Congress has passed and President Obama has signed into law the deal extending the Bush tax cuts that he struck in December with Congressional Republicans during the “lame duck” session of Congress. The legislation restores the estate tax for two years. Estates up to $5 million will be exempt from paying any federal estate tax at all ($10 million for couples). The tax rate for estates over $5 million will be 35%. If Congress does not change the law by the end of 2013, the estate tax will revert to what it was scheduled to be in 2011 — a $1 million exemption and a 55% tax rate. That would create significant problems and planning challenges for individuals whose estates are considered modest, even though they are more than $1 million. The $801 billion tax-cut bill makes several other significant changes to wealth transfer taxes. Here are some of them:
▲The new $5 million estate tax exemption and 35% rate are retroactive to January 1, 2010. The heirs of individuals who died in 2010 will have a choice between applying the new rules or electing to be covered under the rules that applied in 2010 — no estate tax but only a limited step-up in the cost basis of inherited assets. This will benefit the heirs of tens of thousands who died in 2010 with relatively modest estates but who would have been subject to capital gains tax on inherited assets above a certain threshold. If someone in your family died in 2010, it is a good idea to consult with your attorney or tax preparer immediately, whether or not you have filed an estate tax return (Federal Estate Tax returns are due 9 months after the date of death), to determine whether the new rules apply, and, if they do, to make sure you take maximum advantage of the change in the law. (For a more detailed explanation on this, which includes a technical discussion from early 2010, click here.)
▲The new law also makes the estate tax exemption “portable” between spouses. This means that if the first spouse to die does not use all of his or her $5 million exemption, the estate of the surviving spouse can use it.
▲The law unifies the estate, gift and generation-skipping transfer tax exemptions at $5 million. (For 2010 there is no generation-skipping tax, while the gift tax exemption has been $1 million for a number of years.) A 35% tax rate will apply to gifts or transfers over the $5 million threshold. (There is no change in the $13,000 annual exclusion amount for gifts.) These high exemption levels mean that wealthy individuals will have a two-year window in 2011 and 2012 to protect huge amounts of their estates from taxation for generations.
But that window is open even wider than was previously assumed because of an additional loophole for the wealthy in the new law. Although taxpayers have until December 31, 2010, to transfer funds outright to grandchildren and avoid the generation-skipping tax, there’s the risk that the grandkids will squander the sudden influx of cash.
The generous estate tax provisions were the main sticking point for progressive Democrats. A vote in the House on an amendment to increase the estate tax, including lowering the exemption to $3.5 million, was defeated by a vote of 233 to 194. After some minor changes to the bill were made, it passed the House by a 277 to 148 margin, after having been approved overwhelmingly by the Senate 81 to 19.
The site Politico quotes one senior House Republican aide as saying, “I’m trying to remember something that we passed under Bush that was this good.”
The new tax law presents previously unavailable planning opportunities, especially for the well-off, but it also contains provisions that could be traps for the unwary. It is also temporary, good for only two years. Also, the changes to the federal estate tax laws do not affect the New Jersey estate tax law, which continues to tax estates that are more than $675,000 (there has been no increase in this amount since 2001). Like the federal estate tax, New Jersey’s law does not impose a tax on anything left to a spouse, but failure to take advantage of planning techniques can result in the loss of one $675,000 exemption and subject the estate of the survivor to taxes that otherwise might have been avoided.
For those who THINK AHEAD. PLAN AHEAD! it is still necessary to implement a plan that will take into consideration what might happen when the new amendment expires. Failure to do so might leave you with an outdated plan at a time when you may not have the capacity to make changes.