On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “Tax Relief Act of 2010”). In addition to extending for two years all Bush-era income tax cuts and long term capital gains and qualified dividend tax rates, the Tax Relief Act of 2010 includes important changes to the Federal estate, gift and generation-skipping transfer tax provisions that may have a substantial and far-reaching impact on your estate plan. However, it is important to note that the new provisions will “sunset” on December 31, 2012, so the new tax rates and exemptions will not remain in effect unless subsequent legislation is enacted to continue the changes beyond 2012.

The most significant provisions of the Tax Relief Act of 2010 that will affect estate planning are discussed below:

Estate Tax: Effective January 1, 2010, the estate tax is retroactively reinstated through December 31, 2012 with a 35 percent rate, a $5 million exemption and a stepped-up basis for all assets included in the estate for estate tax purposes. Executors of estates of decedents dying in 2010 have the option of electing instead the prior 2010 regime – no estate tax and carryover basis rules, with an allocation of $1.3 million of basis step-up for assets passing to any beneficiary and an additional $3 million for assets passing to a spouse.

Gifts: Effective January 1, 2011, the gift tax exemption is once again unified with the estate tax exemption. Accordingly, beginning January 1, 2011, individuals can give up to $5 million free of gift tax (or $10 million per couple with a split gift), reduced by any portion of the gift tax exemption used in prior years. Gifts in excess of $5 million will be subject to a 35 percent tax rate. Significantly, many states that impose a state estate tax (including Maryland and the District of Columbia) do not impose a state gift tax, so large gifts during lifetime often save a significant amount in state estate tax.

Generation Skipping Transfer Tax (GST tax): The GST tax is reinstated effective January 1, 2010, with a $5 million exemption, but with a zero percent tax rate for 2010 transfers (which rate is consistent with the prior law, which repealed the GST tax for transfers made in 2010). Accordingly, the GST exemption may now be allocated to a trust created or funded in 2010. Effective January 1, 2011, the GST tax rate for transfers in excess of $5 million is 35 percent.

Portability: Portability is a new concept under the Tax Relief Act of 2010. For decedents dying in 2011 and 2012, if an estate tax return is filed and an election is made, the surviving spouse can use the unused estate tax exemption of the decedent spouse. However, unless the two-year effective period is extended, both spouses would have to die within the two-year period for the portability feature to apply.

2013 Sunset: As comprehensive as it is, the Tax Relief Act of 2010 is merely a two year reprieve. If Congress does not act to change the law before 2013, all income tax and estate, gift and GST tax provisions will sunset on January 1, 2013. After the sunset, tax rates are slated to return to what they were before 2001. This means that unless the two-year period is extended, on January 1, 2013 we will revert to a 39.6 percent top ordinary income tax rate and qualified dividend tax rate, a 20 percent long term capital gains tax rate, a 55 percent top estate and gift tax rate, a flat 55 percent GST tax rate, a $1 million estate and gift tax exemption, a $1 million GST exemption (indexed for inflation), and no portability of the first deceased spouse’s unused estate tax exemption.
 

Planning in 2011 and Beyond: In light of the new tax law, we strongly suggest that estate plans be reviewed to make sure they are compatible with the new rates, applicable exemptions and portability features. Formula bequests that were drafted under prior law, particularly if they benefit children or grandchildren and do not include the surviving spouse, may need to be revised to ensure that they continue to meet the donor’s intentions. In addition, because the new portability feature may not be available after 2012, the titling of assets between spouses should be reviewed in order to ensure that the exemption amounts will be fully utilized in each estate.

For wealthy individuals, the next two years will bring significant new opportunities for gifts that use the new $5 million per individual ($10 million per couple) gift and GST tax exemptions. The Tax Relief Act of 2010 provides more opportunity than ever to engage in tax efficient estate planning, but because of the two year shelf life, the time for planning is now.

Please contact Holly Bastian, Earl Colson, or Lynn Pearle to schedule a review of your estate plan in light of the new tax law and to discuss gift giving plans in 2011 and 2012 that may produce significant estate tax savings.