tax return form

Estate and Gift Tax Rules Change

On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. Included in this act were major changes to the estate and gift tax laws for 2011 and 2012. It is important to review your estate plans and understand these rules and and how they may affect your estate plans.

As many people will recall, the last ten years have been a confusing time when deciphering the estate and gift tax rules. Initially, the “Bush Tax Cuts” increased the amount each of us could pass free of estate tax (often called the exemption) and reduced the rate of the tax on assets in excess of the exemption. In 2009 the estate and gift tax exemption was $3.5 million and the tax rate was 45%. In 2010, the estate tax was eliminated for one year. In December 2010, Congress enacted the 2010 Tax Relief Act.

The 2010 Tax Relief Act imposed the following estate and gift tax changes:

1. The estate and gift tax exemptions were unified. A unified tax system means that we can use the exemption against gifts during our lives or against our estates at our deaths.

2. The estate and gift tax unified exemption was set at $5 million. This amount is indexed for inflation after 2011 and will therefore increase accordingly.

3. The gift and estate flat tax rate will be 35% on amounts exceeding the exemption.

4. The estate tax exemption is portable between spouses. A surviving spouse will be permitted to use any unused portion of a deceased spouse’s exemption in addition to the surviving spouse’s own exemption. In essence if a deceased spouse had not used any exemption the surviving spouse will have a $10 million exemption.

Related to the estate tax changes were changes to a few other tax systems with which we have grown familiar. These included:

1. Under the pre-2010 estate tax rules, capital assets were permitted a step-up in basis at the time of death. Basis is an accounting term which refers to the amount of investment in an asset for tax purpose. If the basis is stepped up at the time of death it eliminates the capital gains tax which otherwise would have been due on the assets. The step-up was lost in 2010 when the estate tax was eliminated. The step-up in basis has been reinstated under the Tax Relief Act of 2010.

2. A generation-skipping tax is imposed (in addition to the estate tax) if more than an exempt amount is passed to grandchildren or people deemed to be more than one generation younger than a donor. In 2011 the generation-skipping tax exemption is set at $5 million dollars. It is also indexed for inflation after 2011.

3. The charitable rollover provisions from prior laws were extended retroactively. A taxpayer who is 70 ½ years of age or older may make a tax-free distribution to a charity from their IRA of up to $100,000.

While implemented in December, 2010 these rules only apply for the years 2011 and 2012. Unless action is taken prior to December 31, 2012, the estate and gift tax laws in 2013 will revert back to what we had expected in 2011 without this intervening legislation. The gift, estate and generation-skipping exemption will return to $1 million and the maximum tax rates will be 55%.

Under the Tax Relief Act of 2010 approximately 35,000 estates in 2011 will not be subject to federal estate tax. The changes in the law permit us to consider actions which may further reduce exposure to future taxation.

It is therefore important to meet with your advisors and review your estate plans in order to make sure your documents are up-to-date and maximize the tax savings opportunities which might be available.