Special Bulletin
Prior to year-end 2010, President Obama signed into law “The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” (“Act”). Among other things, the Act adopted taxpayer-friendly rules for estates of decedents dying in 2010 and drastically changed the transfer tax regime for 2011 and 2012. This article summarizes portions of the Act and highlights planning opportunities that should be considered in light of these changes and the current economic environment.
Rules for Estates of Decedents Dying in 2010
Through most of last year, it appeared that the estate of a decedent dying in 2010 would not be subject to estate tax, and only a limited amount of the estate’s assets would receive a “step-up” in basis for capital gains purposes. The Act revised the default rules so all of the estate’s assets will receive a “step-up” in basis, but an estate tax will apply for estates in excess of $5,000,000. For estates under the taxable threshold, this is an advantageous change.
The Act also allows large estates to opt out of the default rules to avoid the estate tax. In that case, however, only a portion of the estate’s assets will receive a step-up in basis.
Transfer Tax Laws in 2011 and 2012
The following summarizes how the federal estate, gift, and generation-skipping transfer (“GST”) taxes will apply in 2011 and 2012:
- Estate Tax. The estate tax exemption has been set at $5,000,000, meaning that the first $5,000,000 of a decedent’s estate will be free of any tax. Absent an applicable deduction, assets in excess of this amount will be subject to federal estate tax at a 35% rate.
- Gift Tax. The gift tax exemption has been raised to match the estate tax exemption, meaning individuals can make up to $5,000,000 in lifetime gifts without the imposition of tax. (Those lifetime gifts, however, will reduce the amount that can be left estate tax-free at death.) Gifts in excess of the exemption will be subject to tax at a 35% rate.
- GST Tax. The GST tax, which is imposed on certain transfers benefiting generations more than once removed from that of the transferor, will be applied at a 35% rate. The tax, however, applies only to GST transfers in excess of the $5,000,000 lifetime exemption.
- Portability of Estate and Gift Tax Exemptions. If a spouse dies during 2011 or 2012, the deceased spouse’s unused estate and gift (but not GST) tax exemptions can be added to the surviving spouse’s exemptions. To make use of these portability provisions, the deceased spouse’s estate must make the requisite election on a timely-filed estate tax return.
These rules and exemption amounts (which are indexed for inflation) will apply for 2011 and 2012 only. Absent extension legislation, transfer taxes will become much less taxpayer-friendly beginning in 2013.
Planning Opportunities
The new transfer tax rules and the current economic environment make certain estate planning strategies especially appropriate at this time.
- Gifts. Given the considerable increase in the gift tax exemption, certain wealthy individuals should consider making significant gifts during 2011 or 2012. This strategy is advantageous because gifting allows future appreciation to occur outside of the donor’s taxable estate – thus preventing later estate tax. Because many asset classes (such as real estate) are down in value right now, this strategy is especially timely. The use of “discounts” if the gifted asset is an interest in an LLC or other closely-held entity can leverage these gifts even further.
- Intra-Family Loans and Grantor Retained Annuity Trusts (“GRATs”). Interest rates currently are very low. To take advantage of this environment, we are recommending to appropriate clients that they make loans to family members in exchange for interest-bearing notes. The assumption is that the borrowed funds can be invested and will out-perform the interest rate which will result in a net transfer of wealth with no tax. Our clients also like this technique because their principal ultimately is returned, often over a short time period.
A GRAT works in a similar manner as the intra-family loan, except it involves a trust and the asset being lent is not cash. Another difference is that the taxpayer must out-live the GRAT’s repayment term for the transaction to succeed.
- Charitable Lead Annuity Trusts (“CLATs”). The low interest rate environment makes CLATs another attractive planning opportunity. CLATs operate in a manner similar to GRATs, but the annual annuity is paid to one or more charities. There is no mortality risk with CLATs, so the term can be longer. If an individual routinely makes charitable gifts on an annual basis, the CLAT could be a more tax-efficient way for the gifts to be accomplished.
- Charitable IRA Rollover Gifts. The Act reinstated the Charitable IRA Rollover Gift for 2010 and 2011. It allows persons 70½ years of age or older to donate up to $100,000 a year from a traditional or Roth IRA to a public charity (but not a donor-advised fund). In return, the donor receives the equivalent of a 100% income tax charitable contribution deduction. The 2010 IRA Rollover gift deadline is January 31, 2011, so you must act quickly to take advantage of this planning opportunity.
- Sales of Assets. The Act extends the so-called Bush tax cuts with respect to long-term capital gains, and we are advising many of our clients to take advantage of the opportunity to sell assets in order to realize gains at a favorable 15% federal rate.
- Sales to Special Trusts. Another strategy we are recommending to appropriate clients is to sell assets to special trusts established for the benefit of family members. These sales are designed to take advantage of several factors discussed above (depreciated asset values, discounts, and low-interest rates) to achieve significant transfer tax savings. We are working with clients to complete these transactions as soon as possible because of potential Congressional action that would limit them in the future.
- General Revisions to Estate Plans. Finally, many of our clients are requesting a review of their existing estate planning documents to confirm that the documents (1) make sense given the changes to the transfer tax law and (2) are reflective of their current intent. In addition, beneficiary designations for retirement plans and life insurance need periodic review to ensure the designations are consistent with the overall estate plan.
Conclusion
New transfer tax rules and current economic conditions make now an excellent time for estate and tax planning. The convergence of favorable rules and conditions, however, is not permanent, and time is of the essence. Those who act can potentially achieve long-term savings for their families.
For further information regarding the issues described above, please contact Eldridge D. Dodson, Jeannette A. Parrott, Gregory T. Peacock, John R. Sloan, or Matthew W. Thompson.
