Publications: Opportunities, challenges exist for estate planning

On Dec. 17, 2010, President Barack Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Jobs Creation Act of 2010 (the 2010 act). The enactment of this law creates multiple opportunities, and some challenges, for estate planning professionals.

The 2010 act provides certainty, but only for two years, for gift and estate tax planning. On Jan. 1, 2013, the law in effect prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA or the Bush tax cuts) will be reinstated. The 2010 act also adds some confusion relative to generation-skipping tax and provides tax treatment options for those estates of the decedents dying in 2010 when there was no estate tax.

Clarity in exemptions for those dying in 2010
The 2010 act provides two tax treatment options for taxing the estates of the decedents dying in 2010. The representative of the estate can elect to be taxed under an ʺestate tax regimeʺ or a ʺcarryover basis regime.ʺ If the representative chooses the ʺestate tax regime,ʺ the estate is permitted a $5 million exclusion (adjusted for certain lifetime gifts) and the assets of the estate receive a basis adjustment to values on the decedentʹs date of death (or, if applicable, values on the date six months after the decedentʹs death, the alternate valuation date). If the representative chooses the ʺcarryover basis regime,ʺ there is an unlimited exclusion and thus there is no estate tax payable, but the income tax basis in the assets of the estate is not adjusted to fair market value on the date of the decedentʹs death. Rather, the beneficiaries receive up to a $1.3 million ʺstep-upʺ adjustment which the representative of the estate would allocate to assets which have appreciated since being acquired by the decedent. In addition, if property passes to a surviving spouse, either outright or in a certain type of marital trust, an additional $3 million increase in basis is provided for such property. The representativeʹs choice between the two regimes becomes quite difficult and complex in those estates which have values close to the exclusion amount because the gain achieved by opting out of the estate tax may be less than the increase in income tax incurred by the beneficiaries upon the sale of the assets. In all cases the representative should contact an estate planning professional to ʺrun the numbers.ʺ Time remains for making these decisions since the government has yet to provide the form (believed to be Form 8939) upon which the election is to be made and a date for filing.

Increase in estate and gift tax exemptions
The estate and gift tax applicable exclusions are unified and each is set at $5 million. Prior to 2010, the estate tax exclusion was $3.5 million per taxpayer and the lifetime gift tax exclusion was $1 million per taxpayer. These amounts were reconciled at death by adding back any lifetime gifts which utilized exemption and then calculating the estate tax applying the full $3.5 million exemption. Practitioners were not surprised by the increase in exemption from $3.5 million (on Dec. 31, 2009) to $5 million (retroactive to Jan. 1, 2010, for estates choosing the ʺestate tax regimeʺ). However, we were pleasantly surprised that the gift tax exclusion per taxpayer was raised from $1 million, where it had been since 2004, to $5 million. This change presents a myriad of planning opportunities, but as stated above, the window is limited.

Portability of spouseʹs unused exemption
The 2010 Tax Relief Act provides for portability of a deceased spouseʹs unused exemption. Planners, at least for the years 2011 and 2012, do not have to equalize spousesʹ estates to assure maximum utilization of each spouseʹs exemption. Any unused federal estate tax exemption of a deceased spouse may be used by the surviving spouse provided the representative of the deceased spouseʹs estate makes an election on a timely filed federal estate tax return to allow the surviving spouse the use of the unused exemption. The portability could be lost, however, if the surviving spouse remarries, and the second spouse then dies, because the portability rule applies only to the last deceased spouse. However, if the second spouse has a greater unused exemption, it may be a benefit.

Decrease in estate and gift tax rates
The maximum estate and gift tax rate is set at 35 percent. This caught some practitioners by surprise, especially those who convinced their clients to make gifts in 2010 to take advantage of a 35 percent gift tax rate.

Indexing exemptions for inflation
The estate tax applicable exclusion of $5 million is indexed for inflation beginning in 2012. This effectively is a one-year adjustment since the law expires on Dec. 31, 2012, and there may be no adjustment at all given todayʹs sluggish economy. The concept of ʺindexing for inflation,ʺ however, is a good one and hopefully one which will be included in future law changes. During the 10-year period from 1987 to 1997, the exemption was stuck at $600,000. Had it been indexed, it would have been nearly $1 million by 1998, when Congress raised it from $600,000 to $625,000.

Generation-skipping transfer tax impact
The 2010 act retroactively reinstates the generation-skipping transfer (GST) tax on transfers made to skip persons (simply defined herein as grandchildren) after Dec. 31, 2009, sets the GST tax exemption at $5 million for years 2010, 2011 and 2012 and sets the GST tax rate at zero percent for 2010 transfers and 35 percent for 2011 and 2012 transfers. The 2010 actʹs treatment of 2010 GST transfers to certain trusts may greatly complicate future treatment of distributions from those trusts to skip persons. Because of the zero percent tax rate for 2010 GST transfers, it might be assumed that the GST tax is not and will not be applicable to such transfers. However, because of the interplay between Sections 2664 and 2653(a) and Chapter 13 of the Internal Revenue Code (which analysis is beyond the scope of this article), only those 2010 transfers which were either outright to the grandchild or to a ʺskip trustʺ (a trust where all beneficiaries are grandchildren) are clearly not subject to GST tax. Trusts created in 2010 for the benefit of both children and grandchildren (nonskip trusts) may be subjected to GST tax upon post 2010 taxable distributions (a distribution to a grandchildren when a child remains a beneficiary of the trust) and taxable terminations (distribution when no child remains a beneficiary). There are many questions and few answers to the dilemma caused by the 2010 actʹs treatment of 2010 GST tax transfers. We will have to wait and see.

Limited window or opportunity
All of the above provisions are set to expire on Dec. 31, 2012, and the law in effect prior to the Bush tax cuts is reinstated. Thus on Jan. 1, 2013, the federal estate and gift tax exemptions return to $1 million with maximum rates of 55 percent, the federal GST exemption returns to $1 million with a  tax rate of 55 percent. If a tax payer has previously used his/her $1 million lifetime gift exemption ($2 million, if a married couple), the taxpayer, for the next 17 months, has an additional $4 million ($8 million, if a married couple) which can be given away gift tax free. When combined with other gift strategies such as GRATs, ILITs, Split Interest Charitable Trusts, QPRTs, sales to grantor trusts, etc., there is a tremendous opportunity to move assets and all future appreciation on those assets to the next generation and beyond tax free. The window of opportunity is limited, but the opportunities are not.

Reprinted with permission from Chicago Daily Law Bulletin.