Estate Planning Under the 2010 Tax Relief Act

The 2010 Tax Relief Act, which was signed into law on December 17, 2010, creates significant estate planning opportunities for the next two years before “sunsetting” at the end of 2012.

Estate, Gift and GST Exemptions and Rates

Beginning this month and ending on December 31, 2012, the exemption amounts for the estate, gift and generation-skipping transfer (“GST”) taxes are set at $5 million, and the rate for each of these taxes for transfers in excess of $5 million is 35%. The three types of taxes are now on the same footing, with the highest exemption levels and lowest rate in recent memory.

Opportunity for Lifetime Gifts

For the next two years, individuals can transfer up to $5 million and married couples can transfer up to $10 million (reduced by prior gifts), during life or at death, without incurring gift, estate or GST tax. Donors who have already used the $1 million gift tax exemption under prior law now have an additional $4 million in exemption (and potentially much more for married couples) that can be applied to lifetime gifts. Such gifts not only benefit donees during the donor’s lifetime, but they also shift future appreciation of the transferred property out of the donor’s potentially taxable estate. Any portion of the $5 million exemption not used for lifetime gifts will be available – along with the traditional marital and charitable deductions – to shelter transfers at death.

If made to grandchildren or more remote descendants, gifts and bequests up to $5 million ($10 million for married couples) will also be free of the separate GST tax. Donors who applied GST exemption to prior gifts can make use of the higher exemption amount, less what they have already used, either for additional gifts or for transfers at death.

The Act thus creates the opportunity for significant transfers of wealth between now and December 31, 2012, when – unless Congress passes additional legislation – the higher exemption amounts and lower tax rates will expire and pre-2001 levels will be reinstated. Clients who are interested in making sizeable gifts to their children or grandchildren may wish to do so sooner rather than later, but should seek advice first to discuss the possible consequences in the event pre-2001 law is in fact reinstated in 2013.¹

Taking Another Look

All clients, however, should review their current estate plans in light of the higher exemption levels. A Family Trust intended to hold property exempt from federal estate tax would have held $2 million if the trust donor had died in 2006-2008 but will be funded with $5 million if the donor dies this year or next. Similarly, a trust for grandchildren intended to hold assets exempt from GST tax would have held $1.5 million in 2004 or 2005 but will receive $5 million if created under the trust instrument of a donor who dies this year or next. If the funding formula in your estate plan is no longer consistent with your wishes, a simple revision imposing a cap on funding amounts may be sufficient. Other clients may wish to revise their plans more broadly to take advantage of the opportunities under the 2010 Act.

Charitable Rollovers from IRAs

The Act extends until the end of 2011 the IRA charitable rollover opportunity previously available through the end of 2009. The Act permits direct charitable rollovers by taxpayers 70½ or older of up to $100,000, from traditional and Roth IRA accounts, to certain charities other than private foundations and donor-advised funds. This technique allows donors to avoid income tax on charitable contributions that might otherwise be subject to deductibility limits, and it might lower a donor’s state income taxes in certain states as well. Charitable rollovers can also be applied to IRA minimum distribution requirements for 2011.

Sharing Exemptions

Other changes made by the Act include making the estate tax exemption “portable”: a surviving spouse can make use of the unused exemption of his or her deceased spouse – either for lifetime gifts or upon his or her own death – with no need for either spouse to create a “bypass” or family trust. However, unless extended, this new provision will become effective only if one or both spouses die during the two-year period before the law expires. In addition, it has no effect on the $1 million exemption from the Massachusetts estate tax (or on similar exemption amounts in other states that impose an estate tax), and it does not apply to the GST exemption. For these and other reasons we do not recommend that clients revise their current estate plans to take advantage of this provision unless the new law is made permanent. It is nevertheless an important development that if extended may make estate planning simpler for many clients.

Alphabet Soup (GRATs, QPRTs, CRTs, etc.)

The Act makes no change to some of the most valuable estate planning tools currently available. These include grantor-retained annuity trusts (“GRATs”), personal residence trusts, intra-family loans, and charitable trusts. These tools can be effective in reducing gift, estate and GST taxes as well as income taxes under the appropriate circumstances.

2013 and Beyond

Like the legislation that preceded it, the 2010 Act by its terms sunsets, this time at the end of 2012. Without further action by Congress, pre-2001 exemption amounts and tax rates will go into effect again on January 1, 2013. We of course do not know what the law will be two years from now, and while we hope for a “permanent fix” to the estate tax system before 2013, in the current political climate, change may in fact be the new constant.

We would be happy to discuss with you how you might take advantage of the opportunities presented by the 2010 Tax Relief Act in the context of your individual estate plan.