This guide to 2011 changes in United States tax law was specially prepared for Grandparents.com readers by James S. Kaplan, Esq, head of the Herzfeld & Rubin Tax and Estates Department, on January 12, 2011. It is provided here as a resource for our readers. The opinions and analysis are Mr. Kaplan's alone.
The recently enacted 2010 tax law (the "2010 Act") makes important changes to the taxation of estates and gifts, which will affect many grandparents. The 2010 Act ends the uncertainty relating to the existence of the estate tax (at least until the end of 2012, when the 2010 Act expires), and significantly increases the prior exemptions for estates and gifts over the 2009 levels. The 2010 Act will affect many existing wills and estate plans; thus it would be wise for grandparents to review their estate planning documents with their attorneys to determine if changes are appropriate.
I. Estate, Gift, and Generation Skipping Tax
A. General Rules
1. Rates and Exemptions (35 percent and $5 million):
The estate tax had been in a state of limbo since Congress last year unexpectedly let it expire beginning January 1, 2010. This meant that for the year 2010 only, there was no estate tax, and also no increase in the income tax basis of assets inherited from a decedent as there had been under prior law (except for a $1.2 million allowance, and an additional $3 million for marital property). Had Congress not acted this year, the estate tax would have returned to 2001 levels of a $1 million exemption for individuals and a top estate tax rate of 55 percent. Instead, the 2010 Act reinstates the federal estate tax at rates of 35 percent (as opposed to 45 percent under prior law) and a federal exemption of $5 million for individuals and $10 million for a husband and wife for years 2011 and 2012. This means that many fewer estates will actually be subject to federal estate taxes than were subject in years prior to 2010, since in essence the federal estate tax will not apply to couples with assets of less than $10 million. Thus, standard commonly used estate tax planning techniques such as credit shelter trusts, intentional defective trusts, and Grantor Retained Annuity Trusts may for purposes of federal estate taxes become irrelevant for estates worth less than this amount.
The re-imposition of the estate taxes is automatically retroactive to 2010 for the estate of any decedent that died in 2010. However, the fiduciary of any such estate may elect to be taxed under the law as in effect for 2010 before the Act — i.e., it can elect not to be subject to estate tax (in which case there would be a limited step up in income tax basis for estate assets). For the heirs of tens of thousands of estates of decedents who died in 2010 with less than $5 million of taxable assets, it will generally be advantageous to remain under the new law because they will receive a full step up in the basis of the estate's assets. It is only for estates with more than $5 million in assets that an election to remain under the 2010 law may be beneficial. For estates of decedents dying in 2010, an analysis thus must be made to determine whether it is better to elect out of the new rates.
2. Other Significant Changes:
a. Increase of Gift Tax Exemption
The Act makes significant and highly favorable changes to the gift tax. Under prior law, even with the expiration of the estate tax, there was still a gift tax on lifetime gifts in excess of a $1 million lifetime exemption (in excess of the annual per person exclusion of $13,000 plus educational and medical expenses) at a rate of 35 percent (down from 45 percent in prior years). The Act keeps the tax rate at 35 percent for gifts made in 2010 through 2012. The lifetime exemption amount remains at $1 million for 2010, but going forward is reunified with the $5 million estate tax exemption providing for a unified lifetime exemption of $5 million for gifts made in the years 2011 and 2012. This means that individuals who have made $1million in lifetime gifts can now make an additional $ 4 million and still fall within the exemption. This should open up significant estate planning possibilities.
b. Generation Skipping Taxes
The Act retroactively reinstates the Generation Skipping Tax (GST) for transfers made in the year 2010. However, the tax rate applicable for transfers made during 2010 is 0 percent. For transfers made in the years 2011 and 2012, the GST tax rate is 35 percent with an exemption of $5 million. As a result, opportunities exist for asset transfers of any kind, including interests in businesses and real estate that can be transferred to grandchildren and beyond either outright or in trust starting in 2011. These transferred interests would escape estate tax in the future, a tax whose rates may be significantly higher than today, both at the donor's level and at the next generational level as well. With the value of assets appreciating over time, the dynastic wealth transfer potential has never been greater. This tax benefit generally applies to estates with more than $10 million.
