Estate, Gift, And GST Taxes: What Actually Happened

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1 Estate, Gift, And GST Taxes: What Actually Happened Kenneth A. Goldstein The increased gift tax exemption and other provisions contained in the 2011 Act provide tremendous opportunities to save federal estate and GST taxes and if applicable, state estate taxes. Kenneth A. Goldstein is a partner at the law firm of Horwood Marcus & Berk Chartered, Chicago, Illinois. His practice focuses on estate and federal income tax planning as well as business planning and entity selection. His primary areas of proficiency include income, estate, gift, and generation-skipping transfer tax planning; drafting wills and trusts; representing taxpayers in income, estate and gift tax audits; and planning for real estate matters and owners of a closely held business. Ken is a frequent lecturer to various organizations on income, estate and gift taxation and has also written and published articles on the subject. He can be reached at kgoldstein@hmblaw.com. THE TAX RELIEF, Unemployment Insurance Reauthorization, and Job Creation Act was signed into law by President Obama on December 17, 2010 (2011 Act). This new law provides sweeping changes to the rules governing federal estate taxes, gift taxes, and generation-skipping transfer taxes for the 2010, 2011, and 2012 tax years. FEDERAL ESTATE TAXES The Economic Growth and Tax Relief Reconciliation Act of 2001 (the 2001 Act) gradually increased the applicable exclusion amount (the amount of assets that can be passed tax free to the next generation without estate tax). An individual who died in 2009 could pass up to $3,500,000 in assets free of estate tax. The 2011 Act provides that an individual who dies in 2010, 2011 or 2012 may pass up to $5 million (the 2012 exemption could be slightly higher due to possible inflation adjustment) in assets free of estate tax. However, the 2011 Act allows the estate of an individual dying in 2010 to elect to pay no estate tax regardless of the size of the estate. If the estate so elects, the modified carryover basis provisions set forth in the 2001 Act will apply (which limits The Practical Lawyer /11/ :15:05 PM

2 26 The Practical Lawyer October 2011 the ability to step up the cost basis of the inherited assets to fair market value). Pursuant to the sunset provisions of the 2011 Act, an individual dying in 2013 and thereafter may pass only $1 million in assets free of estate tax. The 2011 Act offers portability of the federal estate tax exemption between married couples. In 2009 and prior years, the estate tax exemption was personal to the individual. Therefore, although a married couple could pass on two times the federal estate tax exemption free of estate tax, this was typically done by establishing a credit shelter trust. (The first spouse to die also needed to have assets in his or her name at least equal to the estate tax exemption.) The 2011 Act may eliminate the need for credit shelter planning for federal estate taxes by allowing married couples to add any unused portion of the estate tax exemption of the first spouse to die to the surviving spouse s estate tax exemption. This effectively allows married couples to pass $10 million free of estate tax. However, credit shelter trust planning may still be advisable because if these portability provisions are used, any appreciation in the value from the date of death of the first spouse to the date of death of the surviving spouse is lost. In addition, if these portability provisions are not extended beyond 2012, it appears that under current law, the portability benefits will be lost (even for a couple in which the first spouse died in 2011 or 2012) $3,500,000 Estate Tax Applicable Exclusion Amount 2010 $5,000,000 (subject to the ability to elect to pay no estate tax regardless of the size of the estate, but if so modified carryover basis provisions apply) 2013 and thereafter $1,000,000 The 2001 Act also gradually decreased estate tax rates. For an individual who died in 2009, the highest marginal estate tax rate was 45 percent. Pursuant to 2011 Act, for an individual who dies in 2010, 2011, or 2012, the highest marginal estate tax rate is 35 percent. Pursuant to the sunset provisions of the 2011 Act, the highest marginal estate tax rate for an individual dying in 2013 and thereafter will increase to 55 percent. In addition to the 55 percent tax rate, there is a five percent surcharge for estates between $10 million and $17,184,000. The purpose of this surcharge is to eliminate the benefit of the lower marginal tax rates. 26 8/11/ :15:05 PM

3 Estate, Gift, and GST Taxes 27 Highest Marginal Estate Tax Rates percent (subject to the ability to elect to pay no estate tax regardless of the size of the estate, but if so modified carryover basis provisions apply) 2013 and thereafter 55 percent (with five percent surcharge) GENERATION SKIPPING TRANSFER TAXES The generation skipping transfer tax (GST Tax) is an additional tax that applies to gifts during lifetime or transfers upon death made to grandchildren or other persons who are more than one generation younger than the transferor. For transfers made during 2009, the GST Tax exemption was $3 million. For transfers made during 2010, 2011 or 2012, the GST Tax exemption is $5 million (the 2012 exemption could be slightly higher due to possible inflation adjustment). For transfers made in 2013 and thereafter, the GST Tax exemption will be $1 million indexed for inflation since 1998 (estimated to be between $1,300,000 and $1,400,000 in 2013). GST Tax Exemption Amount 2009 $3,500, $5,000, and thereafter $1,000,000 indexed for inflation since 1998 (estimated to be between $1,300,000 - $1,400,000 in 2013) The 2001 Act also gradually decreased the GST Tax rates. For 2009, the GST Tax rate was 45 percent. Pursuant to the 2011 Act, the GST Tax rate for 2010 was 0 percent. For 2011 and 2012, the GST Tax rate is 35 percent. Pursuant to the sunset provisions of the 2011 Act, the GST Tax rate in 2013 and thereafter will increase to 55 percent. 27 8/11/ :15:06 PM

