Probably the most dramatic change brought about by the 2010 Tax Act is in the area of transfer taxes: federal estate, gift, and generation-skipping taxes.
The estate tax that had expired in 2010 and was replaced with a modified carryover-basis regime has been reinstated by the Tax Act for decedents dying and transfers made after 12/31/09. The estate-tax applicable exclusion amount is $5 million and is indexed for inflation for decedents dying after 2011. The estate-tax rate is a flat 35%.
The Tax Act continues the gift tax for 2010 with a 35% tax rate and an exemption of $1 million. Now, the gift and estate taxes are reunited with a 35% tax rate and a $5 million gift-tax exemption.
The generation-skipping tax exemption is $5 million for 2010, but the tax rate is 0%. After 2010 the exemption remains at $5 million but the tax rate is 35%.
The modified carryover-basis rules are generally repealed by the Tax Act, and step-up basis now applies to property acquired from a decedent who dies after 12/31/09.
Executors of estates of decedents who died in 2010 may elect to have the estate be subject to estate tax and thus benefit from step-up basis or not subject to the estate tax but subject to the 2010 modified carryover-basis rule. Generally, under the modified step-up rule there is no step-up allowed and the heir’s basis in the property is the same as the decedent’s cost basis. So if a decedent paid $100 for a stock and it was worth $1,100 at death, the heir’s basis is still $100; and when later sold the heir would realize capital gain of $1,000 plus any future appreciation subject to tax at the then prevailing capital-gain tax rate.
There is a $1.3 million exemption from this tax per decedent and an additional $3 million for a surviving spouse.
One of the most innovative concepts introduced by the Tax Act is the portability of a decedent’s unused applicable exclusion. So if Spouse 1 dies with a $2 million taxable estate, then Spouse 2 can add the unused $3 million exemption to his or her $5 million for a total of $8 million that may be used for lifetime gifts or for transfers at death.
The new provisions apply to transfers made before 1/1/2013, less than two years remaining. Unless congress acts, the law will revert to the 2001 $1 million exemption and 55% tax rate.
According to IRA statistics in 2009 there were 8,238 estate-tax returns filed that were valued at $5 million (the current applicable exclusion amount) and over—a miniscule number considering that there were about 2.5 million deaths reported in the U.S. for that filing period. (In 2001, more than 108,000 estate-tax returns were filed.)
Those affected by the transfer tax will likely continue to use highly sophisticated estate-planning techniques to minimize the impact of the 35% transfer-tax bite. And those estates that include significant amounts of retirement-plan benefits also have to be mindful of the combined estate-income tax that could consume nearly 58% in taxes.
Clearly for these estate owners a charitable designation of retirement-plan benefits should be at the top of the list of planning opportunities to reduce the impact of the combined taxes.
Does releasing more than 99% of estate owners from the reach of the transfer tax alleviate the need for estate planning? Again the answer is clearly no. The principal point of estate planning has always been and continues to be to make sure that your assets go to those individuals and institutions that you wish to have them. As we all know, in the absence of planning this is not going to happen—especially with respect to those institutions that you cherish and which serve your philanthropic objectives and ideals. Without an estate plan that specifically includes a charity or charities as beneficiary, the state is not going to step in and do this for the decedent.