The Tax Relief Act of 2010 brought long overdue temporary relief to the tax landscape wrought by EGTRRA in 2001. While the landscape has undoubtedly shifted in the wake of this legislation, additional aftershocks are expected and will bear monitoring.
“Certainty: In this world nothing is certain but death and taxes.”
“Here today, gone next year, and back again the following year” was often the easiest way to describe the Economic Growth and Tax Relief Reconciliation Act of 2001
(EGTRRA). Under EGTRRA, we had a federal estate tax and generation-skipping transfer tax in 2009, which was repealed1 in 2010, and then reinstated at 2001-era exemption levels and rates in 2011.2
Following EGTRRA’s passage in 2001, pundits almost uniformly opined that Congress would pass an alternative prior to its foreordained repeal in 2010. From 2002 through 2009, various bills were proposed that would have repealed the federal estate tax, while others offered different exemption amounts and various other reforms. Notwithstanding tremendous interest by estate planning attorneys and billionaire investor Warren Buffett, none of these bills moved forward.
On January 1, 2010, the federal estate tax was (temporarily) repealed. Many estate planners steadfastly held to the belief that this “Alice in Wonderland” moment would not last and that a bill would be passed retroactively reinstating the federal estate tax effective January 1st. The clamor for such legislation grew as billionaires Dan Duncan and George Steinbrenner passed.
When rumors circulated in late November and early December 2010 of changes in the works, most—having had their hopes of clarity dashed several times previously—chose not to get their hopes up this time.
On December 6, President Obama announced that he had reached a deal with congressional leaders. The estate tax provisions of the deal would include a $5 million federal estate tax exemption and a top federal estate tax rate of
35 percent. The deal would be temporary and the changes to the estate tax would sunset after two years. Nevertheless, the chasm between federal estate tax repeal and a $1 million federal estate tax exemption had been bridged.
Eleven days later, the “The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” (P.L. 111-312 12/17/2010) was signed into law (Tax Relief Act). The Tax Relief Act:
- Provided a temporary extension of EGTRRA’s sunset provisions;3
- Reinstated the federal estate tax and generation-skipping transfer tax with applicable exclusion amounts of $5 million and a top tax rate of 35 percent;4
- Provided special rules for decedents dying in 2010;5
- Extended the deadline within which to make a disclaimer of assets for estates of certain decedents under Internal Revenue Code Section 2518(b);6
- Provided for indexing of the applicable exclusion amount;7
- Reunited beginning in 2011 the federal gift and estate tax exemption amounts;8 and
- Provided for post-2010 portability of the applicable exclusion amount for a decedent’s spouse.9
The Tax Relief Act extends the sunset of estate, gift and generation-skipping transfer tax provisions of EGTRRA by replacing “December 31, 2010,” with “December 31, 2012.” Stated differently, stay tuned for further developments as the changes to federal estate tax law are only temporary and we will have to wait for further action to provide finality. If, however, nothing further is done, the federal estate and gift tax exemptions will return to pre-EGTRRA levels in 2013 together with a 20 percent increase in the top tax rate.
As things now stand, the applicable federal estate tax exemptions and rates and gift tax exemptions and rates for 2009 through 2013 are as shown below:
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The Tax Relief Act provides that an “executor” of an estate for a decedent dying after December 31, 2009 and prior to January 1, 2011 may do nothing and the decedent’s estate will have a $5 million exemption and a step-up in basis. Alternatively, the executor may affirmatively opt out and elect the pre-Tax Repeal Act repeal of the federal estate tax and carryover basis.10 The Tax Relief Act also provides that the Secretary of the Treasury must provide forms and regulations necessary to make such an election, and practitioners are waiting for further guidance on this. This guidance is anticipated soon.
In the meantime, practitioners administering estates of decedents who passed in 2010 (2010 estates) will need to be prepared to make a recommendation to their clients: stay in or opt out. Generally speaking, most 2010 estates will not benefit from making an election. These estates will not pay federal estate tax anyway and will benefit from a step-up in basis.
As estates increase in size, even estates owing a modest federal estate tax may wish to consider paying taxes now for the benefit of the step-up in basis.
The estates for which opting out mathematically makes the most sense are generally those that are significantly larger than $5 million. That said, practitioners need to run the numbers and advise their clients of the pros and cons of the election. The Minnesota Department of Revenue has a useful calculator for estimating taxes.11
Deadlines, Indexing & Reunification
The Tax Relief Act also provides for extensions within which to file and pay federal estate taxes. Specifically, the Tax Relief Act provides that the due date “will not be earlier than the date which is nine months after the date of the enactment of this Act.”12 Nine months following the date of enactment is September 17, 2011.13
Certain other federal tax filings may also be extended. One such is the time within which to file a qualified disclaimer of property passing by reason of the death of a decedent under Internal Revenue Code Section 2518(b). Note that while the deadline to disclaim appears to be extended under federal law, the ability to do so is dependent upon state law14 and Minnesota statutes have not been changed to allow this. At least not yet.
Similar to what was done with annual exclusions previously, the Tax Relief Act provides for the indexing of the federal estate, gift and generation-skipping transfer tax exemptions (with rounding in $10,000 increments). Indexing is based on the “cost-of-living adjustment determined under section 1(f)(3) for such calendar year by substituting ‘calendar year 2010’ for ‘calendar year 1992’ in subparagraph (B) thereof.”15 The indexing of the exemptions begins in 2012. As the tax relief provided in the Tax Relief Act is scheduled to sunset at the conclusion of 2012, further analysis on the details of indexing seems unwarranted, but further developments should be anticipated.
