On Dec. 17, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. In essence, the act extends through 2012 most of the so-called “Bush era tax cuts,” which were originally contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). With respect to the federal estate tax, generation-skipping transfer tax and gift tax, the act defers for two years the “sunset” of the EGTRRA provisions, but with several significant modifications.
EGTRRA phased-out the estate and generation-skipping transfer taxes so that they were fully repealed in 2010. The gift tax remained in 2010, subject to a $1 million exemption amount and a maximum gift tax rate of 35 percent. The EGTRRA phase-out and eventual repeal of the estate and generation-skipping transfer tax were scheduled to “sunset” in 2011. Therefore, absent legislation, the estate and generation-skipping transfer taxes would have been reinstated in 2011 with the pre-EGTRRA unified exemption amount of $1 million and a top tax rate of 55 percent.
The act reinstates the estate tax and the generation-skipping transfer tax for decedents dying after Dec. 31, 2010, with a special elective rule for decedents dying in 2010. The act also continues the gift tax for transfers made after Dec. 31, 2010. For decedents dying and lifetime transfers made after Dec. 31, 2010, the estate tax and the gift tax are subject to a unified exemption amount of $5 million and the generation-skipping transfer tax has a similar exemption amount of $5 million. These exemption amounts are to be indexed for inflation after 2011. The act also imposes a top estate and gift tax rate of 35 percent, which is also the tax rate applicable to taxable transfers subject to the generation-skipping transfer tax.
The most dramatic of the above changes is the increase in the exemption amount applicable to lifetime gifts. For a married couple, the combined exemption amount for gifts has been increased from $2 million to $10 million.
Prior to the repeal of the estate tax under EGTRRA in 2010, the recipient of property passing from a decedent received a “stepped-up” basis in the inherited property. The basis of property passing from a decedent’s estate would be the fair market value of the property on the date of the decedent’s death (or, if the alternative valuation date is elected, the earlier of six months after the decedent’s death or the date the property is sold or distributed by the estate). This step-up in basis eliminates the recognition of income upon a subsequent sale of the property with respect to any appreciation of the property as of the date of the decedent’s death. If the value of property on the date of the decedent’s death was less than its adjusted basis, the property would receive a step-down in basis when it passed from a decedent’s estate.
Under EGTRRA, property passing from decedents dying in 2010 would not receive a step-up in basis. Rather, EGTRRA imposed a modified carry-over basis regime so that property passing from decedents dying in 2010 would receive a basis equal to the lesser of the decedent’s adjusted basis or the fair market value of the property on the date of the decedent’s death. EGTRRA also contained several exceptions and modifications to this carry-over basis approach. Under these rules, each estate was generally permitted to increase the basis of assets transferred by up to $1.3 million, which could be further increased by the amount of the decedent’s unused capital losses, net operating losses and certain “built-in” losses. Moreover, the basis of property transferred to a surviving spouse could be increased by an additional $3 million. The act repeals the modified carry-over basis rules and restores stepped-up basis for assets passing from decedents who died after Dec. 31, 2009.
However, the act provides an interesting choice for executors of decedents who died in 2010. Essentially, an executor can elect to either have the provisions of EGTRRA apply without regard to the act or subject the estate to the estate tax and generation-skipping transfer tax provisions of the act with the benefit of stepped-up basis for assets passing from the estate. If the election is made to apply the EGTRRA rules, the estate would not be subject to any estate tax but assets passing from the estate would be subject to the modified carry-over basis rules discussed above. In essence, this election would eliminate any estate tax but could cause the recipients of property passing from the estate to incur capital gains tax on the subsequent sale of the inherited property. If the decision is made to subject the estate of a decedent who died in 2010 to the provisions of the act (which is the default position under the act), an estate with assets in excess of $5 million could give rise to an estate tax but the recipients of any property passing from the estate would receive a stepped-up basis in the inherited property. To make this decision, an executor needs to calculate the overall estate and income tax consequences.
