ESTATE TAX CHANGES

by Shana Siegel, Esq., CELA*

2010 was a very unusual year for elder The federal estate tax provisions were repealed for a single year – 2010 and then were scheduled to revert to a much lower exemption in 2011. Because Congress did not act until December, the first half of the 2010 was spent watching and waiting, with most analysts betting that Congress would retroactively impose an estate tax. As the year went on and several billionaires like George Steinbrenner died, we shook our heads in wonder.

Late December, Congress finally enacted estate tax changes. An estate tax was not ultimately imposed retroactively for 2010, although they did muddy up the waters for large 2010 estates by giving them a choice of imposing the 2010 or 2011 rules.

For the rest of us, we now know where we are--at least for the next two years. The new federal estate tax exemption is $5,000,000 and the estate tax rate is 35% (down from 45% in 2009).

Moreover, the exemption is now portable between spouses. To understand what this means you have to understand the old rule.

Imagine that in 2009, there is a husband and wife with an estate of $7 million. The estate tax exemption was $3.5 million that year. If the husband died first and all of the couple’s assets were owned jointly, then everything passed directly to his wife. She paid no estate tax when her husband died. However, when she died, her estate would only have an exemption of $3.5 million and the rest of the estate would be taxable. If this same couple had seen an estate planning attorney, they would have split the assets and created a bypass trust so that the wife would not directly inherit more than $3.5 million. The rest would go into a bypass trust for her benefit. Her husband’s estate could take his $3.5 million exemption and pay nothing on the assets on the trust. She would not pay taxes on the share she inherited and then when she passed away, her estate would be worth $3.5 million and therefore no tax would be owed.

• • •

So let’s fast forward to 2011. Now when the first spouse dies, even if he cannot use his whole exemption because there a bypass trust was not created or there are insufficient assets in his estate to fund the trust, the surviving spouse can make an election to preserve the exemption. Of course, that will only work if the law does not revert back in 2013 or some other later point. There are other disadvantages such as potential of losing the portability due to second marriage. Therefore it does not eliminate the need for legal advice or estate planning.

Another important area of change is the lifetime gifting rules. As most of you know, you may gift up to $13K a year without having to file a gift tax return. What you may not know is that you can actually gift substantially more during your lifetime without paying tax and often it is advisable. Since 2001 you could gift up to $1 million without being subject to gift tax. However, your lifetime gifts reduce your estate tax exemption dollar for dollar. Now, in 2011, the lifetime exemption has been raised to $5 million. For some clients with income-producing assets, it may make sense to shift these assets to children with lower tax rates. Lifetime gifting has many other advantages which you may want to discuss with a knowledgeable attorney.

The $5 million exemption both for estate tax and lifetime gifting are to be adjusted annually for inflation beginning 2012.

Lastly, the income tax step-up in basis upon death returns in 2011. This is important for decedents who die in 2011 or 2012 owning a highly appreciated asset like a house they owned for 50 years. The income tax cost basis is “stepped up” to the date of death value. This means that the heirs don’t have to pay capital gains upon the sale of the property based on the appreciation over that entire 50 year period. This also restores the usefulness of certain types of trusts and life-estate deeds.

As mentioned, all of these changes apply through the end of 2012. As of now, in 2013 the exemption will return to $1 million and the tax rate will increase to 55%. Of course, one would expect Congress to take further action in 2012. However, in an election year anything could happen. This is just one reason why it is important to create an estate plan which incorporates flexibility.

Of course, all of this only relates to the federal estate tax. New Jersey still imposes an estate tax (albeit at a significantly lower rate) on estates over $675,000, which is based on the 2001 federal exemption amount. This is another reason that estate planning remains important for those of us with estates under $5 million.

This is purely educational and is not intended as legal advice.

Shana Siegel, Esq., CELA*, is a certified elder law attorney and focuses her practice on representing seniors and individuals with special needs.