Late last year Congress passed the Tax Relief, Unemployment Insurance Re-authorization, and Job Creation Act, (the “Act”) which was signed into law by President Obama on December 17, 2010, reinstating a federal estate tax for tax years 2010 through 2012. For 2010 deaths, representatives may be treated under the law as it existed in 2010 (no estate tax, but no step up in basis) or the new law.
ESTATES OF PERSONS DYING IN 2011 & 2012: For persons dying in 2011 and 2012 the federal estate tax exemption will be $5 million, with tax on anything over that amount charged at 35%, and the decedent’s assets receiving a full step-up in basis to date of death value.
The estate tax has also been reunified with federal gift tax law so that the gift tax exemption will also be $5 million, and the tax rate for both of these taxes will be 35%. The Generation Skipping Tax, targeting certain gifts to grandchildren and other persons in succeeding generations, has also been reinstated with the same rate and limits. Beginning in 2012 the exemption amounts will be indexed for inflation.
For many clients the new law means simplification of their estate plans. The estate tax exemption is now subject to the so called “portability provision.” This allows married couples to directly apply any unused portion of the estate tax exemption of the first spouse to die to the surviving spouse’s estate tax exemption. This will effectively allow married couples to pass up to $10 million to their heirs free from estate taxes without requiring the use of a second, separate “By-pass Trust” which complicated prior estate tax planning for married persons. However, it may still be advisable to set up second trust if you have children from a prior marriage, or your estate must provide ongoing care for family members in need.
ESTATES OF PERSONS DYING IN 2010: If you are dealing with an estate in which the decedent passed away in 2010 you need to be aware of the following changes in the tax law which may impact the estate:
1. ESTATES VALUED AT LESS THAN $5 MILLION. The Estate Tax is reinstated retroactively for estates of decedents who died in 2010 unless the estate representative elects not to subject the estate to the tax. If the estate representative does not elect out of the estate tax the exclusion for 2010 estates is $5 million, the maximum rate of taxation is 35%, and assets acquired from a 2010 decedent’s estate will receive an income tax basis stepped up to date of death value.
Because the exemption eliminates estate tax in these less than five million dollar estates it makes sense to accept the benefit of the new law with its full step-up in basis to date of death values for all assets of the estate. This means on a subsequent sale of an estate asset the capital gains tax will be calculated on the difference between date of death values and the sales price, instead of on the value of the gain over the original acquisition value, potentially resulting in a substantial tax savings.
2. ESTATES VALUED AT MORE THAN $5 MILLION. The estate of any 2010 decedent which exceeds the $5 million exemption must be carefully analyzed by the representative. The representative must make his evaluation based on the size of the estate, the composition of the assets, and the adjusted basis of those assets in order to make an appropriate decision. A decision made to opt out of the new law must be made before September 17, 2011 – the extended return due date adopted in the new law for decedent’s dying before December 17, 2010.
If the representative opts out of the new law, there will be no estate tax on the decedent’s estate, but the estate will not receive a full step-up to date of death values for purposes of capital gains taxation on the subsequent sale of estate assets. Instead, the estate will be subject to “carryover basis” rules. However, depending on the size of the estate, and the type of property, this may not matter. Under carry over basis rules, there is a step up in basis for the first $1.3 million worth of selected assets for all beneficiaries, and if the beneficiary is a surviving spouse, an additional $3 million of assets may be stepped up to date of death value, for a total of $4.3 million in stepped up assets. For this reason, in selected circumstances, it may make economic sense to opt out of the new law, for example, with an estate consisting largely of cash or cash equivalent assets with little or no capital gains. Let us assume an estate which leaves the surviving spouse a total of $10 million, of which less than $4.3 million represents appreciated assets and the balance cash or cash equivalents. In that case, the spouse should opt out of the new law, stepping up the appreciated assets while avoiding estate tax.