In 2010, we experienced an unprecedented reprieve from federal
estate and generation-skipping transfer (GST) taxes. How did we get
here? In 2001, Congress enacted the Economic Growth and Tax Relief
Reconciliation Act of 2001 (EGTRRA), which, in part, provided that
the federal estate and GST tax laws would not apply to the estates
of decedents dying, or transfers occurring, after Dec. 31,
2009.
Estate planning practitioners never thought, even up until
December 2009, that the federal estate and GST taxes would be
"repealed," but the reprieve did materialize due to Congress'
inaction. This reprieve potentially provides substantial savings
for applicable heirs. For example, the estate of a Massachusetts'
decedent dying in 2010 with a $10 million taxable estate will only
pay the Massachusetts estate tax. The decedent's heirs will receive
$8,932,400, instead of $6,487,820 had the decedent died in
2009.
The reprieve, however, has not been a complete reprieve; the
estate and GST tax repeal brought with it the modified carryover
basis system. Under the modified carryover basis system, excepting
a $1.3 million basis increase and a $3 million spousal basis
increase, the assets retain the decedent's basis. Accordingly, when
the inherited assets are sold, the heirs will recognize a gain
totaling the difference between proceeds received and the carryover
basis.
On Jan. 1, 2011, this estate tax reprieve ends. With the sunset of
the EGTRRA provisions, the estate tax laws are brought back to
their status prior to 2001. That is, unless Congress acts to make a
change. What does this mean for clients? The federal estate and GST
exemption amounts, which have been to a high of $3.5 million;
federal estate and GST tax rates, which have been to a low of 45
percent; and the federal gift tax rates, which are at a low of 35
percent, will return to their pre-2001 levels. The federal estate
and GST tax exemption amounts decrease to $1 million and
approximately $1.34 million, respectively. The federal gift tax
exemption rate remains at $1 million. The highest gift, estate and
GST tax rates increase to 55 percent.
In addition, the step-up in basis system returns. In the example
above, the heirs will only receive $5,205,000 after the paying
federal and state death taxes if the decedent dies in 2011 or
thereafter.
What should we expect in 2011? There appears to be
three possible outcomes:
First, Congress retroactively reinstates the
estate and GST tax laws. Given that we are now in November 2010,
retroactive reinstatement of the estate and GST laws seems
unlikely. Instead, Congress may enact legislation providing estates
of decedent's dying in 2010 with an option to pay either a federal
estate tax at 2009 levels with the estate's assets receiving a
stepped basis or pay no federal estate tax with the estate
remaining subject to the modified carryover basis system.
Second, Congress does nothing. In this case, the
estate, gift and GST taxes will return to pre-2001 levels, as
described above.
Third, Congress enacts legislation effective for
tax years beginning Jan. 1, 2011, reinstating the estate, gift and
GST taxes to 2009 levels, or to different rates and exemption
amounts.
Of course, we have no way of knowing what Congress will do, but we
hope, at the very least, that Congress will address some
uncertainties that EGTRRA's sunset will cause. For example, what
happens with the GST exemptions deemed allocated during tax years
2001 through 2009? Or, if the GST exemption has been allocated in
an amount above the pre-EGTRRA GST exemption amount, will such
allocation still be considered to have been made?
As the reprieve year is ending, there are planning opportunities
that clients should consider to reduce their overall estate, gift
and GST tax burdens.
- Make federally taxable gifts subject to the 35 percent gift tax
rate. As retroactive reinstatement is unlikely, and the gift tax
rate is as low as it will ever likely be, wealthy clients who are
most likely to be subject to federal estate taxes on death have an
opportunity to transfer assets to the next generation at the low
gift tax rate, if done before the end of 2010.
- Make outright gifts to grandchildren and/or
great-grandchildren. Again, there will be an overall savings by
paying a low gift tax rate now as opposed to a higher estate tax
rate in the future. Additionally, the donor can skip one or more
generations without incurring the GST tax, thereby completely
escaping one or more transfer tax levels.
- Trustees of trusts that are not exempt from the GST tax should
consider making beneficiary distributions to beneficiaries two or
more generations below the trust's donor, thereby eliminating a
future GST tax.
- Personal representatives of estates of decedents dying in 2010
who left a surviving spouse should fund QTIP trusts with as many of
the assets passing the surviving spouse as possible. The QTIP
trusts' assets will not be subject to the federal estate tax upon
the surviving spouse's death, thereby escaping the federal estate
tax on both the decedent's and surviving spouse's death.
The estate tax reprieve's end brings more transfer tax planning
uncertainty, but provides some opportunities - which may never be
available again - for wealthy clients if they act quickly before
year's end.
Lisa M. Rico is a partner at Gilmore, Rees & Carlson
PC in Wellesley. She concentrates her practice on estate, gift,
generation-skipping transfer and income tax planning for high net
worth individuals, estate and trust administration, and the
representation of nonprofit organizations and charitable trusts. In
addition, she provides tax advice to partnerships and other pass
through entities. She is currently the chair of the MBA's Taxation
Law Section, as well as the co-chair of the Estate Planning and
Administration for Business Owners, Farmers and Ranchers Committee
of the American Bar Association's Real Property, Trust and Estate
Law Section.