Make the most of recent estate tax legislation changes

Published 11:06 am Thursday, March 31, 2011

Thanks to the new estate and gift tax rates and exemptions signed into law in December, taxpayers have an unprecedented opportunity to preserve more of their estate wealth. As a result, evaluating your estate planning strategy has never been more important — or more urgent, since some of the n

ew rates and exemptions will be in effect only through 2012.

Prior to the new law, families whose loved ones died in 2010 owed no federal estate tax. Yet, with certain exceptions, many of these families didn’t have the opportunity for a tax-free step-up in asset basis along with the ability to set aside assets in certain types of generation-skipping trusts that may have been provided for in the decedent’s final documents. The new law gives 2010 estates a choice: Opt in and be taxed under the new law, or opt out and be taxed under the law that existed before.

Without legislation to extend the new rules, everything reverts back to the 2001 rules after Dec. 31, 2012.

Here are the major contours of the estate tax landscape over the next two years, compared with what things will look like after 2012, absent new legislation:

Rates and exemptions

Gift tax rate, 2011-’12, 35 percent

Gift tax rate, 2013 on, 55 percent

Estate tax rate, 2011-’12, 35 percent

Estate tax rate, 2013 on, 55 percent

Estate tax and lifetime gift exemption, 2011-’12, $5 million

Estate tax and lifetime gift exemption, 2013 on, $1 million

Generation-skipping tax exemption (inflation indexed), 2011-’12, $5 million

Generation-skipping tax exemption (inflation indexed), 2013 on, $1 million

Portability of estate tax exemptions between spouses, 2011-’12, yes

Portability of estate tax exemptions between spouses, 2013 on, no

The lifetime gift exemption has been increased to match the exemption otherwise available at death. This means that (for 2011 and 2012 only) a married couple who has used none of their lifetime exemption could gift up to $10 million (up to $5 million each) with no gift taxes due. After 2012 (absent new rules), that same $10 million transferred at death could trigger an $8 million taxable transfer — $10 million minus their combined $2 million exemption — with a federal tax liability as high as $4.4 million (55 percent of $8 million).

The new law caps the highest federal marginal rate at 35 percent for gifts and bequests in excess of the $5 million exemption (for 2011 and 2012 only). After 2012 the rate is scheduled to increase to 55 percent, the top rate in effect under the 2001 law.

Under old law, if a married person died without using the entire estate exemption, the unused portion was lost. The new law permits an executor or trustee to transfer the deceased spouse’s unused exemption to the other spouse, but an estate tax return must be filed even for estates of less than $5 million.

The increase in the federal lifetime gift tax exemption, from $1 million to $5 million, creates more transfer tax planning flexibility than appears at first blush, especially when taking into consideration the corresponding generation-skipping trust increase.

Your documents may require at least two separate kinds of trusts — a “credit trust” equal to the lower of your available federal or state exemption and a “marital trust” for the excess. It’s important to structure your documents properly to take advantage of the increased federal exemption of $5 million while also ensuring that there are no state inheritance taxes due on the first death by using a “state only” marital trust for the difference in exemptions.

While it’s conceivable that Congress may extend some or all of the current provisions, one has to acknowledge that the possible federal transfer tax savings are simply too big to ignore.

Parents should first be concerned about taking care of themselves, since no parent ever wants to burden his or her children. However, gifting assets to your children now might make a good deal more tax sense than waiting. It’s just a question of which of the planning alternatives best fits your particular business and family circumstances.

Noni LaLone is a tax partner with Moss Adams LLP in Everett. She serves closely held businesses, high-net-worth individuals, and families. Call 425-317-3045 or email noni.lalone@mossadams.com.