The 2010 Tax Relief Act Highlights for Estate and Charitable PlanningJanuary 27, 2011
Federal Estate Taxes
Some of the biggest news in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 TRA”) involves estate taxes. The federal estate tax changed significantly over the past 10 years, with gradually increasing exemptions from imposition of estate tax rising to $3.5 million dollars per person in 2009. In 2010 the federal estate tax went away for one year, but was poised to return in 2011 at the old rates and exemption amounts (55% and $1 million per person) if no legislation had been passed last December.
The 2010 TRA revives the estate tax for decedents dying after December 31, 2009, but at a significantly higher applicable exclusion amount and lower tax rate than had been scheduled under the old law. The maximum estate tax rate is 35 percent with an applicable exclusion amount of $5 million per person. This new estate tax regime, however, is itself temporary and is scheduled to sunset on December 31, 2012.
Together with the revival of the estate tax, 2010 TRA eliminates the modified carryover basis rules that applied in the absence of an estate tax. Property inherited after 2010 TRA receives a stepped-up basis equal to the property’s fair market value on the date of the decedent’s death (or on an alternate valuation date).
Option for 2010
The 2010 TRA gives estates of decedents dying after December 31, 2009 and before January 1, 2011, the option to elect not to come under the revived estate tax. The new law gives those estates the option to elect to apply (1) the estate tax based on the new 35 percent top rate and $5 million applicable exclusion amount, with stepped-up basis or (2) no estate tax and modified carryover basis rules. Any election would be changeable only with IRS consent.
The 2010 Tax Relief Act provides for “portability” between spouses of the estate tax applicable exclusion amount. Generally, portability would allow a surviving spouse to elect to take advantage of the unused portion of the estate tax applicable exclusion amount of his or her predeceased spouse, thereby providing the surviving spouse with a larger exclusion amount. A “deceased spousal unused exclusion amount” would be available to the surviving spouse only if an election is made on a timely filed estate tax return. Portability would be available to the estates of decedents dying after December 31, 2010. Under the Tax Relief Act of 2010, the portability election will sunset on January 1, 2013.
With the election and careful estate planning, married couples can effectively shield up to $10 million from the estate tax by providing that each spouse maximize his or her $5 million applicable exclusion. Because this provision is scheduled to sunset after 2012, the utility of the portability election is limited to situations where both spouses die with the two-year term (that is, 2011-2012), or if this provision is extended, after 2012.
For gifts made in 2010, the 2010 TRA provides that gift tax is computed using a rate schedule having a top rate of 35 percent and an applicable exclusion amount of $1 million. For gifts made after 2010, the gift tax is reunified with the estate tax with a top gift tax rate of 35 percent and an applicable exclusion amount of $5 million. This “reunification” of estate and gift tax exemption amounts presents tremendous lifetime planning opportunities to preserve family wealth.
Donors of lifetime gifts also continue to be able to use their annual gift tax exclusion before having to use part of their applicable lifetime exclusion exemption. For 2010 and 2011, that inflation-adjusted annual exclusion amount is $13,000 per recipient (married couples may continue to “split” their gift and may make combined gifts of $26,000 to each recipient), to an unlimited number of individual recipients.
The 2010 TRA provides a $5 million exemption amount for 2010 (equal to the applicable exclusion amount for estate tax purposes) with a Generation Skipping Tax (GST) rate of zero percent for 2010. For transfers made after 2010, the GST tax rate would be equal to the highest estate and gift tax rate in effect for the year (35 percent for 2011 and 2012).
State of Washington Estate Taxes
The State of Washington continues to have its own parallel estate tax system to the Federal Estate Tax. The State of Washington will impose an estate tax on the estates of persons resident to Washington with a net worth in excess of $2 million dollars per person. Estate taxes paid to Washington State are deductible for Federal estate tax purposes, but with the higher Federal exemption amounts there will be very few estates that benefit from this deduction. Estate tax rates in Washington range from 15% to 19% of the value of the taxable estate.
Washington residents with the ability to make gifts to family or friends may realize a significant tax savings benefit by making lifetime gifts rather than gifts under a Will or Trust. Gifts made during the gift-maker’s lifetime remove the gift from the gift-maker’s estate for Washington State estate tax purposes, thereby saving the State of Washington estate taxes that may otherwise apply if the gift were transferred at death. With the recent increase to $5 million per person in lifetime giving that can be done without incurring Federal gift tax, there is significant incentive to consider lifetime gifts that result in reduced State of Washington estate taxes in the future.
Charitable Giving and the 2010 Tax Relief Act
In 2011, taxpayers age 70 & ½ or older may make charitable transfers of otherwise taxable distributions from their traditional IRAs and Roth IRAs up to a total of $100,000 per taxpayer, per taxable year. So, rather than adding your required distributions to your taxable income, you can choose to donate those distributions to charity up to $100,000 per year.
Taxpayers were not able to make these tax-free transfers to charity in the 2010 tax year because the relevant tax code provisions expired at the end of 2009. As part of the recent tax law changes, charitable transfers can once again be made directly from an IRA to a charitable organization. While no income tax deduction results from this type of transfer, neither does this transfer cause income recognition to the donor from the IRA distribution.