The Impact of the 2010 Tax Act on Estate Planning

In late December, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Act”). The enactment of this legislation provides Financial & Investment Management Group clients several estate planning opportunities that have never before been available. Unfortunately, the Act is set to expire on January 1, 2013, so its opportunities have limited availability, and planning past 2012 will continue to be a challenge.

One of the most significant components of the Act is the unification of the gift, estate and generation-skipping transfer (GST) tax exemption set at $5 million per individual and $10 million for a married couple, and a top estate, gift and GST tax rate of 35% with an unlimited step-up in basis for qualifying estate assets. For someone who died in 2010, the $5 million exemption amount and 35% top estate tax rate can apply retroactively if an election is made. Recall, in 2010, there was no estate tax, but rather a modified carryover basis rule that included a step-up in cost basis of up to $1.3 million relating to the appreciation inherent in non- IRA assets passing through the estate, and an additional $3 million of basis step-up for assets left to the surviving spouse. You should consult with your attorney to determine which election is most appropriate for your situation.

Another significant aspect of the Act is the introduction of the “portability” feature for the estate tax exemption. In the past, for a married couple, if you failed to take advantage of the full estate exemption upon the first spouse’s death, you lost any remaining exemption amount. With the introduction of the portability provision, each spouse has $5 million of estate exemption that can be used toward their estate. However, now, any unused portion can be carried over to the surviving spouse and added to the exemption for his/her estate. Don’t throw out equalizing your estate or your by-pass trusts just yet. The portability expires at the end of 2012, and how Congress will elect to treat any portable amount that comes into play for a decedent in 2011 or 2012 is of question.

For 2011 and 2012, based on the increased GST exemption limit to $5 million, clients have a great opportunity to make large gifts to multigenerational or dynasty trusts. If a married couple structures a generation-skipping gift to a dynasty trust for the benefit of children and their descendants, up to $10 million can be exempt from both gift and GST taxes. As a note, the portability provision discussed above does not apply to the generation-skipping tax, and a decedent’s unused GST exemption is not carried over to the surviving spouse. In addition, the favorable gift tax exemption increase from $1 million to $5 million and lower gift tax rates provide additional incentives to clients with significant estates to explore lifetime gifting strategies over the next two years.

The new law also contains a provision that might help some clients complete their charitable intentions more efficiently. For the 2011 tax year, Congress has extended the Qualified Charitable Distribution opportunity for individuals over 70½ to direct all or a portion of their IRA required minimum distribution to a qualified charitable organization and have it excluded from their federal gross income. The amount of the charitable contribution is limited to $100,000.

The question we need to ask now is, “What will Congress elect to do for 2013 and beyond?” If Congress does not act to change the law before 2013, the unified credit amount for gift and estate taxes will revert back to $1 million per individual, while the GST exemption will return to $1 million per individual. In addition, the maximum marginal rate of 55% will apply to all types of taxable transfers. In the meantime, the new law has provided some unique opportunities for wealth transfer that might not exist again in the future.