DEATH AND TAXES UPDATE

In the “Death and Taxes” article, Hartman Shurr wanted you to be aware of the chaotic and potentially catastrophic federal estate tax situation late this past summer.  At that time, all we could do was speculate about what taxes might be imposed on the estate of someone who dies in 2011 and beyond.  Well, Congress just ended the chaos by (finally!) enacting an entirely new federal estate tax law as part of extending the so-called Bush tax cuts.

If a new law had not been enacted, the estate of a decedent dying in 2011 would have been exposed to a maximum marginal tax rate of 55% (60% in some cases) on all assets over the exemption equivalent of $1 million.  This would have had the effect of exposing many frugal middle-class families to this devastating tax, as well as virtually confiscating larger estates.  There were basis, gift tax and generation skipping tax implications as well.

The 2010 Tax Relief Act changes the game for the better.  The new maximum federal estate tax rate is 35%, not 55% (or 60%).  The exemption equivalent has been raised from $1 million to $5 million and the exemption equivalent amount has finally become “portable” (more on that below).  The bad news, however, is that the new estate tax regime is only in effect for two years – until December 31, 2012.

As you probably know, transfers between spouses at death are not subject to federal estate tax due to the martial deduction, allowing the estate of the first spouse to die to deduct anything passing to the surviving spouse.  Thus, no matter how large the estate, there would be no federal estate tax at the first death if everything was left to the surviving spouse.  But, by passing everything on to the surviving spouse, there would be an unnecessarily large federal estate tax at the second death because the surviving spouse would have only his/her own exemption equivalent to protect all of the assets from tax and the protection of the exemption equivalent of the first spouse to die would have been wasted. 

“Portability” means that it is no longer necessary to engage in the complex and costly sham of having spouses own separate property and undergo probate at the first death in order to fund a “by-pass” trust at the death of the first spouse to die so that his/her exemption equivalent (also often called unified credit) is not wasted.  Under the 2010 Tax Relief Act, elections can be made to utilize the unused portion of the exemption equivalent of the predeceased spouse in the estate of the second spouse to die.  Therefore, both $5 million exemption equivalents (or a total of $10 million worth of exemption equivalent) would be available to the last spouse to die with timely and proper elections and careful planning, provided no prior taxable gifts had been made.  Note, however, that the portability rules only work if both spouses die during the term of the 2010 Tax Relief Act - namely on or before 12/31/2012.  Special rules exist for situations in which someone had more than one predeceased spouse.

Gift taxes have undergone substantial changes as well.  For gifts made in 2010, the 2010 Tax Relief Act provides for a top marginal rate of 35 percent and an exemption equivalent of $1 million. For gifts made after 2010, the gift tax is, once again, “unified” with the estate tax with a top marginal rate of 35 percent and a $5 million exemption equivalent.  For 2010 and 2011, the inflation-adjusted annual gift tax exclusion is $13,000 per donee.

The 2010 Tax Relief Act also extends certain taxpayer favorable provisions in the old estate tax law dealing with matters such as qualified conservation easements, qualified closely held business interests and the ability to pay the estate tax in installments for estates that have a sufficient portion of closely-held businesses.  In addition, the 2010 Tax Relief Act extends the state death tax deduction through 2012.

There have been a number of technical and substantive changes in the generation skipping transfer tax rules as well.  This complicated area is beyond the scope of this newsletter, but in general, the 2010 Tax Relief Act provides a $5 million GST exemption equivalent and a 35% GST tax rate.

There are a number of special rules for the estates of decedents who died between 1/1/10 and 12/31/10 that, among other things, allow an election to use the modified carryover basis scheme that was in effect during the so-called “repeal” period; or to come under the new rules and get a stepped-up basis for income tax purposes.  There are also extended filing and payment deadlines.  Again, a detailed discussion of these rules is beyond the scope of this letter.

So, what does all of this mean to you?  With your attention directed to the caveat below, here are a few things to consider.

If you are a married couple with a combined estate under $10 million and you have simple, non-tax oriented Wills and hold your property “jointly” as husband and wife, then you may not need to worry about exposure to federal estate tax, should both spouses die in the next two years.  The same would be true of a single person with an estate under $5 million.  If you have made taxable gifts in the past, the above may not apply.

If you are a married couple with a combined estate under $10 million and you have tax-oriented Wills or trusts designed to deal with federal death tax exposure under the law as it existed prior to the 2010 Tax Relief Act; and/or you hold property in individual names for the same reason, then you may want to move as soon as possible to simple Wills that do not have a bypass trust or the like both to avoid the complication and because under the new law the formula clauses used in such Wills may well lead to a disposition of assets at death in a manner that is wildly different than what you may desire.  Also, holding property in individual names as was required to fund trusts at the death of the first spouse to die under the former law will lead, at the very least, to unnecessary probate at the first death under the new law.  If you have made taxable gifts in the past, the above may not apply.

If you are a married couple with a combined estate over $10 million, you will want to immediately proceed with careful planning to get the benefits of the new law; and also to consider certain gifting and other opportunities for death tax savings that are presented by the new law.  

CAVEAT:  THIS IS A MUCH OVER-SIMPLIFIED GENERAL NEWSLETTER AND SHOULD NOT BE RELIED UPON AS LEGAL ADVICE.  THE DEATH TAX LAWS ARE EXTREMELY COMPLEX AND EACH FAMILY’S SITUATION IS DIFFERENT.   A MISTAKE IN PLANNING FOR THE APPLICATION OF THESE LAWS TO YOUR PARTICULAR SITUATION OR INACTION ON YOUR PART IN SEEKING ADVICE ON HOW THESE LAWS MAY AFFECT YOU COULD LEAD TO EXTREMELY HIGH TAX EXPOSURE FOR YOUR FAMILY.

If you have questions about any of this, please feel free to contact any of the attorneys at Hartman Shurr and we will do our best to provide you with clear answers.

Cordially,
Gregory C. Hartman
Hartman Shurr
1100 Berkshire Blvd, Suite 301
Wyomissing, PA 19610
(610) 779-0772