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This client alert is intended to inform you of developments in the law and to provide information of general interest.   It is not intended to constitute legal advice regarding a client's specific legal issues and should not be relied upon as such.  This client alert may be considered advertising under the rules of the Massachusetts Supreme Judicial Court.
December 27, 2010

Estate Planning Opportunities After the 2010 Tax Relief Act


As you know from our previous alerts, President Obama recently signed into law a two year tax compromise, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the "Tax Relief Act"), settling some major questions about the federal estate, gift, and generation-skipping transfer tax law until January 1, 2013.

 

Because the Tax Relief Act is a relatively temporary fix, unless Congress takes further action within the next two years, at the end of 2012 we will again be facing uncertainty regarding the ultimate fate of federal transfer taxes.

 

The following chart depicts the major estate, gift, and generation-skipping transfer tax provisions of the Tax Relief Act:

 

 

2009

2010

2011 and 2012

2013

Tax

Exemption

Rate

Exemption

Rate

Exemption

Rate

Exemption

Rate

Gift

$1M

45%

$1M

35%

$5M**

35%

$1M(?)

55%(?)

Estate

$3.5M

45%

$5M*

35%*

$5M**

35%

$1M(?)

55%(?)

GST

$3.5M

45%

$5M

0%

$5M**

35%

$1.4M(?)**

55%(?)

 
In light of these changes, we recommend reviewing your estate plan and considering the following: 

Additional gifting in 2010?

 

Due to the increase in the gift tax exemption to $5,000,000 in 2011 and the continuation of the 35% tax rate, it is advisable to put off gifts to children, nieces and nephews (and other "non-skip" persons) in excess of the $13,000 annual exclusion until after the new year. 

 

It may be advisable to make gifts to grandchildren, grandnieces, grandnephews, and other more remote descendants in 2010 since under the Tax Relief Act the generation skipping transfer tax (GST) exemption is $5,000,000 and the GST tax rate is zero.  Such gifts will necessitate the filing of a gift tax return for 2010 if you choose to elect out of automatic allocation (the automatic use of your GST exemption required under the law for such gifts) in order to save more of your GST tax exemption for use in coming years and have the GST transfer be taxable at the zero percent rate.

 

Your gifts could be made outright to the person, to Uniform Transfers to Minors Accounts (UTMA), to 529 plans, and to certain types of trusts.

 

You should be aware that if you have already used up your entire $1,000,000 gift tax exemption amount, then making additional gifts to grandchildren in 2010 to take advantage of the zero percent GST tax rate would result in a gift tax in 2010 at the rate of 35%.  If you have not used your $1,000,000 gift tax exemption, you may want to use it before year end.  By way of example, if you give $1,000,000 to grandchildren in 2010, you will have no gift tax to pay (due to the $1,000,000 exemption) and no GST tax to pay (zero percent GST rate in 2010).  However, if you have already used all of your lifetime $1,000,000 gift exemption, there would still be no GST tax but you would owe a gift tax of $350,000 (35% of $1,000,000).  If instead you wait until 2011 to make this $1,000,000 gift, there will be no gift tax (due to the additional unused $4,000,000 exemption) and no GST tax (covered by the $5,000,000 exemption).

 

Remember that you can still take advantage of the $13,000 per person per year gift tax annual exclusion for 2010, if you have not yet done so.  Also, gifts of tuition payments and payment of medical expenses (if paid directly to the institutions) are still tax-free and can be made at any time.

 

Distributions from (or terminations of) Non-Exempt GST trusts before year-end. 

 

Until the end of the year, due to the zero percent GST tax rate under the Tax Relief Act, GST distributions that would otherwise be subject to tax can be made tax-free.  In addition, a non-skip beneficiary, such as a child, may be able to disclaim an interest (or exercise a limited power of appointment) to pass trust assets to a skip person in 2010.  If the amount disclaimed (or appointed) does not exceed the $1,000,000 gift tax exemption for 2010, the transfer will not be taxable to the child and no GST tax will apply due to the zero percent tax rate.

