By Attorney Maria Baler (March 2011)
In mid-December, Congress passed and the President signed into law the long-anticipated 2010 Tax Relief Act, bringing significant changes to the federal estate and gift tax laws. Even though the provisions of the new law are effective only for two years, it’s important to understand how these changes may affect you and your estate plan.
Here are five important facts you should know about the new federal estate and gift tax laws.
1. The Unified Federal Estate and Gift Tax Exemption is now $5 million
You may recall that Congress’s inaction at the end of 2009 resulted in a period of time where there was effectively no federal estate tax for individuals who died in 2010 (see additional details below). The new law reinstates the federal estate tax for 2011 with a federal estate tax exemption of $5 million per person. The new law also reunifies the estate and gift tax exemption amounts. What this means is that each person has a $5 million exemption that can be used, during his or her lifetime and/or at death to transfer assets estate and/or gift tax-free. The $5 million exemption will allow the vast majority of people in the United States to pass all of their assets to their heirs without the payment of federal estate or gift tax.
2. Estates of those who died in 2010 may pay estate tax or not – their choice
The new law retroactively applies the new federal estate tax law to estates of those who died in 2010. However, executors of those who died in 2010 have the option of electing out of the new federal estate tax law, paying no federal estate tax, and instead accepting the carry-over basis provisions that were in effect for 2010 estates prior to the enactment of the new tax law. For example, the executor of the estate of Sue Smith who died in 2010 owning a house and an investment account with a total value of $1,250,000 will most likely allow the new law to retroactively apply to the estate. Because Sue’s estate is under $5 million in value there will be no federal estate tax payable by the estate. However, the executor of George Steinbrenner’s estate will have some thinking and calculating to do before making that decision. Since George’s estate was well over $5 million in value, opting out of the estate tax may make sense, depending upon the capital gain tax implications of accepting the carryover basis rules. If you are the executor of the estate of someone who died in 2010, be sure to consult your attorney for advice about what steps you may need to take in light of the changes to the tax laws for 2010 estates.
3. The New Concept of Portability
For the first time, the new tax law introduces the concept of “portability” of the estate and gift tax exemption for husbands and wives. This allows the unused estate and gift tax exemption of a husband or wife to be “portable,” meaning that a spouse’s unused exemption amount may be used by their surviving spouse if an appropriate election is made on the federal estate tax return for the estate of the first spouse to die.
For example, if Fred and Freida have a $10 million estate and Fred dies leaving all of his assets to Freida, Freida will have an estate valued at $10 million. Fred will not need to use any of his $5 million exemption because assets passing to a spouse pass tax free under the unlimited “marital deduction.” If Freida dies after Fred with a $10 million estate, and if at her death she is able to use only her $5 million exemption, her estate will pay federal estate tax on the remaining $5 million. However, if at the time of Fred’s death his executor makes an election to transfer his unused exemption to Frieda, then at Frieda’s death, her executor may apply both Freida’s $5 million exemption and Fred’s $5 million exemption against Freida’s taxable estate, thereby eliminating the federal estate tax on Frieda’s entire $10 million estate.
Although portability saved Fred and Freida’s children from having to pay federal estate tax in the above example, it is much better to be proactive with respect to estate tax planning than to rely on the portability provisions of the tax code. The future of portability is uncertain. As of right now, it is only available to estates of individuals dying between January 1, 2011 and December 31, 2012. Also, portability will not shelter assets from Massachusetts estate tax. In addition, there are significant advantages to proactive estate tax planning which cannot be achieved by relying on portability.
4. Inherited Assets Receive a Step-Up in Basis Once Again
Along with the new federal estate tax comes the old concept of a step-up in basis for inherited assets for capital gain tax purposes. This means that if you inherit capital assets, such as real estate or stock, from a deceased person (except for a person who died in 2010 and elected out of the new federal estate tax), those inherited assets will have a basis for capital gain tax purposes equal to the value of the assets on the date of death of the deceased owner. In other words, all capital gains that accumulated during the lifetime of the deceased person are essentially wiped out.
5. All This and a Rate Reduction Too!
The new law sets a flat estate tax rate of 35 percent for estates in excess of the $5 million exclusion amount, with tax paid only on the value of the estate in excess of the exclusion. This rate reduction represents a real savings over the 55 percent rate that would have taken effect in 2011 if Congress had not passed the 2010 Tax Relief Act.
Similar to the prior estate tax law, this new law “sunsets” on December 31, 2012, after which time the “old” law, with its $1 million federal exemption amount and top estate tax rate of 55 percent will be reinstated unless Congress acts to extend the new law or make it permanent.
In thinking about your own estate plan, keep in mind that in Massachusetts we are in the somewhat unique situation of having a separate state estate tax (enacted in 2003) which is unaffected by the recent change in the federal estate tax law. The Massachusetts estate tax has a filing threshold of $1 million and there is no portability provision. If you are above the threshold, your heirs will pay tax on the full value of your estate. Now is a great time to sit down with an experienced estate planning attorney to review your situation and any existing documents, and determine if any planning is necessary to take advantage of the tax savings strategies afforded by these different estate tax laws. Equally as important is a review of how your assets are owned and how beneficiaries of life insurance and retirement assets are designated, to ensure that your assets will be distributed as you intend under the terms of your estate plan.
Attorney Maria Baler is an estate planning attorney and a partner with the Dedham firm Samuel, Sayward & Baler LLC. She is also a director of the Massachusetts Chapter of the National Academy of Elder Law Attorneys (MassNAELA). For more information, visit www.ssbllc.com.