Estate Tax for Years 2011 & 2012

  Tax 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

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 $17,184,00

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.

State Estate Tax

The Commonwealth of Virginia has repealed its estate tax law. There is currently no estate, gift, GST or separate inheritance tax in Virginia.

When there are real estate properties outside of Virginia, the executor shall check whether these states have an estate tax (payable by the estate) or an inheritance tax (payable by the beneficiary).[4] The residence of the decedent determines the levy of inheritance or estate tax, but a state where the decedent had real estate may impose estate or inheritance tax calculated on the value of the real estate property. Seeking the assistance of local tax counsel is highly recommended.

Before the EGTRRA, states were following the federal estate tax, and they had a death tax credit carved out of the federal estate tax reported on line 15 of the Form 706. However, their due date and filing requirements may have been different. The death tax credit has been replaced with a deduction that is reported on line 3b of Form 706. If EGTRRA sunsets, the state death tax credit will be resurrected.
Some states have refused to see their income reduced and have decoupled from the federal estate tax. Among these are the state of Maryland and the District of Columbia. Both jurisdictions have an estate tax for estates above $1 million with a 16% tax but with different filing requirements. When there are real properties located in several states, the executor needs to check the estate and inheritance tax of each state.

While the District of Columbia does not have inheritance tax, the State of Maryland has in addition to its estate tax an inheritance tax. Close family members of the decedent are exempted from the inheritance tax: surviving spouse, children, parents, grandparents, and siblings. Other individuals pay a 10% tax on the estate assets that they receive. The estate tax gives a tax credit to the inheritance tax.

Please note that the new Tax Act provides a Federal extension for disclaimers. Since a qualified disclaimer must satisfy state law, state disclaimer statutes may need to be amended to accommodate an extended deadline. 
a.) Tuition Fees

The exemption is limited to the payment of tuition fees; it does not include books, supplies or dormitory expenses. A qualifying education institution is defined as one that maintains a regular faculty and curriculum and has a regularly enrolled student body at the place where its educational activities are carried out.  The donor can also enter into a contract with the institution to pay future tuition. The IRS rules that a grandmother would qualify for the exclusion under § 2503(e) for the payment in advance of the tuition of her grandchildren. The IRS required that the payments could not be refunded and were to be forfeited if the grandchildren ceased to attend the school.

b.) Medical Expenses

Medical care is defined to include expenses incurred for the diagnosis, cure, mitigation, treatment or prevention of disease, or for transportation for such medical care, and applies only to payments that have not been reimbursed by the donee’s insurance. In addition, the person who pays medical expenses for a third person may report the payment as a deduction on his/her own income tax returns. If the yearly medical expenses exceed 7.5% of the AGI, then this deduction can be reported. This is very important when a family member pays a nursing home. Health care premiums and long-term care insurance are deductible medical expenses. The person who pays tuition fees for a spouse or a dependent may also be eligible for an income tax deduction by filing Form 8917 with the federal income tax return.

c.) Using the Annual Exclusion

For gifts of present interest only, a donor may exclude the first $10,000 of gifts, adjusted to inflation, made to each donee during any calendar year. Currently the annual exclusion amount is $13,000. As a result the first $13,000 of gifts made to each donee during the year is subtracted from the total gifts made during the calendar year in determining the amount of taxable gifts. If the donor is married, the annual exclusion may be aggregated per couple and increased to $26,000.

In addition, a donor can contribute a lump sum of $60,000 ($120,000 for married donors) to a 529 College Savings Plan. The IRS accepts that the donor books his/her coming 5 years of annual exclusion for the beneficiary of the 529 College Savings Plan. The beneficiary will be able to take immediate advantage of the potential growth of the 529 Plan investments. If the donor were to die within this 5-year period, a portion of the gift may be includable in the gross estate of the donor.

d.) Annual Exclusion for Non-Citizen Spouse

As we will discuss in more detail below, a U.S. citizen spouse has an unlimited transfer deduction. A non-U.S. citizen is not allowed to this deduction. In addition, the presumption that joint property with right of survivorship held between spouses is owned 50% by each, does not apply either. Upon the death of the first spouse, the IRS will presume that the joint property was owned 100% by the decedent. The alien spouse will have to prove his/her ownership interest in the property by tracing the origin of the fund.

The IRS, under Section 2523(i), allows an annual exclusion of $100,000, adjusted to inflation. The annual exclusion is in the amount of $34,000 for 2010. This is a good estate planning tool when at least one spouse is an alien and the other spouse has a higher income. By making an annual gift, the couple can rebalance their assets.

e.) Deductions for Transfer to Spouse

There is an unlimited marital deduction[7] for transfers to a U.S. citizen spouse. This unlimited marital deduction is recognized for transfers of joint property, but where a life estate or a terminable interest in property is created the deduction is generally not allowed. There is an exception to this rule. When the life estate is coupled with a power of appointment in the donee spouse, a marital deduction will be allowed if the following five (5) conditions are met: The donee spouse is entitled for his/her lifetime to all of the income generated by the property;· The income is paid to the donee spouse at least annually;· The donee spouse has the power to appoint the interest to himself/herself or his/her estate;· The donee spouse’s power to appoint rests solely in the donee spouse; and
The entire interest is not subject to a power in any other person to appoint any part to any person other than the donee spouse.

Therefore, a terminable interest in trust will be eligible for a marital deduction if it is a “qualified terminable interest” and satisfies all of the requirements set forth under IRC § 2523(f)(2) for “QTIP” treatment.

A non-citizen spouse may have the bequest qualifying for the marital deduction if the bequest is held in a Qualified Domestic Transfer Trust (QDT). This trust postpones the payment of the tax due until the first spouse dies, whereas under the unlimited marital deduction the assets are transferred into the surviving spouse estate and the tax is calculated on the surviving spouse estate. Basically, the QDOT needs to have a U.S. trustee and when distributions of principal are made, estate tax needs to be paid.

f.) Deductions for Transfers to Charity

A charitable deduction is allowed for all transfers to or for the use of the public or any corporation exclusively established for religious, charitable, scientific, literary or educational purposes. The income tax charitable deduction[8] is parallel to the estate and gift tax charitable deductions.[9] However, the estate and gift tax charitable deductions for property passing outright to charity are unlimited and do not vary with the identity of the charity, so long as the charity is qualified, and are available for foreign charities.

Some donors are making a charitable gift through a “split interest.” A split interest gift is a gift made in part to a charity and in part to a non-charitable beneficiary. For instance, a property is transferred in trust to pay income to an individual for life with the remainder interest going to charity. No charitable deduction is allowed for a split interest gift unless the charity’s interest is in the form of a
  • Charitable remainder annuity trust[10]
  • Charitable reminder unitrust[11]
  • Pooled income fund[12]
  • Charitable lead trust (in the form of either an annuity or unitrust)[13]
Section 725 of the Act provides tax-free distributions from individual retirement plans for charitable purposes. The termination date of IRC Section 408(d)(8) extended through December 31, 2011, is retroactive to January 1, 2010. For instance, a donor age 70 ½ or over may make charitable donations up to $100,000 directly from IRA accounts to charity. Donations made in January 2011 may be counted as having been made in 2010.