Estate Tax Thru 2012

The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 has changed the gift and GST tax laws, and the federal and state estate tax liabilities by increasing the applicable exclusion amount, reducing the taxable rates, and changing the status of the state tax. This Act will sunset in 2010. This means that the federal estate, gift, and GST tax laws will be restored to their pre-EGTRRA provisions on January 1, 2011. 

Section 301 of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“TRUIRJCA”) changed again the gift and GST tax laws, and the federal and state estate tax liabilities by increasing the applicable exclusion amount, reducing the taxable rates, and providing an option regarding the estate tax for year 2010. This Act repeals the provisions of EGTRRA which abolished estate and generation-transfer skipping taxes for decedents dying in 2010 (Subtitle A of Title V of EGTRRA) and which replaced the unlimited basis increase for assets owned by decedent with a more limited basis adjustment (Subtitle E of Title V of EGTRRA). TRUIRJCA will sunset in 2013 to restore the federal estate, gift, and GST tax laws to their pre-EGTRRA provisions.

Federal estate tax applies only to assets exceeding a certain threshold based on the size of an estate that the unified credit protects. The unified credit equals the “applicable credit amount,” which is defined as the amount of tentative tax determined on the amount of the “applicable exclusion amount” set forth. For non-U.S. residents, the threshold is $60,000. For U.S. citizens and U.S. residents, under EGTRRA, the threshold varied because the applicable amount was set as follows:

  • 2009 $3.5 million with a maximum tax rate of $45% 
  • 2010 Estate tax is repealed for one year, but replaced by the elimination of “stepped-up” basis[1]
  • 2011 $1 million with a maximum tax rate of 55% 
  • 5% surtax on certain transfers over $10 million 
  • State death tax credit resurrected Under TRUIRJCA, a new tax regime is established for years 2010 through 2013, therefore this law is retroactive regarding year 2010. 
 1.) Estate Tax for Year 2010

Individuals can either select the tax regime of EGTRRA set for year 2010 – estate tax repealed – or select the tax regime of TRUIRJCA that provides an increase to the estate tax exemption of $5 million.

a.) Under EGTRRA, the estate tax due on the estate of a person deceased in 2010 is replaced by a capital gain tax. Before 2010, people inheriting property from a decedent were entitled to a step up in basis for the inherited assets for capital gains tax purposes. Under EGTRRA, the step up in basis is abolished for estates of people dying in 2010 and replaced by a modified carryover basis.

The basis is either the value on the date of death or the decedent’s basis in the property, whichever is less. This modified carryover basis system allows for a basis increase of $1.3 million for property passing to anyone and an additional basis increase of $3 million for property passing to the surviving spouse. The $1.3 million and $3 million are indexed for inflation after 2010.

The personal representative or executor has the authority to allocate the basis increase to particular assets. Most Wills give the executor the power to “do all acts and things necessary for the management of the estate” and to “make any election under law relating to taxes.” However, it is not certain that the personal representative has the power to allocate to both probate and non-probate assets. In the event of uncertainty, the executor should promptly petition the court to grant the power to make the allocation.

Although it seems that the personal representative has the authority to make the allocation, the representative, when making the decision as to whether to select the carryover basis election rather than filing an estate tax return, should take into consideration whether the marital deduction share goes to the spouse and whether the non-marital deduction share goes to the deceased spouse’s children. In addition, the personal representative should look at which properties get the limited basis increase and maybe seek a family agreement with court approval or a pro rata allocation with court approval.

The executor will file an informational return[2] related to large transfers at death, which includes any estate in which the value of all property exceeds $1.3 million (or $60,000 for a non-resident, non-citizen decedent). The return will generally be due at the same time as the final income tax return for the decedent (April 15 of the year following the year of death). However, the Tax Act allows an extension. The due date for filing this report may be deferred up to 9 months after the date of enactment (December 17, 2010). see Form 8939 released by the IRS on December 16, 2010. The IRS is currently collecting comments regarding the form. This form may be revised as a result of the Tax Act.

Any allocation basis increase must be described on the informational return. The executor will supply each recipient of property with information as to the allocation of basis to property received by that recipient within 30 days after filing the informational return.

Each estate will be allowed a stepped-up basis not to exceed a maximum of $1.3 million, meaning that the cost basis of all property beyond $1.3 million will carry over with either the original cost basis or the value as of the date of death, whichever is less.

