 35% for 2011 and 2012.

·         A “portability” provision is included, which allows surviving spouses to use any applicable exclusion amount that is not used by the first spouse to pass away.

·         The GST exemption amount is increased to $5 million for 2010 through 2012.

·         The Act sunsets at the end of 2012, thus making the foregoing changes temporary in nature.

Generally

Generally, the estate and gift tax provisions of the Act are very favorable to taxpayers because of the substantial increase in the applicable exclusion amount, to $5 million, and the lower maximum estate and gift tax rate of 35%.  The Act also addresses several technical estate, gift and GST tax issues in a manner that is favorable to taxpayers (e.g., the impact of the lapse of the estate tax, including the application of basis rules, on decedents passing away during 2010).

Temporary Fix

The Act is a temporary fix, which sunsets on December 31, 2012, immediately after the next election cycle.  It is impossible to predict whether it will be extended in either its current or some modified form, especially given the fact that it is a hot button issue with both major political parties.  If Congress fails to act, the Act will lapse and the estate tax will revert to what it would have been under prior law (i.e., $1 million applicable exclusion amount and 55% maximum estate and gift tax rate).

Increased Gift Tax Applicable Exclusion Amount

From 2001-2010, the applicable exclusion amount for gift tax purposes has been $1 million.  The Act increases this to $5 million, or $10 million per married couple.  This change provides an unprecedented opportunity to move substantial amounts of wealth out of individuals’ estates.  There are several techniques that individuals can use to leverage this $5 million applicable exclusion amount, to move substantially more wealth out of their estates.

To illustrate, individuals can now make gifts of $5 million to trusts governed by the laws of certain states, such Delaware and Alaska, move all growth in such wealth out of their estates, provide a significant amount of asset protection for such assets, and the transferor may continue to be a discretionary beneficiary of such trusts, without any gift tax cost.

In addition, the increased gift tax applicable exclusion amount increases the amount of assets that individuals can transfer via an installment sale to a dynasty/grantor trust.  Under this estate planning technique, individuals can now make an initial gift of as much as $5 million ($10 million per married couple) to a dynasty trust, and then transfer as much as $45 million ($90 million for a married couple) to such dynasty trust in exchange for an installment note.  This technique works especially well for family businesses that are expected to grow significantly in value over time.

Given the fact that the Act will sunset without further Congressional action in 2012, it is generally advisable to implement estate planning techniques utilizing lifetime gifts before the December 31, 2012 sunset date.

State Estate Taxes

Many states have separate estate tax regimes with lower applicable exclusion amounts than the federal applicable exclusion amount.  These include the District of Columbia, Maryland, New Jersey, and New York, among others.  It is critical that the estate plans of individuals living in or owning property located in such states address such estate tax exposure.

Portability

One of the more notable provisions contained within the Act is the “portability” provision, which provides in general terms that if one spouse does not fully utilize his/her entire $5 million applicable exclusion amount, the unused portion can be used by the surviving spouse’s estate. Some may think that there is no need for credit shelter trusts in estate planning documents as a result of portability but, unfortunately, both spouses must die before 2013 in order to benefit from the portability provision.

In addition, credit shelter trusts continue to provide significant additional benefits beyond just the use of each spouse’s applicable exclusion amounts.  These include the following:

• Ensuring that assets contained in the credit shelter trust pass to children of the couple and not to any new spouse of the surviving spouse.
• Ensuring that appreciation on the assets contained within the credit shelter trust, which may exceed the applicable exclusion amount at the surviving spouse’s death, are not subject to estate tax at that time.
• Protection of assets in the credit shelter trust from creditors of the surviving spouse, including any marital claims of future spouses.

Given the fact that the portability provision will sunset in 2012, as well as for the reasons stated above, it is generally advisable to continue to use estate plans that incorporate credit shelter trusts.

Things Not In the Act

There are two key provisions that many commentators feared would be in the Act, but which were not included in it.  Specifically, there have been several proposals to place limits on Grantor Retained Annuity Trusts (“GRATs”), which allow individuals to transfer wealth out of their estates with as little as a zero estate or gift tax cost that would have made GRATs less valuable from an estate planning perspective.  There have also been several proposals to limit valuation discounts in connection with certain estate planning techniques such as family limited partnerships.  There were no such provisions included in the Act.  Therefore, these techniques continue to be available to move wealth to lower generations.

Recommendation

Regardless of the changes, it is generally advisable that clients review their estate plans periodically and/or whenever a significant life event occurs (e.g., birth of a child, death of a spouse, purchase of new home, etc.).  For those with substantial amounts of wealth and/or with closely held businesses, consideration should be given to using lifetime gifts to take advantage of the current $5 million lifetime gift tax applicable exclusion amount, which will expire absent further Congressional action at the end of 2012.