In 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Tax Act”) which, following in the footsteps of The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), reduced the number of people who would have to pay estate and gift taxes. The 2010 Tax Act, by its terms, extended the estate tax repeal put into place by EGTRRA. However, the 2010 Tax Act only applies for 2010, 2011, and 2012, after which time it will “sunset” (disappear), reinstating the 2001 estate tax provision. Unless the 2010 Tax Act is extended by Congress or replaced by new tax provisions, the estate tax exemption will revert back to $1 million, with a tax rate of 55% for any assets not falling within the exemption.
In order to understand the significance of this potential change, the following is a summary of the current transfer tax exemptions
|
2012 Tax Exemption |
Tax rate over $5.12M exemption |
||
| Estate Taxes |
$5,120,000.00 |
35% |
|
| Gift Taxes |
$5,120,000.00 |
35% |
If lifetime gift amounts exceed $5.12M * |
| Generation skipping Transfer Taxes (GST) |
$5,120,000.00 |
35% |
The GST is the amount individuals can transfer to their grandchildren or put into continuing trusts that will not be subject to estate tax at a later date. |
| * Currently, individuals are allowed to give up to $13,000 each year to each of an unlimited number of people without any tax consequences. Any amount over that $13,000 is added up over the individual’s lifetime. If the total is greater than the gift tax exemption when the individual passes away, the individual’s estate must pay tax on that amount. | |||
One additional aspect of the 2010 Tax Act that will disappear if the Act sunsets is the “portability” provision that allows a surviving spouse to use a decedent spouse’s unused estate tax or gift tax exemption, e.g., a husband and wife have assets valued at $8,000,000, and each spouse has a $5,120,000 estate tax exemption, and the husband passes away in 2012. In the past, each spouse would lose his/her exemption if it wasn’t used. But, with the portability provision, the decedent husband’s estate can file an estate tax return which elects to allow the surviving wife to use the husband’s unused exemption, meaning that when the wife passes away, she will have a $10,240,000 exemption to use and all of the couple’s $8,000,000 would fall within the exemption.
So what would it mean if all these provisions disappeared after December 31, 2012? Essentially, all the exemption amounts would revert back to pre-2001 exemptions ($1M per person) and it would be as if the last 11 years had never happened. Estate plans implemented between 2001 and 2012 relying on the higher exemption amounts may have to be materially revised, and there would be no authority to recognize portability exemptions between spouses, even if the portability election had been made in 2012. Additionally, non-exempt transfers would be taxed at a rate of 55%.
We have experienced this uncertainty before. The transfer tax exemption provisions of EGGTRA were originally set to sunset at the end of 2010; however, at the last minute, they were extended (and expanded) by Congress. The Treasury currently has proposals in place for 2013, including making portability permanent, but Congress has not yet acted. It remains to be seen if and when these provisions will be revised. While it is impossible to know what the provisions of 2013 will look like, traditional estate planning strategies, including trusts, remain viable options for ensuring needed flexibility. As always, vigilant estate planning remains the taxpayer’s best tool to minimize estate tax liability.
