On December 17, 2010 President Obama signed the “Tax Relief, Unemployment Insurance Reauthorization & Jobs Creation Act of 2010” (hereinafter called “TRA 2010”). This legislation has the result of temporarily extending the “Bush tax cuts” which generally featured reduced federal income and transfer taxes. Unless further extended by later legislation, the provisions in TRA 2010 will expire on December 31, 2012. The Act’s provisions are quite broad. This article will summarize only the provisions of TRA 2010 pertaining to federal estate taxes and purposely avoids the impacts to gift and generation skipping transfer taxes.
New Rules For Estates of 2010 Decedents
The estates of people who died in 2010 were not subject to the federal estate because of unique tax rules in place for 2010. These unique rules did not permit assets in those estates to receive a step up in basis for income tax purposes. Instead the basis of estate assets was to be determined under a modified carryover basis system. In many cases, beneficiaries receiving assets from these estates may have preferred to receive a step up in basis, even if it meant possibly paying federal estate taxes. TRA 2010 reinstates the federal estate tax for estates of decedents who died in 2010 but it also permits the executors of those estates to elect between two alternatives:
1. No estate tax but the modified carryover basis tax regime for estate assets (in essence, the pre-TRA 2010 tax result), or
2. An estate tax based on a 35% maximum rate and a $5,000,000 exclusion with a stepped up basis for estate assets to date of death value.
The ability to choose between these alternatives should be a real potential advantage for estate beneficiaries, especially beneficiaries of estates where the taxable estate was less than $5,000,000. Beneficiaries of these estates may possibly get the best of both worlds—a step up in basis on the assets they receive and no federal estate tax.
TRA 2010 has a number of taxpayer-friendly provisions which are likely to reduce both the number of estates which will be subject to federal estate taxes in 2011 and 2012 and the amount of federal estate taxes that taxable estates must pay. Some of these provisions include:
1. Setting the maximum federal estate tax rates at 35%.
2. Replacing the modified carryover basis rule of 2010 with the “step up” basis rule of 2009 and previous years.
3. Establishing a federal estate tax exclusion amount at $5,000,000.
4. Indexing the federal estate tax exclusion amount for inflation in years after 2011.
5. Adopting the concept of “portability” of estate tax unified credits between spouses (a surviving spouse may elect to take advantage of the unused portion of the estate tax exclusion of a predeceased spouse thereby potentially allowing a surviving spouse to have an estate tax exclusion amount in excess of $5,000,000).
The adoption of TRA 2010 continues the uncertainty around estate and wealth transfer planning. Since its provisions expire on December 31, 2012, the Act does nothing to create a reliable and predictable platform for transfer tax planning. Unless a new law is enacted before December 31, 2012, individuals dying after 2012 will be subject to an exclusion of $1,000,000 per person and a maximum tax rate of 55%.
TRA 2010 sets the stage for wealth transfer taxes to be an important issue in the 2012 election. Thus, as attractive as some of its provisions are, it is important for individuals to understand that TRA 2010 is TEMPORARY. Many individuals may want to believe that the temporary $5,000,000 exclusion and 35% maximum tax rate is going to become permanent. Although this is possible, it is far from certain and a risky estate planning strategy.
The temporary increase in the personal exclusion to $5,000,000 may lead some individuals to believe they may not need life insurance for estate tax liquidity. However, it’s critical to understand that you must die before 2013 to take advantage of the $5,000,000 exclusion.
TRA 2010 continues the uncertainty that surrounds wealth transfer planning. Its provisions are temporary and expire at the end of 2012. The changes it creates, although temporary, do create immediate wealth transfer opportunities for individuals who have the ability and desire to take advantage of them. These opportunities include a number of valuable life insurance strategies which may help them in efficiently passing on their wealth to their children and grandchildren, and avoid the pitfall of making Uncle Sam the primary beneficiary of their estate.
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