Gift Tax And GST Tax Reduction
The most significant feature of the new law is the dramatic, but temporary, increase in the gift tax and GST tax exemption amounts. Prior to the change each individual could make tax free gifts during his or her lifetime in the amount of $1,000,000,whether those gifts were to children or to grandchildren. This amount was in addition to so-called “annual exclusion” gifts of $10,000 per year (indexed so that the current exemption is $13,000). Lifetime gifts in excess of the $1,000,000, however, were subject to gift tax at prevailing estate tax rates (for 2009 generally 45%). If the transfer was to a grandchild, not only was the amount in excess of $1,000,000 subject to a gift tax of 45% but, if the grandchild’s parents were still alive on the date of the gift, an additional GST tax, also at the 45% tax rate, was imposed. Thus, gifts to grandchildren which exceeded $3,500,000 were, before 2010, subject to tax at an effective tax rate of about 70%. Under the new law, during 2011 and 2012, the gift tax exemption and the generation skipping tax exemption amount is increased to $5,000,000, reduced by any portion of the $1,000,000 and $3,500,000 exemption previously utilized. Thus, a couple who have not previously utilized any portion of their $1,000,000 exemption can make tax free gifts to grandchildren during 2011 and 2012 with a total value of $10,000,000 tax free. However, unless there is a law change before 2013, that same couple, making that same transfer on January 1, 2013, will pay a combined gift and GST tax of more than $5,000,000!
Lower Rate and Higher Exemption for 2011 and 2012
For estates of individuals dying in 2009, the top estate tax rate was 45% and there was a $3.5 million exemption. The estate tax does not apply to estates of individuals dying in 2010 who elect to forego a “step-up” in basis of estate assets to their fair market value at the date of death. (See more below). The top rate was scheduled to rise to 55% for estates of individuals dying after 2010, and the exemption was to be $1 million. For 2011 and 2012, the 2010 Tax Relief Act reduces the top rate to 35%. It also increases the exemption to $5 million for 2011 with a further increase for inflation in 2012. But these changes are, at this time, only temporary. After 2012, unless Congress acts, the top rate will return to 55%, and the exemption will go back to $1 million.
Special Tax Savings Choice for Persons Deceased in 2010
The 2010 Tax Relief Act allows estates of decedents who died in 2010 to choose between (1) estate tax (based on a $5 million exemption and 35% top rate) and a step-up in basis, or (2) no estate tax and modified carryover basis. The executor should make whichever choice would produce the lowest combined estate and income taxes for the estate and its beneficiaries. This would depend, among other factors, on the decedent’s basis in the assets immediately before death and how soon the estate beneficiaries may sell the assets.
New Portability Feature
Under the 2010 Tax Relief Act, any exemption that remains unused as of the death of a spouse who dies after Dec. 31, 2010 and before Jan. 1, 2013 is generally available for use by the surviving spouse in addition to his or her own $5 million exemption for taxable transfers made during life or at death.
What The Future Holds
We believe that it is more likely than not that the $5,000,000 estate tax exemption will at some point be made permanent. We would also expect, though with somewhat less confidence, that the $5,000,000 generation skipping tax exemption will be made permanent. We are hopeful, but also somewhat less confident, that the 35% maximum estate and gift tax rate will not be increased. We have serious concerns that a condition for making some or all of the beneficial changes in the 2010 Tax Relief Act permanent may be the restriction of certain techniques which are presently available such as short-term Grantor Retained Annuity Trusts, family partnership discounts, and the like. Thus, for those individuals with estates in excess of $10,000,000, 2011 and 2012 may be a critical window of opportunity in which to undertake major gift and estate planning transactions.
The estate tax benefits under the new law are substantial, but may be temporary. For couples with assets in excess of $10,000,000, estate planning to reduce taxes remains an important consideration and 2011 and 2012 may be a critical time in which to engage in tax reducing transactions.