After much speculation, in December of 2010, the President signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Act”), which contains important estate tax provisions.
There are three important temporary changes under the Act which impact your overall estate planning to which I would like to draw your attention:
- Lifetime gift tax exemption amount is increased to $5 million for gifts made in 2011 and 2012. This lifetime exemption returns to only $1 million in 2013.
- The estate tax exemption amount is increased to $5 million. The estate tax exemption also returns to only $1 million in 2013.
- Portability. This means that the first spouse to die can leave his/her entire estate outright to the surviving spouse, who makes an election on the deceased spouse’s federal estate tax return claiming the unused exclusion of the first spouse to die. Thus, at the death of the surviving spouse, he/she will have both his/her own exclusion amount plus any remaining exclusion amount of the first spouse to die. Barring any lifetime gifts, a married couple can pass $10 million to estate beneficiaries free of estate tax. In order to carry the predeceased spouse’s unused exclusion amount, a timely estate tax return must be filed and an election must be made.
Those clients who have already used most or all of their $1 million gift tax exemption now have an additional $4 million with which to work to transfer wealth to the next generation. As with all gifting, this will also transfer the future appreciation on the assets transferred now.
Those clients who sold assets to an irrevocable trust in exchange for a promissory note may simply want to forgive all or part of the outstanding balance of those notes given the new 5 million dollar gift tax exemptions now in play.
As an important matter, we must now determine whether the formula clause contained in the revocable trust of a married couple will function as intended. For instance, with the increased exclusion amounts, and the potential to pass $10 million to beneficiaries free of estate tax, the classic ABC formula three trust structure (Survivor’s Trust/Marital Trust/Bypass Trust) may no longer be desirable or appropriate. However, in many cases the ABC three trust structure mentioned above is still important for non-tax reasons because under that system, separate property and community property assets are typically divided into a decedent’s share and a survivor’s share consisting of each spouse’s one half of the community property and all of his or her separate property. The decedent’s share runs for the benefit of the surviving spouse but then passes to the deceased spouse’s children or other heirs and not to a new spouse of the survivor or some other person.
One of the benefits of this structure is the control afforded to the first spouse to die by guaranteeing that his/her share of the estate will be distributed to remainder beneficiaries whom he/she has chosen during his/her lifetime. Under the new tax law, this can still be accomplished, but without the need to divide the deceased spouse’s estate into both a Marital and a Bypass Trust. The Bypass Trust also offers creditor protection to the surviving spouse.
Keep in mind, however that the substantial exclusion amount of $5 million falls back to $1 million in 2013. It is therefore important to draft plans which have some formula, either a disclaimer formula or a forced ABC formula, be in place for clients whose combines estates exceed $2 million in case Congress fails to exceed the current 5 million dollar exemptions.
An important choice must be made by the fiduciaries of estates of decedents that died in 2010. Fiduciaries have the option of electing to have their estates be subject to the federal estate tax at a 5 million dollar exemption level and obtain a full “step up” in basis under §1014 of the Internal Revenue Code to date of death value or alternatively elect out of being subject to the federal estate tax for 2010 and have the income tax basis of the assets in the estate remain that of the decedent before his or her death. The later position results in the heirs of the decedent receiving a “carry over” basis in the assets rather than a full “step up” to the date of death value of the assets. There are important upward adjustments allowed if one elects out of the estate tax, but in general these adjustments are limited to approximately $1,300,000.
This article is written with the goal that you will take a moment to consider how you are currently managing your planning activities around the ever changing Estate Tax Legislation. Find out how to develop a strategy that works during these tumultuous times in today’s article.
Quote To Ponder
“The first responsibility of a leader is to define reality,
the last is to say “Thank you.”
In between the two, the leaders must become a servant.”
~Max De Pree