Important Changes Affect Federal Estate Tax Laws

By Frank S. Macgill, published on August 31, 2011, in Business in Savannah.

Under the Economic Growth and Tax Relief Reconciliation Act of 2001, the federal estate tax was repealed for individuals who died in 2010. However, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, which became law on December 17, 2010, retroactively reinstated the estate tax for persons who died in 2010 and provided much-needed answers about federal laws governing estate taxes for 2010, 2011 and 2012.

The top estate tax rate was originally scheduled to rise to 55 percent for estates of individuals dying after 2010, with an exemption of $1 million. However, the 2010 Tax Relief Act restored the estate tax for individuals dying in 2010, with a $5 million exemption and maximum rate of 35 percent. The Act also reduced the top rate to 35 percent and allows an exemption of $5 million for 2011 and 2012.

Under a special rule for estates of decedents who died in 2010, the 2010 Tax Relief Act allows the executor of an estate to choose between the default federal estate tax rules with a full step-up in basis to the asset’s fair market value or “opting out” of the estate tax and being subject to the modified carryover basis rules with limited step-up in basis. Under the full basis step-up rules, pre-death gain or loss in the assets is eliminated because the basis of the assets received by heirs or beneficiaries of an estate is increased (or decreased) to the date of death value of the asset. On the other hand, with a modified “carryover” basis, an heir or beneficiary gets the decedent’s original income tax basis, plus certain increases, which can be substantial but may not cover the full fair value of the estate’s assets in all circumstances.

The executor should make whichever choice would produce the lowest combined estate and income taxes for the estate and its beneficiaries. This will depend, among other factors, on the decedent’s basis in the assets immediately before death and how soon the estate beneficiaries may sell the assets.

Executors of the estates of decedents who died in 2010 who wish to opt out of the estate tax and instead elect to be governed by the now repealed carry-over basis provisions of the 2001 Act must file IRS Form 8939, Allocation of Increase in Basis for Property Acquired from a Decedent, which the IRS says will be available this fall. According to the IRS, Form 8939 is due Nov. 15, 2011. Any executors considering this should verify the required filing date with the estate’s tax professional.

If an executor does not submit Form 8939, the federal estate tax will apply for 2010, with a $5 million exemption and a top tax rate of 35 percent.

Looking forward, the 2010 Tax Relief Act provides temporary relief, reducing estate, gift and generation-skipping transfer taxes for 2011 and 2012. However, these rules only apply for the short-term future, with more draconian restrictions returning for years after 2012 when the current law expires. After 2012, the top tax rate is scheduled to increase to 55 percent and the exemption will be reduced to $1 million.

For estates of decedents dying after December 31, 2010 and before January 1, 2013, a deceased spouse’s unused exemption may now be transferred to the surviving spouse. Under the 2010 Tax Relief Act, any exemption that remains unused after the death of a spouse who dies after Dec. 31, 2010 and before Jan. 1, 2013 is generally available for use by the surviving spouse in addition to his or her own $5 million exemption.

Under prior law, the exemption of the first spouse to die would be lost if not used. To take advantage of the so-called “portability” of the estate tax exemption, the estate is required to file a federal estate tax return within nine months of the date of death of the first spouse to elect portability, even if a return would not otherwise be required.

In addition, the new law also affects the gift tax and generation-skipping transfer (GST) tax. The gift tax applies to gifts or transfers to any recipient (other than a spouse in most cases) and the GST tax applies to gifts or other transfers to grandchildren or other beneficiaries who are more than one generation younger than the donor. The 2010 Tax Relief Act lowered gift and GST taxes for 2011 and 2012 by increasing the exemption amount to $5 million and reducing the rate 35 percent. The 2010 Act also reduced the GST tax rate to 0% for certain GST transfers that occurred in 2010.

The 2010 Tax Relief Act will have a substantial but ultimately a short-term effect on gift, GST and estate tax laws in the U.S. Strategic estate planning to reduce taxes remains an important consideration. Even if an estate’s value falls below the prescribed exemption level, it is important to have a comprehensive estate plan to ensure that the needs of intended beneficiaries are met.

Now is the time to review your estate plan with a knowledgeable attorney who can advise you on the range of variables affecting your estate plan and who can adjust your estate plan based on the latest tax law changes. Careful planning could make an appreciable difference in your ability to transfer wealth to your loved ones this year and in the future.
____________________
Frank S. Macgill is the managing partner at HunterMaclean in Savannah. His practice focuses on trusts and estates, taxation, tax-exempt organizations and corporate law. He can be reached at 912-236-0261 or fmacgill@huntermaclean.com.