New Estate Tax Laws Provide Some Temporary Relief

By Chris Watkins

Well, in typical Washington fashion, the politicians waited until the very last possible moment to deal with the looming tax crisis that was to occur on January 1, 2011, when the Bush tax cuts were set to expire.  In addition to the multitude of other tax increases that would have hit us, we were facing a dramatic increase in the estate tax rate, along with an equally dramatic decrease in the estate tax exemption.  Also in typical Washington fashion, Congress didn’t enact any legislation that would provide long-term, reliable solutions to our problems.  Rather, they passed very temporary relief, forcing the next Congress to deal with this issue in two years.  However, what they did pass, at least in the short term, was pretty good.  Here is a quick synopsis of the new Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (or TRA 2010) as it pertains to estate taxes.

Estate Tax Exemptions and Rates.  For the years 2011 and 2012, the new law sets the estate tax exemption amount at $5 Million per person, with a maximum estate tax rate of 35%.  If not for the TRA 2010, the exemption amount would be $1 Million, with a maximum rate of 55%, which is the exemption and rate that will apply in 2013 if the law isn’t changed again.

Gift Tax Exemptions.  Like the estate tax exemption, the gift tax exemption is now $5 Million for the next two years, increased from $1 Million.  The annual exclusion amount remains $13,000.  In other words, you can make a gift of up to $13,000 per person per year with no gift tax obligations.  Beyond that, you are allowed to gift up to $5 Million gift tax free ($10 Million per married couple).  This represents a potentially HUGE opportunity for families to transfer significant wealth to future generations, tax free.   Remember, this $5 Million exemption is tied to both the estate and gift tax exemptions.  So if you use some of it up during your life, your exemption at death is reduced by the same amount.  There is some speculation about what will happen if someone makes a large gift now and how it will be treated if the law sunsets to the $1 Million exemption amount.  Will it be recaptured by the estate at death?  It seems unlikely the IRS will do that, but you never know.

Portability of Exemptions.  One very interesting change has to do with the ability of spouses to take advantage of each other’s estate tax exemptions.  At least during 2011 and 2012, to the extent you have not used up all of your $5 Million estate tax exemption, that amount can be utilized by your spouse at his or her subsequent death.  The downside to this is that both spouses must die before 2013.  Furthermore, the executor for the first spouse to die must file an estate tax return with the IRS to preserve his or her unused exemption, even if no estate tax is due.

Conclusion.  While these are all good changes to the estate tax laws, they provide very limited benefit from the planning side.  We think you still have to plan with the assumption that Congress will fail to make these changes permanent.  The biggest potential windfall may be in the ability of people to make very large gifts – at least in the short term.