Changes to the federal gift, estate and generation-skipping transfer taxes that will be effective in 2011 and 2012 may create significant new estate planning opportunities. In addition, these changes call for a review of existing estate plans to avoid the possibility of unintended estate consequences for those who die while the new law is in effect. The summary below provides helpful background information and a summary of the major provisions of interest to our estate planning clients, friends of the firm and our colleagues.

The tax “compromise” brokered by the White House and Senate Republicans has been passed by both houses of Congress after attempts to change the estate tax provisions of the proposal ended in stalemate. Title I of the new law, which is entitled the “Tax Relief, Unemployment Insurance Authorization and Job Creation Act of 2010,” extends—for an additional two years, through 2012—most of the provisions of two major bills that were scheduled to expire at the end of 2010: the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA); and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) (known collectively as the “Bush tax cuts”). It also extends a number of provisions enacted as part of EGTRRA that were modified in the American Recovery and Reinvestment Act (the Obama “stimulus” bill). 

Title III of the bill is entitled “Temporary Estate Tax Relief.” In general, it provides liberal—and, in most cases, retroactive—relief for estates of decedents dying since January 1, 2010, and gift and generation-skipping transfers made after that date. These may be summarized as follows:

Increased Exemptions; Lower Rates. The bill sets the exemption amount at $5 million per person and $10 million per couple for the estate, gift, and generation skipping transfer (“GST”) taxes for two years, through 2012. The exemption amount is indexed for inflation, in increments of $10,000, beginning in 2012. The bill also imposes a top tax rate of 35 percent (which is reduced from the 2009 top rate of 45%). 

Effective Dates of Increased Estate and GST Tax Exemptions. The increased ($5 million per person) estate and GST tax exemptions and 35% rate are effective January 1, 2010 (making them retroactive to the beginning of 2010 and, in a sense, the “default” option), but the proposal allows an election to choose no estate tax and modified “carryover” basis for estates of decedents dying on or after January 1, 2010 and before January 1, 2011. No matter which option is chosen, the decedent could still treat any testamentary generation-skipping transfer as having a “transferor” for GST tax purposes, so that, for example, the “move down” rule (which moves the transferor of any GST transfer down one generation for the purpose of determining the taxability of future distributions and terminations) would apply to shelter subsequent distributions from GST trusts from GST tax.

Effective Date of Increased Gift Tax Exemption. The increased gift tax exemption takes effect on January 1, 2011. Until that date, the gift tax exemption amount will remain at $1 million ($2 million per couple). Since the proposal sets a $5 million generation-skipping transfer tax exemption and zero percent rate for the 2010 year, it should be possible to make direct skip gifts during the remainder of 2010 at no GST tax cost (although a gift tax would still be due on gifts in excess of $1 million).

Reunification of the Estate and Gift Taxes. Under EGTRRA, the estate and gift taxes were “decoupled,” so that, by December 31, 2009, the estate and GST tax exemptions were equal to $3.5 million per person ($7 million per couple), while the gift tax exemption remained at $1 million per person ($2 million per couple). The proposal reunifies the estate and gift taxes, effective for gifts made after December 31, 2010.

Portability of Deceased Spouse’s Unused Exemption. Under current law, as it existed on December 31, 2009, in order to take full advantage of a husband’s and wife’s combined $7 million estate tax exemption, the first spouse’s exemption amount would have to be held in a “credit shelter” or “bypass” trust, thus requiring complicated estate planning. The proposal allows the executor of a deceased spouse’s estate to transfer any unused exemption to the surviving spouse without creating a trust. The portability provision applies only with respect to “the last such deceased spouse of [the] surviving spouse,” thus eliminating the possibility of accumulating exclusion amounts from serial marriages. By making use of the deceased spouse’s unused exemption, instead of a bypass trust, the surviving spouse’s estate will be able to step up the basis of the assets that would not have been stepped up through use of a bypass trust. Planners should be aware, however, that a bypass-type trust may still be useful for sheltering appreciation in assets placed in the trust, as well as for all of the reasons that trusts are typically used, such as creditor protection and divorce/second marriage protection.

Extension of Time to File Returns. The proposal extends the due date for any estate and generation-skipping tax return for the estates of decedents dying (and generation-skipping transfers made) after December 31, 2009 and before the date of enactment, to 9 months after date of enactment.

Offsets. It should be noted that the proposal currently on the table contains none of the “pay-fors” that have been included in previous bills, such as limitations on grantor retained annuity trust (“GRAT”) terms and remainders, restrictions on discounts for family-held entities, and uniformity of basis rules for estate and income tax purposes.

GST Tax Allocation Issues. Effective for “estates of decedents dying, and transfers made after December 31, 2009,” the pre-EGTRRA GST tax provisions are “reinstated.” This means that the ability to allocate GST tax exemption (and to opt out of the automatic allocation of exemption) to 2010 transfers is reinstated as well. This ability to allocate to 2010 transfers is important for a number of reasons, not the least of which is to insulate transfers to generation-skipping life insurance (and other) trusts that are “indirect skips” from future GST taxation. However, those making “direct skip” gifts to grandchildren during the remainder of 2010 (when the GST tax rate is zero) will want to elect out of the automatic allocation of GST exemption to avoid wasting any of the transferor’s GST tax exemption on gifts that are not subject to the tax.

Ancillary Provisions. Because the new law reinstates most existing provisions of EGTRRA, those provisions not specifically amended by Title III, such as the deduction for state death taxes and the liberalized criteria for deductible qualified conservation easements will remain intact.

Sunset. Section 304 of Title III of the proposal provides that the “sunset” provision of EGTRRA (Sec. 901) shall apply to the amendments made by “this section.” Thus, the entire issue of extending the tax cuts will have to be revised in 2012, which is, of course, a Presidential election year.

What This Means for You: For at least the next two years, it will be possible to make large inter vivos transfers of wealth to future generations without incurring a gift or generation-skipping transfer tax during 2011 and 2012. Even couples who have used their combined $2 million gift tax exemptions prior to 2011 will have an additional $8 million that can be transferred via gift to children or grandchildren (or in trust for their benefit) during this period. This opportunity will be particularly valuable to those seeking to transfer interests in family-owned businesses, the value of which may be subject to marketability and minority interest discounts (the availability of which was not affected by the new law). GRATs —particularly “zeroed-out,” short-term GRATs—will remain a useful planning technique that was not targeted by the new law as had been feared by some. For those who want to make significant transfers to grandchildren during the remainder of 2010, and who do not mind paying a gift tax, there is an opportunity to do so at no GST tax cost.

For more information or to schedule an appointment to review an estate plan, please contact a member of the Estates and Trusts Group of Buchanan Ingersoll & Rooney PC:

Aen Walker Webster   202/ 452-7935
Deborah Beers  202/ 452-7919
Carol Kelley  202/ 452-7981
Elizabeth Carrott Minnigh  202/452-6048
David Margolis    412/562-8497