4 28 The Practical Lawyer October 2011 Highest Marginal GST Tax Rates percent 2013 and thereafter 55 percent GIFT TAXES The 2001 Act increased the maximum amount of gifts that could be made without incurring gift tax to $1 million. The 2011 Act increases the maximum amount of gifts that could be made in 2011 and 2012 without incurring gift tax to $5 million. Pursuant to the sunset provisions of the 2011 Act, the maximum amount of gifts that could be made without incurring gift tax in 2013 and thereafter is reduced to $1 million. The temporary increase in the amount of the gift tax exemption for 2011 and 2012 to $5 million (plus a possible cost of living increase for 2012) provides tremendous transfer tax reduction opportunities. This means that if you are married, you and your spouse can gift up to $10 million without incurring any gift tax. This exemption is over and above any annual exclusion gifts that you and your spouse may make (currently $13,000 per person per year or $26,000 for a married couple per person per year). The gift tax exemption as far back as 2002 has only been $1 million. So even if you have fully utilized your previous $1 million gift tax exemption, you have an additional $4 million of available gift tax exemption. In addition to the increased gift tax exemption, the 35 percent highest marginal rate provides even greater opportunities if you are willing to incur gift taxes. The temporary nature of the increased gift tax exemption is a huge incentive to make gifts in 2011 and To the extent that this increased gift tax exemption is not used by December 31, 2012, it will be lost, unless extended by Congress. Gift Tax Applicable Exclusion Amount 2009 $1,000, $1,000, and thereafter $1,000, /11/ :15:06 PM

5 Estate, Gift, and GST Taxes 29 Since gift tax rates are generally tied to the estate tax rates, the 2001 Act also gradually decreased gift tax rates. Therefore, for gifts made during 2009, the highest marginal gift tax rate was 45 percent. However, unlike the estate tax, the gift tax was not repealed for Instead, the highest marginal gift tax rate in 2010 was 35 percent. Pursuant to the 2011 Act, for gifts made in 2011 and 2012, the highest marginal gift tax rate is 35 percent. Pursuant to the sunset provisions of the 2011 Act, for gifts made in 2013 and thereafter, the highest marginal gift tax rate is 55 percent. Highest Marginal Gift Tax Rates percent 2013 and thereafter 55 percent STATE TAX PLANNING OPPORTUNITIES The increased transfer tax exemption may also provide opportunities for those who are subject to state estate taxes. Many states have separate estate tax regimes with lower applicable exclusion amounts than the federal applicable exclusion amount. These States include Illinois, Maryland, New Jersey, and New York, among others. For example, Illinois imposes an estate tax if the decedent s taxable estate exceeds $2 million. However, this $2 million amount is a filing threshold and not an exemption. For example, if the value of the person s estate is $2,000,001, the tax is paid on the full $2,000,001 and not just on the $1 excess over the $2 million exemption amount. Since the amount of the Illinois estate tax is based only on the decedent s taxable estate, any gifts made during the person s lifetime reduce the amount of Illinois estate tax. The catch is that any gifts (other than annual exclusion gifts) will reduce the amount of the $2 million threshold. Also, in making any gifts, the person should be mindful of the Federal gift tax consequences of such gifts. Nonetheless, the increased gift tax exemption may save substantial Illinois estate tax. For example, if an Illinois resident dies with a $5 million taxable estate, the Illinois estate tax would be $352,158. However, if the Illinois resident made a $4 million gift prior to his or her death so that his or her taxable estate was only $1 million, the Illinois estate tax would be $31,439. The savings would be even greater if the value of the gift assets appreciated after the transfer. Therefore, even though your estate will be subject to Illinois estate tax, the gifts you make will substantially reduce the amount of Illinois estate tax that would be due upon your death. CONCLUSION The increased gift tax exemption and other provisions contained in the 2011 Act provide tremendous opportunities to save Federal estate and GST Taxes and if applicable, State estate taxes. However, this window of opportunity expires December 31, 2012, unless extended by Congress. Proper planning may be used to further leverage the increased gift tax exemption to allow for even greater savings. 29 8/11/ :15:06 PM