2010 Tax Relief Act Temporarily Reforms Estate and Gift Taxes

JAN 19, 2011

The 2010 Tax Relief Act, signed into law by President Obama on December 17, 2010, brings sweeping changes to federal estate tax taxes, gift taxes and generation skipping transfer taxes for the 2010-2012 tax years. However, many of the provisions in the act will expire January 1, 2013, making it more important than ever to plan now before uncertainty regarding the future of these provisions sets in.

The power of the temporary estate tax provisions in particular is put into perspective by looking back in history. Less than half of one percent of people who die in 2011 will pay the estate tax. Conversely, in 1977, 10.5% of people who died paid the estate tax.

The heirs of people who died in 2010 have two options: they can treat the estate using the tax laws of either 2010 or 2011. The tax laws of 2010 require that one calculates the capital gains on all assets in the estate to determine if their level is above the allowed level by the IRS. The artificial step up in basis is $1.3 million to any heir and $3 million to a surviving spouse. For decedents who died in 2010, estate tax returns are due by September 2011.

In contrast, under the new Tax Relief Act, the new estate tax exemption and rate is applicable to anyone dying in 2010, 2011, or 2012. The tax exemption is increased to $5 million, with a tax rate of 35% for anything beyond that. A full step-up in tax basis will apply to all inherited assets. Moreover, through 2012, if a decedent does not use all of his or her estate tax exemption amount, the executor may transfer the unused amount to the surviving spouse under the new law of portability. Using portability, a couple may transfer up to $10 million to heirs free from estate tax.

In addition to estate taxes, the gift tax exemption, including continuation of the current rate, is also affected. Prior to the 2010 Tax Relief Act, any individual could gift up to $1 million during his or her lifetime without incurring the 35% gift tax. Now, any individual can gift up to $5 million during 2011 or 2012 without incurring the 35% rate. A decedent’s spouse may also use any of the remaining amount up to $5 million that the decedent did not gift. As a result, up to $10 million, plus any additional increase in value, may be gifted during a couple’s joint lifetime free from tax.

Also,$13,000 may be gifted annually without gift tax, and direct payment of tuition is not subject to the gift tax. Finally, the new tax law changes the generation skipping transfer (GST) amount and rate. There is no GST due for gifts made by grandparents to grandchildren through the end of 2010. Any such gift may be made directly or in trust, but a 35% gift tax rate will be imposed on any gifts made in excess of $1 million in the grandparent’s lifetime. In 2011 and 2012, any such gift to a grandchild will incur a gift tax and a GST tax of 35%. The new law does not provide for portability of the GST tax exemption among spouses, but in 2011, a couple can gift up to $10 million to grand or great-grandchildren free from the 35% GST tax.

With careful planning, many taxpayers can make the most of these new tax laws while they last. Remember, unless anything is done to make these new laws permanent, they are slated to sunset January 1, 2013.