2010 Tax Act The Thompson Law Firm Attorneys Portland Oregon

Significant (but Temporary) Changes to

Federal Estate Tax Laws in the 2010 Tax Act

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act that President Obama signed on December 17, 2010 ("2010 Tax Act") makes fundamental changes to the federal estate, gift, and generation skipping-transfer (GST) tax laws applicable in 2010 and beyond. In general, the 2010 Tax Act extends several provisions of the Bush tax cuts under the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") for an additional two years. Some of the most significant aspects of the 2010 Tax Act include:

Summary

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 percent maximum rate under prior law to a maximum estate and gift tax rate of 35 percent 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 2010 Tax Act sunsets at the end of 2012, thus making the foregoing changes temporary in nature.
Oregon's exemption amount remains unchanged at $1 million.

Increased Exemption and Reduced Top Rate

The 2010 Tax Act lowers federal estate and GST taxes for 2010, 2011 and 2012 by increasing the exemption amount (technically, the applicable exclusion amount) from $1 million to $5 million and reducing the top tax rate from 55% to 35%. The $5 million exemption is per person. Thus, there is a $10 million exemption for a married couple. Plus, as explained below, there is a new portability feature for married couples.

Gift Tax Changes

Under the 2010 Tax Relief Act, for gifts made in 2010, the exemption is $1 million and the gift tax rate is 35%. For gifts made after Dec. 31, 2010, the gift tax is reunified with the estate tax, with an applicable exclusion amount of $5 million and a top estate and gift tax rate of 35%.

Portability of Unused Exemption between Spouses

Under the 2010 Tax Act, any exemption that remains unused as of the death of a spouse who dies after Dec. 31, 2010 (the "deceased spousal unused exclusion amount" or "DSUEA") is generally available for use by the surviving spouse, as an addition to the surviving spouse's exemption. A surviving spouse may use the predeceased spousal carryover amount in addition to his or her own $5 million exclusion for taxable transfers made during life or at death. In technical terms, the 2010 Tax Act achieves this result for decedents dying and gifts made after 2010 by defining the applicable exclusion amount as the basic exclusion amount ($5 million for 2011, as indexed) plus the DSUEA.

If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by such surviving spouse is limited to the lesser of $5 million or the unused exclusion of the last such deceased spouse.

A DSUEA is available to a surviving spouse only if an election is made on a timely filed estate tax return (including extensions) of the predeceased spouse on which such amount is computed, regardless of whether the estate of the predeceased spouse otherwise must file an estate tax return. In addition, notwithstanding the statute of limitations for assessing estate or gift tax with respect to a predeceased spouse, IRS may examine the return of a predeceased spouse for purposes of determining the DSUEA available for use by the surviving spouse.

New EGTRRA Sunset

The provisions of the 2010 Tax Act are temporary. Under the new law, the sunset of the estate, gift, and generation skipping transfer tax provisions under EGTRRA, which was scheduled to apply to the estates of decedents dying, gifts made, or generation skipping transfers made after Dec. 31, 2010, is extended to apply to estates of decedents dying, gifts made, or generation skipping transfers made after Dec. 31, 2012. This means neither the EGTRRA rules nor the new 2010 Tax Act rules will apply to estates of decedents dying, gifts made, or generation skipping transfers made after Dec. 31, 2012.

Observations

Long Term Planning Remains Challenging. Generally, the estate and gift tax provisions of the 2010 Tax Act are very favorable to taxpayers, however, the law sunsets on December 31, 2012, immediately after the next election cycle. It is impossible to predict whether the 2010 Tax Act 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 2010 Tax 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 percent maximum estate and gift tax rate).

Planning for State Inheritance Tax Remains Critical. Oregon has a separate inheritance tax regime with a lower exemption amount ($1 million). It is critical that individuals living in or owning property located in states with a lower exemption amount address such estate tax exposure in their estate plans.

Gifting. From 2001-2010, the applicable exclusion amount for gift tax purposes has been $1 million. The 2010 Tax 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. Given the fact that the 2010 Tax Act will sunset without further Congressional action in 2012, clients are advised to consider and, if appropriate, implement estate planning techniques utilizing lifetime gifts, including business succession planning, before the December 31, 2012 sunset date.

Portability. The portability provision is intended to avoid the need for credit shelter trusts in estate planning documents. 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, we are advising clients to continue to use estate plans that incorporate credit shelter trusts.

Provisions That Did Not Pass. There are two key provisions that many commentators feared would be in the 2010 Tax Act, but were excluded. 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 2010 Tax Act. Therefore, these techniques continue to be available to move wealth to lower generations.

Annual Review Recommended. As always, we recommend 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.).

Please do not hesitate to contact The Thompson Law Firm with any questions that you might have or if you would like to discuss your estate plan in light of the 2010 Tax Act.