- R. J.
Estate Planning Client
In the last few days of December, 2010, Congress delayed the scheduled return of the federal estate tax for estates exceeding $1 million, but only for two years. Any estate of a person dying in the years 2011 and 2012 will have an exemption (basic exclusion amount) of $5 million. And therefore, estate tax planning will continue to be fraught with uncertainty.
From 2001 to 2009 we became accustomed to ever increasing estate tax exemptions, starting with $675,000 and growing to $3.5 million in 2009 with a top rate of 45%. Throughout 2010, we had no estate tax law whatsoever but were staring at a sunset of the repeal which would have taken us to an exemption of $1 million and a top rate of 55%. At least for two years, we have a substantial reprieve.
We have also been temporarily relieved of an onerous tax measure known as carryover basis. If you bought a stock many years ago at $20 that is worth $80, and died before 2010 still owning that stock, your heirs would have had a stepped-up basis to the value on the date of your death. So if your heirs sold it at $85, they would have a capital gains tax to pay on only $5 of gain.
After 2009, unless an exception applied, your heirs would have no stepped-up basis, so if your heirs sold the stock at $85, they would have a capital gains tax to pay on $65 gain. Furthermore, the heirs would have to scour through your records to determine how much you paid for each stock - sometimes not a small task. Thank goodness, the surviving spouse was able to step-up as much as $3 million in capital gain basis for "qualified spousal property" and other beneficiaries were able to step-up as much as $1.3 million of capital gain basis. With the 2010 Tax Relief Act, that carryover basis requirement is gone, at least until 2013.
For decedents who died in 2010 the heirs have two alternatives: (1) pay estate tax (based on a $5 million exemption and 35% top rate) and get a step-up in capital gains basis, or (2) not pay estate tax and accept carryover basis. With this carryover basis, an heir gets the decedent's original basis, plus certain increases, which can be substantial. The choice will depend on whether it is costlier ultimately to pay more capital gains tax (due to the inherited low cost basis) or immediately pay estate tax based upon an exemption of $5 million and a 35% tax rate. The decision may depend on how long the heirs will hold the asset before selling.
A new aspect of the law (but one that has been discussed for a long time) is allowing the unused exemption of the first spouse to die to be used when the second spouse dies. It is useful if the spouse with wealth of less than the exemption dies first. If the husband dies with an estate of $2.4 million, he uses up $2.4 million of his exemption but wastes the rest of his $5 million exemption (he did not use $2.6 million). Under the new law, at his wife's death, she will have a $5 million exemption of her own plus his unused exemption of $2.6 million. We will no longer need to equalize estates between spouses, at least for this purpose.
We have returned to the law as it existed many years ago when the gift tax and estate tax were "unified." The gift tax and estate tax have a shared exemption and the same rates. Therefore, gifts made after December 31, 2010, will be exempt to the extent of $5 million. If all or a portion of that exemption is used up in gift giving, then it is no longer available as an exemption at time of death for the estate tax. (The annual exclusion from gift tax is still part of the law and for 2011 will be $13,000.)
For many years we have had a totally separate tax designed to raise revenue from those families wealthy enough to skip one or more generations (and therefore skip the payment of estate taxes except every few generations). We still have such a tax. Its exemption has been increased to $5 million as well. Its rate is at 35%.
Planning Point: For now, those with an estate of less than $5 million should be concerned primarily with (1) preparing trusts or powers of attorney to plan for unexpected incapacity during life, and (2) updating your will or trust to direct the division of our estate among your chosen beneficiaries at death.
Planning Point: For those with an estate of more than $5 million, the low interest rate and depreciated values present a superb opportunity for estate planning. For instance the same $5 million exemption for estate tax can be used instead for gifting. Gifts of assets that you expect will increase in value can be especially useful in passing that increased value to the next generation without taxation.
U.S. TREASURY DEPT. CIRCULAR 230 NOTICE: Unless expressly indicated, any U.S. federal tax advice included in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding U.S. federal tax-related penalties or (ii) promoting, marketing or recommending to another party any tax-related matter addressed herein. Where appropriate the addressee should seek advice concerning the matter from an independent tax advisor.
This information is general in character and is not intended as legal advice. Application
 of the law may differ substantially in individual situations. Before taking any action as a
result of this information, a professional advisor should be consulted.