Changes to the federal gift, estate, and generation-skipping transfer tax laws passed by Congress in December, 2010, could have significant effects on individual estate plans for the next two years. These laws, however, will expire on December 31, 2012, and, without further action by Congress, will revert to the laws as in effect in 2001, which are much less favorable for taxpayers. During 2011 and 2012, the following apply:
- A $5 million per person ($10 million for a married couple) exemption for federal gift, estate, and generation-skipping transfer tax purposes. This means a person may make lifetime gifts totaling $5 million ($10 million for a married couple), less gifts previously made – a change from the previous limit of $1 million per person for lifetime gifts.
- Reduction of the top marginal federal gift, estate, and generation-skipping transfer tax rate from 45% to 35%, and a full "step-up" in basis for all assets includible in the decedent's gross estate.
- "Portability" of unused estate tax exemption in the estate of the first spouse to die, thereby allowing the surviving spouse's estate to take advantage not only of his or her exemption but also any unused portion of the exemption of his or her spouse.
- Indexing of the $5 million exemption for inflation starting in 2012.
Planning Opportunities—Lifetime Gifting
The reunification of gift and estate tax exemptions, which allows lifetime gifts of $5 million per person, up from the previous $1 million per person, and the increase of the generation-skipping transfer tax exemption to $5 million, offer tremendous opportunities to transfer wealth to future generations. Clients may consider larger outright gifts or transfers to trusts. In particular, multi-generation ("dynasty") trusts and transfers of property with the potential for significant appreciation may be attractive. Moreover, taking advantage of various lifetime gifting strategies to "leverage" the benefits offered by the gift and generation-skipping transfer tax exemptions may be attractive for some clients. Because of the uncertainty of whether these tax law changes will remain after 2012, we suggest consulting with advisors to develop a plan to complete these transfers while the current laws are in effect.
"Portability" of Estate Tax Exemption
"Portability" of the federal estate tax exemption may simplify estate planning for some individuals. In some instances, portability will eliminate the need for "credit shelter" or "bypass" trusts commonly used in estate planning. These trusts are created at the first spouse's death to use the deceased spouse's exemption to protect assets from estate tax at the survivor's death while still making assets available in trust for the surviving spouse. In the past, if a person's estate plan were not structured this way, the first-spouse-to-die's exemption was effectively lost.
If portability remains the law after 2012, the credit shelter or bypass trust may become less important for some individuals. One spouse could simply leave all his or her assets to the surviving spouse, the surviving spouse could add the deceased spouse's unused estate tax exemption to his or her own exemption, and both could be used at the second death. However, because portability is only in effect for two years and does not apply to the generation-skipping transfer tax exemption, and because there are other significant benefits to using credit shelter or bypass trusts – such as creditor protection and the ability to control who the ultimate trust beneficiaries are – we believe many individuals will continue to benefit from using such trusts.
Generation-Skipping Transfer (GST) Tax for 2010
Congress reinstated the GST tax retroactively for 2010 with an exemption of $5 million per person and a tax rate of zero, and confirmed the zero tax rate applied to outright transfers or transfers to trusts that are direct skips. Reporting gifts to which GST exemption will be allocated in 2010 is more complicated, but Congress has clarified many of the uncertainties in this area.
Federal Estate Tax Reinstated for Deaths in 2010
Congress passed an estate tax effective retroactively to January 1, 2010, applying the 2011 exemption levels and tax rates. Estates for persons who died in 2010 have a choice of whether to be governed by: (i) no estate tax and a modified carryover basis allowing an increase of $1.3 million per decedent plus $3 million for surviving spouses; or (ii) estate tax for amounts in excess of the $5 million estate tax exemption amount, an effective tax rate of 35%, and a full "step-up" in basis to fair market value. To choose option (i), estate executors must "opt out" of the estate tax, but details on making such election are not yet available. Failure to "opt out" means an estate will be subject to estate taxes as described in option (ii). We advise those facing this decision to stay in close touch with advisors as guidance is issued by the Internal Revenue Service, particularly as to deadlines for filings and other requirements.
No Changes to Grantor Retained Annuity Trusts
Contrary to expectations, Congress did nothing to change the law on Grantor Retained Annuity Trusts (GRATs). Therefore, GRATs remain available and, with interest rates at historic lows, continue to be an effective estate planning tool.
State Estate Tax LawsStates that impose a separate estate tax, such as Minnesota, are largely unaffected by the changes in federal law. The difference between the federal exemption of $5 million per person and the Minnesota exemption of $1 million per person (not scheduled to change) will make estate planning somewhat more challenging in determining whether to defer both federal and state estate tax at the first spouse's death or pay a state estate tax in order to obtain the larger federal estate tax exemption. Preserving flexibility for post-death planning in this area continues to be advantageous.
 "Lifetime gifts" in this context means gifts to any individual during any calendar year in excess of the donor's $13,000 annual gift tax exclusion amount. Lifetime gifts to any individual falling within the annual gift tax exclusion do not reduce the $5 million lifetime gift tax exemption of the donor.