2010 Tax Relief / Job Creation Act: Changes to Federal Tax Law Affecting Estate Planning
The “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act” signed into law by President Obama last week which affected a number of tax code provisions. I drafted this summary to provide a brief, non-tedious, and “legalese” free overview of some of the major changes affecting estate planning involving estate and gift taxes. Please note there are nuances and caveats to the examples given below as well as other provisions not mentioned.
Under the new law, the estate tax is only applicable to assets of a decedent that exceed $5 million dollars which are then taxed at a rate of 35%. For example, beginning next year an individual’s estate of $6 million is eligible to have the first $5 million exempt from taxes while the remaining $1 million is taxed at 35% (a $350,000 potential tax liability).
The gift tax exemption rate is also $5 million dollars with a tax rate of 35% of any gifts over the exemption. For example, once an individual gives away more than $5 million dollars during their lifetime, they will need to pay a tax of 35% on amounts gifted over $5 million. The estate and gift taxes are also part of a unified system. This means that the estate of an individual that has exceeded the $5 million dollar gift exemption during the lifetime of the decedent will be taxed at a rate of 35% on all assets.
Finally the more obscure generation-skipping transfer (GST) tax will also have a $5 million dollar exemption with a 35% tax rate for assets over the exemption amount. The GST is another layer of taxation in addition to estate and gift taxes, but is only is applicable when a transfer is made to a person who is two or more generations younger than the donor.
One interesting aspect to the new law is that of the “portability” of the federal estate tax exemption between married couples. In the past, estate planners would often draft two trusts for a couple in order to take advantage of each spouse’s exemption. For example, a married couple in 2009 would each have a $3.5 million dollar exemption. Without a trust for each individual, at the death of the first spouse all of the assets would transfer to the surviving spouse which would mean a loss of the decedent’s exemption. By drafting a trust for each spouse, a couple would be able to take advantage of a combined exemption of $7 million dollars by placing half of the assets in one spouse’s trust and the other half in the other spouse’s trust. Under the new portability provision, married couples could conceivably only have one trust and enjoy a combined exemption of $10 million.
Now that you’ve read all this you should know very few estates are subject to estate taxes. In 2009 when the exemption was $3.5 million, it was estimated that only .3% of estates were subject to the estate tax – that’s 1 in 333 estates. Also, the changes that were passed into law last week are only in effect for the next two years and beginning in 2013 the estate and gift tax exemption will return to $1 million and a tax rate of 55%.
Although the majority of individuals and couples are not subject to the federal estate tax, there is still a strong need to have an estate plan in place. Trusts still offer a number of benefits other than tax planning including creditor protection, privacy, and control over assets, as well as all the other benefits that go along with a comprehensive estate plan (appointment of a guardian for children, succession planning for family businesses, charitable giving, etc.). It is also worth pointing out that in two years we do not know what the estate and gift tax exemptions will be so having a well drafted estate plan in place is ever more important.
For a comprehensive summary of the entire Act, CCH has a pretty good overview and analysis of all the various parts (PDF - 10 pages).