c. Portability of Lifetime Exemption
A further change from the prior law relates to the ability of a spouse to use the prior unused lifetime exemption of a deceased spouse. Under prior law (i.e., prior to 2010), the lifetime exemption of each spouse was limited to that spouse. For this reason, wills were usually drafted to include "credit shelter trusts," which provided that upon the death of the first spouse, an amount equal to the available lifetime exemption went to a trust with income to the surviving spouse and the remainder to the children, which would use up the exemption. The Act provides that, starting in 2011, the estate of a surviving spouse may use, in addition to his or her own $5 million exemption, any unused exemption of his or her deceased spouse. Thus, for a married couple, the combined available exemption is $10 million automatically. This provision, in theory, eliminates the need for credit shelter trust provisions in a will. However, there may be other reasons for retaining such provisions in wills, such as insuring that upon the spouse's death assets go to the testator's children. Also it should be noted that the current exemptions only last until 2012. On the other hand, wills with such clauses should be reviewed to insure that they carry out the testator's intent. A will that leaves the maximum amount to reduce federal estate taxes to zero (a standard clause) to a credit shelter trust for the testator's children that was drafted when the exemption was $600,000 may result in all the testator's assets going to such a trust when the exemption is $5 million, and not leaving anything to the testator's spouse.
3. State Estate Tax Issues:
A further issue that must be considered in planning under the new law is the impact of state estate taxes. Even though federal estate taxes have been eliminated on estates of less than $5 million ($10 million in the case of a surviving spouse), there may still be significant state estate taxes on estates of less than $5 million. New York State never changed its $1 million exemption to conform to increases in the federal exemption to $3.5 million in 2009, and thus the tax on an estate passing the maximum $3.5 million exemption in a credit shelter trust was subject to approximately $235,000 in taxes. For an estate claiming the $5 million exemption, the New York State tax would be approximately $400,000. However, since New York State repealed its gift tax in 2000, it would appear that by making a $5 million gift before death, this New York State gift tax could be avoided. For New Jersey estates, the exemption remains at $675,000.
4. General Observations:
With the Act's sweeping changes to the Gift, Estate, and GST exemptions and the extension of historically low gift tax rates, there are opportunities for people with larger estates to make significant wealth transfers that will eliminate or greatly reduce transfer taxes in many estates. Gifting techniques, including the use of Grantor Retained Annuity Trusts (GRATS), Qualified Personal Residence Trusts (QPRTS), Charitable Trusts, and Valuation Discounts, may be available to leverage the increased exemption amounts to enable significant estate tax savings. While there may be questions regarding the ultimate expiration of the law in 2012 and the impact of estate planning into the future, now is the time to take advantage of the opportunities that may only be available during a 24-month window. For clients with estates of less than $5 million, federal estate tax issues will no longer be an issue (although state estate taxes may remain relevant). Since many wills and estate plans may have been drafted with a view toward limiting estate taxes, these plans also should be reviewed.
II. Income Tax Changes
The Act also provides for significant changes to income tax rates for 2011 and 2012. The Act temporarily extends the current income tax rates originally enacted under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), which otherwise would have expired at the end of 2010. As a result, there are lower income tax rates for taxpayers at every income level. The top rate, on taxable income above $379,150, will stay at 35 percent, instead of increasing to 39.6 percent. The bottom rate, on taxable income below $8,500 for individuals and $17,000 for married couples, will stay at 10 percent, instead of increasing to 15 percent.
There is also protection through 2011 from the Alternative Minimum Tax. It includes a new payroll tax credit for virtually all workers, as well as a 13-month extension of benefits for the long-term unemployed. The ceiling for exemptions from the Alternative Minimum Tax is raised to $47,450 for individuals and $72,450 for couples filing jointly. For 2011, it increases to $48,450 and $73,450.
A key component of the Act is a one-year, 2 percent cut in the Social Security wage tax, from 6.2 percent to 4.2 percent, which gives workers an average $934 tax break in the year 2011. According to the Tax Policy Center, an independent research center, households in which workers earn between $40,000 and $50,000 will get $770 back on average; those making $50,000 to $75,000 would get $1,034 back on average; those making $75,000 to $100,000 would get $1,413 back on average; and those making $100,000 to $200,000 would get $2,072 back on average.
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