How the 2010 Tax Relief Act could impact your estate

Richard J. Nelson, Director, Tax Strategies Group, Kreischer Miller

The 2010 Tax Relief Act has resulted in significant changes to the estate and gift tax rules, providing some clarity — at least for the next two years.

The act provides planning opportunities not only for the living but also for those who died in 2010, as the law is also applied retroactively. However, executors have been provided with a special savings choice and can opt out of the new rules.

The passage of the act also provides a good opportunity to review your will.

Smart Business spoke with Richard J. Nelson, the director of the Tax Strategies Group at Kreischer Miller, about the 2010 Tax Relief Act and what it may mean for you.

What are some of the important provisions of the Tax Relief Act?

For 2011 and 2012, the estate tax exemption will be $5 million and the maximum tax rate will be 35 percent. This is a significant increase in the exemption, which was scheduled to be $1 million in 2011, and a significant decrease in the tax rate, which was scheduled to be 55 percent. The $5 million exemption is per person, so for a married couple, this could mean a $10 million exemption.

The new law also provides a portability feature of the exemption amounts for married couples. Unlike prior law, any exemption that remains unused at the death of a spouse after Dec. 31, 2010, and before Jan. 1, 2013, is available for use by the surviving spouse in addition to his or her own $5 million.

For example, say a husband dies in 2011 with an estate of $2 million. The husband’s estate elects to permit the wife to use her husband’s unused exemption of $3 million. Assuming she has not made any prior taxable gifts, the wife has an available exemption of $8 million upon her death.

Because the new rules are only in effect for two years, both spouses would have to die prior to Jan. 1, 2013, to have this advantage apply. In the event that the wife remarries and the second spouse dies, the exemption would be $5 million plus the unused exemption of the second spouse.

Many wills are written with an allocation to a credit shelter trust, which is formed with the assets of an individual’s estate to take advantage of the exemption amounts. Assets placed in this trust, as well as any appreciation, are generally not subject to estate tax upon the death of the second spouse. During the surviving spouse’s lifetime, he or she is entitled to the income of the trust but is limited in how much of the principal that can be taken out of the trust without the permission of the trustee. For a decedent with an estate value of less than $5 million and a surviving spouse with limited assets of their own, a credit shelter trust may restrict the surviving spouse’s use of these assets.

With the new portability rules, a credit shelter trust may no longer be necessary.

What is the current situation with respect to the estate tax and gift tax exemptions?

The new law reunified the estate and gift tax exemptions at $5 million. Many people have previously taken advantage of the $1 million gift tax exemption. They now have an additional $4 million exemption available to them. Generally, you would consider gifting property that you believe will appreciate in value. Gifting takes the current value of that asset and the future appreciation out of your estate.

The annual gift tax exclusion remains unchanged at $13,000 per donee.

The generation-skipping tax (GST) has also been changed. The GST is an additional tax on gifts and bequests to grandchildren while their parents are alive. The exemption amount has been increased to $5 million and the tax rate reduced to 35 percent.

Do executors have flexibility in applying the rules for 2010 decedents?

Technically, the estate tax expired at the end of 2009, leaving 2010 with no estate tax. The new law revised and retroactively reinstated the estate tax to decedents who died in 2010. This leaves executors of decedents who died in 2010 a choice. The executor can either apply the new rules ($5 million exemption, tax rate of 35 percent on the excess and a step-up in basis to the heirs) or elect out of the new rules (no estate tax and the heirs inherit the property at modified carryover basis).

The new rules provide for a step-up in basis. This means that the basis of the assets the heirs receive will be the fair market value of the assets on the date of death or the alternative valuation date, which is six months later. If the executor elects out of the estate tax, the modified carryover basis rules apply, which generally means that the basis of the assets is the lower of the fair market value on the date of death or the adjusted basis of the property immediately before the death, plus an additional $1.3 million, which is allocated among the assets.

An additional increase of $3 million is allowed for a surviving spouse, for a total of $4.3 million.

The executor should choose whichever method will produce the lowest combined estate and income taxes for the estate and its beneficiaries. Generally speaking, it makes sense to apply the new rules to estates under $5 million.

For estates greater than $5 million, the executor should calculate the estate and income tax consequences under both methods to determine which is more advantageous.

Estate planning is something that everyone should consider. Even if your total estate is less than $5 million, it is important that you have properly drafted wills to take advantage of tax planning opportunities available to you and ensure that your intentions and wishes are carried out.

If you already have a will, now is the perfect opportunity to have it reviewed and updated.

Richard J. Nelson is the director of Kreischer Miller’s Tax Strategies Group. Reach him at (215) 441-4600 or [email protected]