By: Randall A. Denha, Esq.
On Friday, December 17th, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“the Act”). The Act does the following:
1. Increases and reunifies the federal estate and gift tax exemption to $5 million per person,
2. Increases the generation-skipping transfer (GST) tax exemption to $5 million per person,
3. Reduces the top estate, gift and GST tax rates to 35 percent,
4. Extends the Bush-era individual income tax rates, and
5. Creates portability of the unused estate tax exemption amount for spouses.
The Act sets a $5 million threshold for an individual or $10 million for a married couple for estate, gift and generation skipping-tax levies, with a top tax rate of 35%. It’s important to note that the Act is temporary. The relief and benefits afforded by the Act are only in effect thru the end of 2012. Put another way, the opportunities presented by the Act are only good for calendar years 2011 and 2012. As such, it’s imperative that action take place sooner rather than later.
Beginning in 2011, the Act provides for “portability” of the estate tax exemption amount. This means that the executor of a deceased spouse’s estate may transfer any unused estate tax exemption to the surviving spouse. But, unless Congress changes the law, the surviving spouse will lose the use of the deceased spouse’s exemption if he or she doesn’t use it before 2013.
Interestingly, despite the threat of legislative attack, and as I reported in previous blogs, the Act did nothing with two very useful wealth transfer tools available to taxpayers today, i.e., Grantor Retained Annuity Trusts (GRATs) and valuation discounts. Except in larger estates, the GRATs may no longer be as necessary given the increase in the gift tax exemption. However, valuation discounts will simply add more positive leverage to transfers of closely-held businesses and other entities, including by way of GRATs.
Gifts made in 2011 and 2012 allow for an exemption of $5 million, adjusted for inflation starting in 2012. This is the same as both the estate and generation skipping tax systems. This re-unification of our transfer tax systems provide serious wealth planning opportunities for those individuals who want to give. For example, in the areas of gifting consider postponing any taxable gifts until 2011 to take advantage of the higher gift tax exemption of $5 million. This will also postpone the payment of any gift tax until 2012.
Does it make sense for the taxpayer to make a gift if the taxpayer is not willing to pay a gift tax? There is generally no advantage to making gifts in December 2010 rather than in January 2011 if the donor does not want to pay gift tax. The tax rate is the same (35%) if there is gift tax, and there is more gift tax exemption in January 2011 to cover gift transfers in case the IRS argues for higher gift values on audit. Of course, by gifting assets earlier rather than later, other non-tax considerations can be met such as: asset protection, removing the appreciation on any growth in those gifted assets and any gift tax paid would be removed from the estate after a 3 year period, to name a few.
Under the Act, several planning opportunities exist. The following are a few to consider:
1. Taxpayers can give or bequeath much more on a tax-free basis than ever before;
2. The surviving spouse can add to his or her own $5 million exemption, whatever amount of exemption the deceased had not used during his or her lifetime. The deceased’s estate will have to file an estate tax return in order to receive this benefit;
3. Reviewing any existing life insurance policies especially those that have a flexible premium structure. Why? You could choose to reduce the premiums to the minimum required to support the death benefit until the future is clarified or, at least, until the next “temporary” set of rules puts things in limbo long enough for the taxpayer to consider that things are “permanent”;
4. The increased estate, gift and GST exemptions permit additional moneys to be placed into insurance trusts to “super-charge” the underlying policies so that the insurance policy doesn’t lapse or remain under water;
5. The increased gift and GST tax exemptions open opportunities for tax-free funding of insurance owned policies to create long-term “family banks” that provide income and capital for successive generations on a transfer tax-free basis;
6. Increased use of intra-family loans and sales to defective trusts permit larger amounts of money to be transferred to the next generation;
7. The beneficiary of a marital trust who will be taxed at his/her death can take a significant distribution and give it to his or her children at a higher gift tax exemption and a lower rate than would be available if that beneficiary passes away after 2012. This opportunity could be expanded and coordinated with GST tax planning.
The wonderful aspect to the Act is that it removes any uncertainty about 2010 transfer and what we can expect for the next couple years. The new law provides many opportunities for planning but it is imperative that planning take place because what we have now is only temporary. The legislation provides something for everybody and while each of us has a different set of facts, the law provides a roadmap for finding the gold at the end of rainbow. You just have to know where to look and be willing to travel the road.
THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION.
CIRCULAR 230 DISCLAMER: NONE OF THE ARTICLES IN THIS NEWSLETTER ARE INTENDED OR WRITTEN BY THE VARIOUS AUTHORS OR DENHA & ASSOCIATES, PLLC, TO BE USED, AND THEY CANNOT BE USED, BY YOU (OR ANY OTHER TAXPAYER) FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON YOU (OR ANY OTHER TAXPAYER) UNDER THE INTERNAL REVENUE CODE OF 1986, AS AMENDED.