 

This may be a once in a lifetime opportunity that should strongly be considered in applicable circumstances.

 

Consider how to make use of the additional $4,000,000 gift tax exemption during 2011 and 2012.

 

Because the Tax Relief Act is only in effect for two years, it may be that the additional $4,000,000 lifetime exemption amount will only be available in 2011 and 2012.  Therefore, you should begin to consider how to take advantage of this additional exemption amount before it may be lost.

 

Executors of estates of decedents who died in 2010 have a choice to make.

 

Under the Tax Relief Act, the estate tax is no longer repealed.  However, the federal estate tax exemption amount has been increased to $5,000,000, with a tax rate of 35%.  With this reinstatement of the estate tax, the "step up in basis" rules for income tax purposes will also apply. 

 

However, the Tax Relief Act also allows the executors of estates of decedents who died in 2010 to elect to have a zero estate tax apply to the estate.  In such case a "modified carryover basis" will be applied to the estate assets, possibly causing a capital gain tax on select assets when the assets are eventually sold. 

 

If the executor takes no action, the $5,000,000 exemption amount applies.  The executor may "opt out" on a timely filed estate tax return (due in September 2011) in order to have the zero estate tax/carryover basis rules apply to the estate.  The decision regarding whether to opt out should be made on a case-by-case basis.  In general, if the value of the estate is $5,000,000 or less, the executor should not opt out.  There will be no estate tax and there will be a full "step up" in basis to the value of the assets on the decedent's date of death.  If the estate is over $5,000,000, the executor needs to analyze whether opting out will create a better overall tax effect. 

 

Portability of deceased spouse's unused exemption amount.

 

Under our prior estate tax law, if a person died without utilizing his estate tax exemption, the exemption was forever lost.  The Tax Relief Act changes this result.  If an individual dies without fully utilizing his or her estate tax exemption, the executor of the estate can elect to transfer the unused exemption amount to the decedent's surviving spouse.  This is known as "portability."  Regardless of the size of the estate, an estate tax return for the decedent must be filed in order to make this election.  Portability applies beginning in 2011, not to decedents who die in 2010.  In addition, there is no portability for any unused GST exemption. 

 

Even with portability, we recommend that married couples should continue to structure their estate plans to take full advantage of their estate and gift tax exemptions by using "Bypass Trusts" and splitting up ownership of their assets.  There are several reasons for this:

 

  • Appreciation of assets placed in the Bypass Trust will escape estate taxation in the survivor's estate.
     
  • Creditor protection for Bypass Trust and Marital Trust beneficiaries is achieved.
     
  • Massachusetts does not recognize portability; Bypass Trusts will preserve the $1,000,000 Massachusetts estate tax exemption amount.
     
  • The GST tax exemption is not portable.
     
  • Portability is dependent on the executor making an election to pass the remaining exemption amount to the surviving spouse.

 

What about GRATS?

 

Grantor Retained Annuity Trusts (GRATs) are not dealt with in the Tax Relief Act.  There have been several attempts in Congress during the past year to require a minimum of a ten year term for all GRATs.  This requirement would have diminished the effectiveness of a GRAT as a wealth transfer tool.  Because the Tax Relief Act is silent with respect to GRATs, for now at least, GRATs with terms of shorter than ten years may still be used.  This means that GRATs remain a viable planning tool, at least for the short term.

 

Our Recommendation

 

Because of these complexities and the uniqueness of each situation, we strongly recommend that you contact us to discuss how the new transfer tax rules affect your own estate plan.  Substantial gifts should not be made until you consult with a tax professional so that the effects of the gifts can be completely understood.  Finally, please keep in mind that, although the federal estate tax law has changed, the Massachusetts estate tax law has not.  Therefore, planning for the Massachusetts estate tax is still necessary.  We are available to help with any questions you may have.



**  Indexed for inflation.

*   Executors of 2010 estates can choose to elect into the "no estate tax/modified carry over basis" rule 
    that
existed under the old tax law.