The step-up in basis applies only to “property acquired” from a decedent. Therefore it does not apply to general power of appointment property, property received via a QTIP trust, when the grantor dies during a GRAT or a GRUT, IRA accounts, and property received via gift within 3 years of death except for property received via gift within 3 years of death from a spouse.

The surviving spouse will qualify for an additional $3 million.

The exclusion is only $60,000 for a non-resident alien.

The executor shall take into consideration the following factors when making the decision between electing for a carryover basis and filing an estate tax return:

Estate tax payable currently versus the capital gain tax on the future sale of assets.
  • Anticipated dates of sale of assets. 
  • Ability to allocate basis adjustments up to the fair market value at the date of death for assets that will likely be sold in the near future. 
  • Anticipated future capital gains rates (and ordinary income rates for “ordinary income property”). 
Weighing the present value of anticipated income tax costs against the current estate tax amount.

b.) Under TRUIRJCA[3]. The exemption amount is increased to $5 million with a maximum rate of 35%. For gross estate above $5 million, the IRS Form 706 usually is to be filed within 9 months from the date of death. However, the filing deadline is September 17, 2011 for estates of decedents dying after December 31, 2009, and before December 17, 2010. 

The stepped-up basis rates are reinstated unless for year 2010 the executor elects to have the modified carry-over basis rules apply as provided under EGTRRA. If elected, the executor will file an information return (IRS Form 8939) with decedent’s final return. Please note that this election is irrevocable without IRS consent. This election has no effect on the applicability of GST tax.

2.) Estate Tax for Years 2011 & 2012 

The exemption amount is increased to $5 million (indexed for inflation adjustments) with a maximum rate of 35%.

TRUIRJCA adds something new: the “Portability of Exclusion Amount between Spouses.” The unused applicable exclusion from the death of a spouse who dies after December 31, 2010, and before December 31, 2012, is generally available to the surviving spouse as an addition to the $5 million exemption. An election must be made on a timely filed estate tax return of the predeceased spouse even if a return would not be required otherwise. This election is irrevocable.

If the surviving spouse has survived two predeceased spouses, both of whose executors made the election, only the unused exemption of the last predeceased spouse is available to the surviving spouse.

Despite the attempt at simplification, which portability of the gift and estate tax exemptions provides, it will still be important to use a bypass trust in planning the predeceased spouse’s estate for the following reasons:

1. The deceased spouse’s unused exemption is not indexed for inflation. Consequently, assets inherited from the predeceased spouse by the surviving spouse may continue to increase in value without sheltering the appreciation from estate taxation at the death of the surviving spouse which a bypass trust would provide.

2. Portability is not provided for the predeceased spouse’s unused generation-skipping transfer tax exemption. Absent creation of a bypass trust (or other trust to which the predeceased spouse’s generation-skipping transfer tax exemption is allocated), all of the generation-skipping transfer tax exemption of the predeceased spouse will be lost.

3. Provides assets protection
4. Provides certainty
5. Provides remarriage protection
6. Organizes the payment of state estate tax
7. Provides income tax shifting

3.) Estate Tax for Years 2013 and Beyond 

Section 901 of EGTRRA states that all of the provisions contained in EGTRRA expire on December 31, 2010. However, Section 101 of the Act amends Section 901 of EGTRRA to extend expiration until December 31, 2012. Section 304 of the Act provides that Section 901 of EGTRRA as amended by Section101 of the Act applies to amendments made by Title III of the Act. This means that all of the amendments made by the Act to the estate, gift, and generation-skipping transfer tax provisions of the code will only apply until December 31, 2012. For years 2013 and beyond, we will have the following taxes unless Congress passes another tax bill:
  • Applicable exclusion amount: $1 million, adjusted to inflation ($1.1 million) 
  • Lowest taxable rate: 41% 
  • Highest taxable rate: 55%, with 5% surtax on certain transfers between $10 million and $17,184,000 
How can we deal with uncertainty? Some recommend the use of Trust Protectors or decanting provisions. Trust protectors can be given the power to grant a beneficiary a general power of appointment or an amendment power to deal with tax changes or a statement of intent. With the increase in exemption amount, the beneficiary could use a general power of appointment in order to include a property in his/her estate and receive a step-up in basis. A formula testamentary general power of appointment could allow a beneficiary to appoint the creditor of the estate that portion of the trust property that would not be subject to estate tax because of the beneficiary’s exemption amount.