As noted above, the federal gift and estate sections are reunified with a $5 million exemption for gifts after December 31, 2010 and prior to, or on, December 31, 2012. The generation-skipping transfer tax exemption amount is also increased to $5 million and the top tax rate for federal gift, estate and generation-skipping transfer taxes is reduced to 35 percent.
The reunification of the rates provides an opportunity for individuals who have already used their prior $1 million lifetime gift exemption to give an additional $4 million of lifetime tax free gifts ($5 million total for an individual or $10 million for a married couple). Keep in mind that the gifts must be made before December 31, 2012 and that any gifts in excess of the exemption are taxed at a 35 percent gift tax rate. For those individuals with significant taxable estates this is one way to take advantage of these temporary tax provisions.
The Tax Relief Act does not impact prior gifts but does provide a bit of clarity regarding the credit permitted by allowing the rate in effect when the credit is being determined, rather than determining the rate when the gift was previously made. Therefore, if a decedent paid gift tax on a prior taxable gift at a 50 percent gift tax rate and the estate tax rate in the year of the decedent’s death is 45 percent, then the credit for the prior gift tax paid is based on the 45 percent rate.
Aside from the increases in exemption amounts and the reduction in top tax rates, the change capturing the greatest amount of attention is portability. Simply stated, if a married person dies without using his or her exemption amount, the decedent’s executor may be in a position to affirmatively elect the remaining exemption be added to the surviving spouse’s federal gift and estate tax exemption. The generation-skipping transfer tax exemption is not portable. The election to receive a predeceased spouse’s exemption is irrevocable and must be made on a federal estate tax return.16 The Joint Committee staff’s examples and explanation on this concept are particularly helpful:
This new concept of portability is a trap for the unwary and ultimately may not be as great a planning tool as one might expect. Some important concepts to remember:
- This provision sunsets, as does all of the Tax Relief Act.
- Due to sunset risk, right now in order to take full advantage of the portability provisions both husband and wife need to die between January 1, 2011 and December 31, 2012. Returning to Example 2 above, both husbands would have had to die within a two-year period.
- The election is irrevocable.
- The election must be made on a timely filed federal estate tax return.
- As with many of the other changes under the Tax Relief Act, this provision has not been enacted in most states.
Ultimately, the estates where the portability provisions will be able to be used to their full potential may be very limited.
While the Tax Relief Act has changed much of the estate tax landscape, it does not address minimum terms for Grantor Retained Annuity Trusts (GRATs), valuation discounts, or Section 6166 elections. Whether these topics will be addressed in the next round of legislation remains to be seen, but soon some permanent solutions to these “hot topics” along with the estate tax will need to be considered.
Whatever ensues, the need for estate planning is here to stay. Clients continue to need planning for tax and nontax considerations and the need for careful estate planning has not changed due to the enactment of the Tax Relief Act. In fact, the need to renew client relationships and to develop new client relationships is now greater.
Further defining the continuing need for estate planning is the fact that Minnesota, unlike a number of other states, continues to impose a separate state estate tax for estates exceeding $1 million. As noted above, Minnesota has not passed legislation to enact portability and, as portability may not be revenue-neutral, it seems unlikely that the state legislature will pass a bill providing portability during a difficult legislative session.
What this means to practitioners is any of a number of different solutions. First, do not be the cobbler who leaves no shoes for her children. Whatever their age, marital status or net worth, everyone needs an estate plan to take care of their affairs. Second, those with existing estate plans need to review their plans. Most clients believe that an estate plan is something that can be done, checked off the list, and forgotten about. This is definitely not the case, and unfortunately, many clients have old estate plans which could result in their paying unnecessary tax or, worse yet, not carrying out their wishes effectively.
In sum, estate planning is ever-changing and just as dynamic as other areas of the practice of law. The federal tax laws are only one important piece in the puzzle of arranging for one’s affairs after death, and for those who practice in this area, further exciting changes are likely. As noted several times above,
1 EGTRRA’s repeal of the estate tax in 2010 was not without income tax consequences. Most important of these was the reinstitution of carryover basis. See former Internal Revenue Code §1014(f).
2 EGTRRA §901(a).
3 Tax Relief Act §§101 and 304.
4 Tax Relief Act §301(a);Tax Relief Act §302(a)(2).
5 Tax Relief Act §301(c); Tax Relief Act §301(d).
6 Tax Relief Act § 301(d)(1)(C).
8 Tax Relief Act §302(b).
9 Tax Relief Act §303.
10 Tax Relief Act §301(c).
11 The calculator can be found by going to http://taxes.state.mn.us/estate_trust/Pages/index.aspx and entering “estate tax calculator” in the search box. Minnesota’s Department of Revenue has various disclaimers on the use of the calculator and you should independently confirm the results provided. A relatively new addition to the calculator is the following disclaimer: “Important: Temporarily do not use this calculator if gifts are included. Continue to check this web page for a corrected calculator.”
12 Tax Relief Act §301(d).
13 Note, September 17, 2011 falls on a Saturday. As such returns may actually be due on Monday, September 19, 2011.
14 See Minn. Stat. §524.2-1101 et seq.
15 Tax Relief Act §302(a).
16 Tax Relief Act §303(a).
17 Staff of the Joint Committee on Taxation, Technical Explanation of the Revenue Provisions Contained in the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” Scheduled for Consideration by the United States Senate (JCS-55-10), pp. 52-53.