Developments of Interest

2011 Tax Relief Act Update

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The Tax Relief Act of 2010 was signed into law by the President on December 17, 2010.  The Act makes some key changes in the law regarding the estate tax, gift tax, and generation skipping transfer tax.  As a result, there are significant differences between the transfer tax laws in 2009, 2010, 2011, and 2012.

The following is a brief summary of the new tax laws under the Act.  This update includes advice for clients who are doing their own planning and also for clients who are acting as trustee or executor of an estate of a person who died in 2010 or 2011.

Estate Tax Planning

The estate tax exemption was increased to $5 million per person for decedents dying in 2011 or 2012.  The estate tax rate on assets over $5 million has been reduced to 35%.  In other words, decedents who die in 2011 or 2012 who have an estate under $5 million do not have to pay estate (death) taxes at death.

An interesting new change to the estate tax law is the concept of “portability” of a deceased spouse’s unused estate tax exemption.  This means that if the first spouse to die does not use any or all of his or her $5 million exemption, the unused portion of the predeceased spouse’s exemption can be used by adding it to the surviving spouse’s $5 million exemption.  Unfortunately, portability is not automatic.  An election must be made on an estate tax return (Form  706) filed at the first spouse’s death, even if the size of the estate would not otherwise require filing of the return.

Traditional estate planning often involved the funding of a tax shelter trust called the “Exemption”, “Credit Shelter”, or “Bypass” Trust on the death of the first spouse.  The “portability” provision of the new law may eliminate the need for this common planning strategy.  However, there may be other tax and non-tax reasons that make it advisable to continue to utilize a tax shelter trust.  Additionally, the use of “Disclaimer Trusts”, which offer the greatest flexibility, may be the best plan for some.  This is a discussion to have with your estate planning attorney to determine what is best for you.

Trust Administration

With respect to decedents dying in 2010, the estate will have the option to either (1) pay no estate tax regardless of the size of the estate, but have only a limited step-up in basis for estate assets (the 2010 rule), or (2) apply a $5 million estate tax exemption and get a full step-up in basis for eligible assets (the 2011 rule).  There are many factors to consider when deciding which option is best for the estate being administered.  We recommend that trustees and executors contact their tax advisors to determine which is the best option under the circumstances.

Gift and Generation Skipping Transfer Tax

The lifetime gift tax exemption increased from $1 million to $5 million per person for 2011 and 2012.  The tax on gifts over $5 million has been reduced to 35%.  The annual exclusion from gift tax remains at $13,000 per recipient.

Like the estate and gift tax, the generation skipping tax exemption increased to $5 million and the tax rate over the exemption will be 35%.

Also, similar to the estate tax law, there is a portability aspect to the gift tax law.  In some cases where the predeceased spouse dies in 2011 or later, the surviving spouse may be able to use part of the predeceased spouse’s unused gift tax exemption.

Expiration of Act

Fortunately, many of these changes are beneficial to the tax payer, but unfortunately, the Act expires at the end of 2012.  Therefore, Congress and the President will have to agree again to extend the current law or make changes.  If they do not take action, then the estate, gift, and generation skipping tax exemptions revert to $1 million in 2013 with transfer taxes imposed at rates that can reach as high as 55%.  Because of this uncertainty, clients interested in making gifts in excess of $1,000,000 should consider doing so in 2011 or 2012.

We recommend that you review your estate plan in light of this new tax law.  Significant life changes, such as births, death, marriage, divorce, changes in the size or nature of your estate may also warrant changes to your plan.  Finally, take this opportunity to make sure that your documents name the people you want as agents.  Please feel free to contact this office if you would like to meet to further discuss some of the concepts briefly described in this memo.

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