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Estate Planning Aspects of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010

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Estate Planning Aspects of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010

On December 17, 2010 President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Act”) into law. In addition to extending the Bush-era income tax cuts that were scheduled to expire in January of 2011, the 2010 Act provides much needed clarification on the rules governing the federal transfer tax system.

Throughout 2010, there has been considerable uncertainty about the rules applicable to the federal estate, gift and generation-skipping transfer (“GST”) taxes. The uncertainty stemmed from the Economic Growth and Tax Relief Reconciliation Act of 2001 (“2001 Tax Act”), which contained a nine-year phase down of the federal estate tax and the GST tax, culminating in the repeal of both the federal estate tax and the GST tax--but not the gift tax--for 2010 only. After 2010, the estate and GST taxes were scheduled to reappear, but at the much higher rate, and with much lower exemption amounts that would have been in effect prior to the 2001 Tax Act.

For much of 2010, commentators speculated that Congress would pass legislation making the estate tax apply retroactively to 2010 estates. Families and their advisors have also wondered whether, after 2010, the estate tax would really be increased to 2001 levels, whether Congress would enact legislation under which the estate tax would revert to where it was in 2009 immediately before repeal, or whether Congress would do something else altogether.

The 2010 Act has answered these questions. The rules governing the federal estate, gift and GST taxes for 2010, 2011 and 2012 will be as follows:

I. Estate Tax

1. Deaths during 2010

The 2010 Act makes a revised estate tax applicable to estates of those dying in 2010 unless executors elect out of the estate tax regime. If this election is made, the estate tax will not apply. However, the quid pro quo is that the decedent’s assets will not receive a complete step-up in the basis to fair market value at death. Instead, only a limited basis step-up of $1.3 million for non-spousal beneficiaries and $3 million for spousal beneficiaries will be available.

If the estate of a 2010 decedent does not elect out of the estate tax, the estate tax will be computed with a $5 million exemption and a top rate of 35%. The tax basis of all assets will be stepped-up to the fair market value of those assets at the date of death. (This does not apply to retirement plans.) Estate tax returns will be due within nine months of enactment of the 2010 Act, rather than the usual due date of nine months after the date of death.

Estates valued at $5 million or less are likely better off without the election. The exemption will prevent any estate tax from being due, and the assets can receive a full basis step-up, reducing future capital gains taxes.

For estates valued over $5 million, executors will need to review the comparative benefits of freedom from estate tax versus the savings on capital gain tax that a full basis step-up will produce.

2. 2011 and 2012 Estates 

For those dying in the coming two years, there will be a $5 million exemption and a maximum tax rate of 35%.

The 2010 Act creates a new rule with respect to the portability of estate tax exemptions between spouses. The first spouse to die has a choice in his or her estate plan. He or she can use all or part of his or her $5 million estate tax exemption by leaving assets worth that amount to his or her children, to other descendants, to a “credit shelter trust” for the benefit of the surviving spouse, or to any other beneficiary who is not the surviving spouse or a charity. The first spouse to die can instead choose to leave the amount of his or her unused estate tax exemption to the surviving spouse.

For example, if the first spouse to die owns $5 million of assets, he or she can leave this amount to his or her children, estate tax free (by using the exemption), or he or she can leave the $5 million to the surviving spouse to be added to his or her own exemption. The surviving spouse will then own all of the couple’s assets, plus have a $10 million exemption (the surviving spouse’s own exemption, plus the exemption inherited from the first spouse). Thus, the couple can shelter $10 million from estate tax without having to re-title assets between the two of them, assuming the $5 million exemption remains in effect.

If the decedent has been married more than once, only the unused estate tax exemption of the last deceased spouse of the surviving spouse can be used.

II. Gift Tax

For gifts made after 2010 and before 2013, the gift tax exemption will be $5 million, up from only $1 million in 2010. As with the estate tax, the maximum gift rate will be 35%. Thus, the pressure to finalize gifts by December 2010 has been eased (apart from $13,000 annual exclusion gifts).

III. Generation-Skipping Transfer Tax (“GST”)

The 2010 Act provides that the GST tax rate during 2010 is zero. It also provides a $5 million GST exemption for 2010, 2011 and 2012, which will be indexed for inflation. The GST exemption is not portable between spouses. Thus, GST planning should be complete before either spouse dies and may include the use of trusts.

It is advantageous to capitalize on the zero GST tax rate in 2010 by making gifts to grandchildren and to trusts for their exclusive benefit. However, 2010 gifts to trusts benefitting both children and grandchildren are problematic. While these gifts are initially GST tax-free, distributions from these trusts in 2011 and later years are subject to GST taxes.

IV. Other Provisions

There are no new provisions on grantor retained annuity trusts (“GRATs”) or valuation discounts. It was widely anticipated that any tax legislation passed this year may have contained rules requiring GRATs to have a minimum term of at least ten years. However, the 2010 Act contains no such limitations. Therefore, short term GRATs remain viable, and the December 2010 interest rate of 1.8% is the lowest and most beneficial rate for GRATs of any month to date.

In addition, earlier proposals to limit valuation discounts such as those used in family limited partnerships were not enacted as part of the 2010 Act; therefore, these planning techniques also remain viable.

The 2010 Act presents families with a number of new wealth transfer opportunities that were not previously available.

For a review of your estate plan to ensure your documents will work to accomplish your goals, in light of the changes contained in the 2010 Act, please contact your estate planning lawyer:

Peter R. Brown

Natalie B. Choate

Julia Satti Cosentino

Thomas P. Jalkut

Deborah J. Manus

Susan L. Repetti
617.439.2267 J

Jeffrey W. Roberts

Circular 230 Disclosure: To ensure compliance with IRS Circular 230, we inform you that any federal tax advice included in this communication is not intended or written to be used, and it cannot be used, for the purpose of (i) avoiding the imposition of federal tax penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered advertising.

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