KEY ESTATE AND GIFT TAX

PROVISIONS OF THE ACT.

Estate Taxes:

Before the Act, the federal estate tax was gradually reduced over several years and then eliminated for decedents dying in 2010. The prior law also 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.

The new Act reinstates the estate tax for decedents dying during 2010, but at a significantly higher applicable exclusion amount of $5 million, or $10 million per married couple, and a lower maximum tax rate of 35 percent.  This estate tax regime continues for decedents dying in 2011 and 2012.  Unfortunately, it is itself temporary and will once again sunset on December 31, 2012 when the prior estate tax regime, with a 55 percent maximum estate tax rate and a $1 million applicable exclusion amount, being reinstated at that time. Accordingly, this change provides an unprecedented opportunity to move substantial amounts of wealth out of individuals' estates. 

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 passage of 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), 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.

Portability:

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. Portability means 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.  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.

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.

Gift Taxes:

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 Act limits the maximum gift tax rate to 35 percent and increases the applicable exclusion amount to $5 million.  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.  This 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 2011, the annual exclusion amount is still $13,000 per donee (married couples may continue to "split" their gift and may make combined gifts of $26,000 to each donee).

State Estate Taxes:

Many states, such as New York, have separate estate tax regimes with lower applicable exclusion amounts than the federal applicable exclusion amount.  New York in particular has a $1 million estate tax exclusion amount. It is critical that the estate plans of individuals living in or owning property located in such states address such estate tax exposure. 

Things Not In the Act:

There are two key provisions that many commentators feared would be in the Act, but which were not included in it.  Specifically, there have been several proposals to place limits on Grantor Retained Annuity Trusts ("GRATs"), which allow individuals to transfer wealth out of their estates with as little as a zero estate or gift tax cost that would have made GRATs less valuable from an estate planning perspective.  There have also been several proposals to limit valuation discounts in connection with certain estate planning techniques such as family limited partnerships. There were no such provisions included in the Act.  Therefore, these techniques continue to be available to move wealth to lower generations.

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 political football 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). 

As always, we recommend that clients review their estate plans periodically and/or whenever a significant life event occurs (e.g., birth of a child, death of a spouse, purchase of new home, etc.).

For clients with substantial amounts of wealth and with closely held businesses, we highly recommend that such clients consider using lifetime gifts to take advantage of the current $5 million lifetime gift tax applicable exclusion amount, which will expire absent further Congressional action at the end of 2012.

Please do not hesitate to contact us with any questions that you might have or if you would like to discuss your estate plan in light of the Act.