Additional Observations on the Gift Tax, State Estate Taxes and the Portability Provision

Increased Gift Tax Applicable Exclusion Amount

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.  There are several techniques that individuals can use to leverage this $5 million applicable exclusion amount and move considerably more wealth out of their estates.

To illustrate, individuals can now make gifts of $5 million to asset protection trusts, move all growth in such wealth out of their estates, provide a significant amount of asset protection for such assets, and the transferor may continue to be a discretionary beneficiary of such trusts, without any gift tax being assessed.

In addition, the increased gift tax applicable exclusion amount increases the amount of assets that individuals can transfer via an installment sale to a dynasty/grantor trust.  Under this estate planning technique, individuals can now make an initial gift of as much as $5 million ($10 million per married couple) to a dynasty trust, and then transfer as much as $45 million ($90 million for a married couple) to such dynasty trust in exchange for an installment note.  This technique works especially well for family businesses that are expected to grow significantly in value over time.

Given the fact that the Act will sunset without further Congressional action in 2012, we are advising clients that it would be prudent to implement estate planning techniques utilizing lifetime gifts before the December 31, 2012 sunset date.  Significantly, the Act preserves a favorable tax environment for making gifts by preserving the 35 percent gift tax rate for two more years.  Now that the threat of a gift tax increase to 55 percent beginning in 2011 has been averted, some individuals may be interested in postponing planned gifts in anticipation of the rate hike.

State Estate Taxes

Another blast from the past is back: the state death tax credit.  Many states have separate estate tax regimes with lower applicable exclusion amounts than the federal applicable exclusion amount.  When the credit was abolished, most states eliminated these symbiotic taxes.  It remains to be seen; however, which states will re-implement their own death taxes.  All states had benefited from these taxes by collecting revenues that would otherwise go to the federal government.  Yet, under the new estate tax rules, it appears that very few estates would be taxable.  It may be critical that the estate plans of individuals living in or owning property located in such states address such estate tax exposure.

Portability

One of the more notable provisions contained within the Act is the “portability” provision, which provides in general terms that if one spouse does not fully utilize his/her entire $5 million applicable exclusion amount, the unused portion can be used by the surviving spouse’s estate.  The significance of this is dramatic in terms of estate planning.  The entire concept of equalizing estates of husband and wife to the tax advantage of each spouse’s unified credit has been made unnecessary for tax purposes.  This 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.

However, 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.

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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.

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What’s NOT in The 2010 Tax Act
Published in: on February 17, 2011 at 8:10 pm  Leave a Comment  
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General Observations Regarding The 2010 Tax Act

Generally, the estate and gift tax provisions of the 2010 Tax Act are very favorable to taxpayers because of the substantial increase in the applicable exclusion amount, to $5 million, and the lower maximum estate and gift tax rate of 35 percent. The Act also addresses several technical estate, gift and GST tax issues in a manner that is favorable to taxpayers (e.g., the impact of the lapse of the estate tax, including the application of basis rules, on decedents passing away during 2010).

The GST exemption in 2011 and 2012 will be $5 million – equal to the exclusion used for estate tax purposes.  The GST tax rate for transfers made after 2010 is equal to the highest estate and gift tax rate in effect for such year – 35 percent for 2011 and 2012.  In 2010, the GST tax will apply, but the tax rate for transfers made in 2010 will be zero percent.  The GST exemption will be $5 million.

The Act also extends the following GST modifications enacted as part of EGTRRA:

  • The GST tax exemption will be allocated automatically to transfers to GST trusts made during life that are “indirect skips.”  An individual making direct or certain indirect skips may elect out of the allocation rules.  An “indirect skip” is a transfer that has an intermediary step before reaching the “skip person.”  The “skip person” is one that is two or more generations below that of the person making the transfer.

  • Under certain conditions, the GST tax exemption can be allocated retroactively.

  • Those inadvertently failing to make timely elections to allocate the GST exemption will have the opportunity to seek relief from Treasury.

  • A “qualified severance” of a trust into two or more trusts, under the governing instrument or local law, will be respected for GST purposes.

  • The value of property to be used for determining the inclusion ratio is the property’s finally determined gift tax value or estate tax value.

  • Substantial compliance with the statutory and regulatory requirements for allocating the GST exemption will suffice to establish that the GST exemption is allocated to a particular transfer or trust.

Temporary Fix

The Act is a temporary fix, which sunsets on December 31, 2012, immediately after the next election cycle.  It is impossible to predict whether it 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 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).

Contact our Tax Planning Attorney in Los Angeles today to review your estate plan.

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Additional Observations on the Gift Tax, State Estate Taxes and the Portability Provision
Published in: on February 17, 2011 at 7:58 pm  Comments (1)  
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Gift Taxes, GST and Misc Effects of The 2010 Tax Act

Gift Taxes

A “gift” is considered any transfer of property (real or personal) without receiving its full value in return.  For gifts made in 2010, the maximum gift tax rate is 35 percent and the applicable exclusion amount is $1 million. For gifts made in 2011 and 2012, the Tax Act limits the maximum gift tax rate to 35 percent and increases the applicable exclusion amount to $5 million.   As discussed below, this change provides an opportunity to move significant amounts of wealth free of estate and gift taxes.

Donors continue to be able to use the annual gift tax exclusion before having to use any part of their applicable exclusion amount. For 2010 and 2011, the annual exclusion amount is $13,000 per donee (married couples may continue to “split” their gift and may make combined gifts of $26,000 to each donee).

Generation Skipping Transfer (“GST”) Tax

The Act provides a $5 million GST exemption amount for 2010 (equal to the applicable exclusion amount for estate tax purposes) with a GST tax rate of zero percent for 2010. For transfers made after 2010, the GST tax rate would be equal to the highest estate and gift tax rate in effect for the year (35 percent for 2011 and 2012). The Act also extends certain technical provisions under prior law affecting the GST tax.