To allow executors adequate time to make an appropriate election with respect to decedents who died in 2010, the act extends the filing deadline for certain transfer tax returns. Specifically, in the case of a decedent dying after Dec. 31, 2009, and before Dec. 17, 2010, the due date for filing an estate tax return will not be earlier than Sept. 17, 2011 (nine months after the date of enactment). Similar extensions are provided for making a qualified disclaimer under Code Section 2518(b) and any return required in the case of a generation-skipping transfer.
One of the most significant changes to the estate and gift tax contained in the act is the ability of a surviving spouse to utilize any portion of a previously deceased spouse’s unified exemption amount. Under this portability provision, any exemption amount that remains unused as of the death of a spouse who dies after Dec. 31, 2010, will be available for use by the surviving spouse, for both estate and gift tax purposes. This portability provision does not allow a surviving spouse to use the unused generation-skipping transfer tax exemption of a predeceased spouse.
As a result of this portability, a surviving spouse could have an available estate tax exemption of as much as $10 million. If a surviving spouse is predeceased by more than one spouse, the amount of the unused exemption that is available for use by such surviving spouse is limited to the lesser of $5 million or the unused exemption of the last deceased spouse.
A deceased spouse’s unused exemption amount is available to a surviving spouse only if an election is made on a timely filed estate tax return (including extensions) of the predeceased spouse on which such amount is computed, regardless of whether the estate of the predeceased spouse otherwise is required to file an estate tax return. In addition, notwithstanding the statute of limitations for assessing the estate or gift tax of the predeceased spouse (generally, three years), the act authorizes the IRS to examine the return of a predeceased spouse at any time for purposes of determining the deceased spouse’s unused exemption amount available for use by the surviving spouse.
The portability provision of the act can be illustrated by the following simple example: Assume that husband dies in 2011, having made lifetime taxable gifts of $3 million and having no taxable estate. An election is made on husband’s estate tax return to permit the surviving wife to use the husband’s unused exemption amount. As of husband’s death, wife has made no taxable gifts. Therefore, wife’s applicable exemption amount is $7 million (her $5 million “basic” exemption amount plus $2 million from deceased husband), which she may use for lifetime gifts or for transfers at death. Every estate plan and all planning documents should be reviewed to determine the impact of portability.
The portability provisions of the act, in many instances, eliminate the need for assets passing to a “credit shelter” trust upon the death of the first spouse to die. Such trusts have been standard planning tools to allow for the full utilization of both spouses’ exemption amounts. Such trusts may still be appropriate to “shelter” assets that have the potential for significant appreciation. Every estate plan and all planning documents should be reviewed to determine the impact of portability.
In addition to the above significant provisions, the act also contains a number of other changes to the estate, gift and generation-skipping transfer taxes. The act extends several provisions contained in EGTRRA relating to the treatment of state death and inheritance taxes, conservation easements and the installment payment of taxes related to closed-held businesses and farms. The act also makes several technical changes to the generation-skipping transfer tax.
Under the act, the previously scheduled “sunset” of the EGTRRA estate, gift and generation-skipping transfer tax provisions, scheduled to apply to estates of decedents dying and transfers made after Dec. 31, 2010, is extended to apply to estates of decedents dying and transfers made after Dec. 31, 2012. Therefore, neither the EGTRRA rules nor the new rules contained in the act will apply to estates of decedents dying or transfers made after Dec. 31, 2012. In other words, absent further legislation, we will be back to the estate, gift and generation-skipping transfer taxes as they generally applied in 2001 as of Jan. 1, 2013. •
Mark L. Silow is the administrative partner and chief operating officer of Fox Rothschild. Silow formerly was chairman of the firm’s tax and estates department. Silow’s work involves a broad range of commercial and tax matters including business and tax planning, corporate acquisitions and dispositions, real estate transactions, estate planning and employee benefits.