New Estate & Gift Tax Rules

Estate tax legislation has been debated in Congress for several years. The recent Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Act) includes estate tax provisions for individuals who died in 2010, as well as those who die in 2011 and 2012. Here is a brief summary.

$5 Million Estate Tax Exemption and 35% Rate. For estates of individuals who die in 2010 through 2012, the Act establishes a $5 million federal estate tax exemption with the 2012 amount indexed for inflation. Big estates are taxed at 35% above the $5 million threshold.

Electing out of the Estate Tax in 2010. For estates of decedents who died in 2010, executors are permitted to elect out of the estate tax rules (the default rules), and instead choose the modified carryover basis rules for property transferred at death. Although no estate tax will be due, assets transferred at death will not get the step-up in basis to date of death fair market value, and the transferees will owe income tax on the appreciation on those assets. Determining whether to follow the default rules or elect out of the estate tax will depend on many factors that will require professional guidance.

Unused Estate Tax Exemption. For the first time, married individuals who do not use up their estate tax exemptions will be able to pass along unused amounts to surviving spouses. In other words, unused exemptions of individuals who die in 2011 or 2012 (but not 2010) will be "portable."

Unlimited Basis Step-ups for Inherited Assets. For heirs of decedents who die in 2011 and beyond, the rule is reinstated that allows the federal income tax basis of inherited capital-gain assets (such as real estate and stock) to be stepped up to reflect fair market value on the date of death. This favorable rule is also reinstated for decedents who died in 2010, unless the estate elects to instead use the modified carryover basis rule. With the restoration of the unlimited basis step-up rule, heirs will not owe any federal capital gains taxes on appreciation that occurs through the date of death—as long as that date is after 2010 or, for decedents who died in 2010, if their estate does not elect to use the modified carryover basis rules.

Estate and Gift Tax Exemptions and Rates Are Equalized. The Act sets the lifetime federal gift tax exemption for 2011 and 2012 at $5 million—with the 2012 amount indexed for inflation (likewise for the generation-skipping transfer tax exemption). Thus, the gift and estate tax exemptions are equalized for 2011 and 2012. This is a huge improvement over the previous $1 million gift tax exemption (which continued to apply for 2010). An unmarried person can now give away up to $5 million while alive without paying any gift tax, and a married couple can give away up to $10 million. However, to the extent you dip into your gift tax exemption, your estate tax exemption is reduced dollar-for-dollar. The tax rate on 2011 and 2012 gifts in excess of the $5 million exemption is 35%, the same as the estate tax rate. Again, due to sunset provisions, the gift tax exclusion reverts back to $1 million after 2012.

Minimizing estate and gift taxes is a complex process. So, please contact us for information on how to reduce these onerous taxes.