Miscellaneous

The Act also extends through 2012 several modifications enacted as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

These include:

  • Expanding the availability of installment payments for estates with interests in qualified lending and finance business;

  • Clarifying installment payment provisions, requiring that only the stock of the holding companies, not that of operating subsidiaries be nonreadily tradable.  (Estates taking advantage of these two provisions would have to make the required payments over five years rather than fifteen);

  • Expanding the availability of estate tax installment payments by broadening the definition of an interest in a closely held business; and

  • Allowing a deduction of estate taxes paid to any state or the District of Columbia for decedents dying after December 31, 2009.

The Act further grants extensions of time for the filing of a tax return for certain estates, making tax payments, or making a disclaimer with respect to an interest of property passing by reason of the decedent’s death.  In the case of an estate for a decedent dying after December 31, 2009, and before the Act’s date of enactment, the due date for this compliance will be the date nine months after the date of enactment.

Contact our Estate Planning Attorney in Los Angeles to review your estate plan today.

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General Observations Regarding The 2010 Tax Act
Published in: on February 17, 2011 at 7:36 pm  Comments (3)  
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Why (almost) Every Estate Plan in the U.S. Needs to be Rewritten Immediately

Almost every estate plan in the United States needs to be rewritten immediately.  Before the 2010 Tax Act, the federal estate tax was gradually reduced over several years and then eliminated for decedents dying in 2010.  Prior law provided that the estate tax, with a maximum tax rate of 55 percent and a $1 million applicable exclusion amount, would be reinstated after 2010.  Additional changes scheduled for years after 2010 affected the gift and generation- skipping transfer (“GST”) taxes.

The Act reinstates the estate tax for decedents dying during 2010, but at a significantly higher applicable exclusion amount of $5 million, and a lower maximum tax rate of 35 percent.  The exemption will be indexed for inflation, beginning in 2012.  This estate tax regime continues for decedents dying in 2011 and 2012. Unfortunately, this new regime is itself temporary and will sunset on December 31, 2012 and the prior estate tax regime, with a 55 percent maximum estate tax rate and a $1 million applicable exclusion amount, will be reinstated at that time.  There is no guarantee that the rules will remain in place permanently.  Among the range of possibilities is another complete repeal (highly unlikely) or a tightening of the rules.  However, Congress has shown that it has a difficult time generating a consensus on tax issues, so the status quo could continue beyond the next two years.

The Act also eliminates the modified carryover basis rules for 2010 and replaces them with the stepped-up basis rules that had applied before 2010. Property with a stepped-up basis generally receives a basis equal to the property’s fair market value on the date of the decedent’s death. Under the modified carryover basis rules that applied during 2010 before the Act, executors could increase the basis of estate property only by a total of $1.3 million (plus an additional $3 million for assets passing to a surviving spouse, for a total increase of $4.3 million), with other estate property taking a carryover basis equal to the lesser of the decedent’s basis or the property’s fair market value on the decedent’s death.

Leave it to Congress to create a “ginormous” loophole, a historic rift in the entire time-space continuum through which several billionaires waltzed on their way out of this mortal coil, even while TSA agents were frisking, x-raying, and imaging elderly people boarding airplanes.  The Act gives estates of decedents dying during 2010 the option to apply (1) the estate tax based on the new 35 percent top rate and $5 million applicable exclusion amount, with stepped-up basis, or (2) no estate tax and modified carryover basis rules under prior law.

The Act also provides for “portability” between spouses of the estate tax applicable exclusion amount for estates of decedents dying in 2011 and 2012 if both spouses die before 2013. Generally, portability allows surviving spouses to elect to take advantage of the unused portion of the estate tax applicable exclusion amount (but not any unused GST tax exemption) of their predeceased spouses, thereby providing surviving spouses with a larger exclusion amount.   Special limits apply to decedents with multiple predeceased spouses.  To preserve the first deceased spouse’s unused applicable exclusion amount, the executor for such spouse must file an estate tax return and make an election on such return, even if such an estate tax return would otherwise not be required.

Now is the time to take advantage of the increased exclusion amount. Contact our Estate Tax Planning Attorney in Los Angeles today.

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Gift Taxes, GST and Misc Effects of The 2010 Tax Act
Published in: on February 17, 2011 at 1:26 am  Comments (1)  
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Important Estate Tax Aspects of the 2010 Tax Act (the “Act”)

Was that the sound of another volcanic eruption from Eyjafjallajokull in Iceland?  Was it a lingering echo of vuvuzelas from the World Cup of 2010 in South Africa?  Or was it an enthusiastic cheer from the Bronx at the news that no estate tax would apply to the estate of billionaire George Steinbrenner?  No, that “thud” was the sound of Congress closing the book on its experiment with estate tax repeal.  The estate tax is back.

On December 17, 2010 President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “Act”). The Act substantially modifies federal taxation of income, gifts and estates, which impacts estate planning for many of our clients, and presents significant estate planning opportunities.  The Act temporarily reinstates and modifies the estate and generation-skipping transfer (GST) taxes retroactive to the beginning of 2010, and modifies the gift tax beginning in 2011.  Importantly, while the new estate tax regime will be effective in 2010, estates of decedents dying in 2010 can elect out of the Act’s regime and use former 2010 estate tax law – a zero rate and modified carryover basis rules.

This blog series summarizes the Act’s key changes and provides you with our observations about the Act’s impact from an estate planning perspective.   Please note that there are several important changes made by the Act that this blog series does not summarize.

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Why (almost) Every Estate Plan in the U.S. Needs to be Rewritten Immediately
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Published in: on February 17, 2011 at 1:14 am  Comments (1)  
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