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The 2010 Tax Relief Act

By Lesley M. Mehalick, Esquire

At long last, Congress enacted legislation regarding the federal estate, gift, and generation skipping taxes; however, this new law will only be in effect for two years, and thus it is essential to have a carefully crafted estate plan with as much flexibility as possible.

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Act”), effective as of January 1, 2011, is applicable to persons who pass away after December 31, 2009 and before January 1, 2013. The Act increased the exemption from federal estate tax to $5 million dollars per individual, and it lowered the maximum federal estate tax rate to 35%.

The Act increased both the lifetime gift tax exclusion and the generation-skipping transfer tax exemption to $5 million dollars each, and the Act established 35% as the rate for both federal gift and generation-skipping transfer taxes.

The Act allows some sharing of spouses’ respective estate tax exemptions, so that a married couple may pass up to $10 million dollars to their children free of estate tax. While this portability clause may initially appear to lessen the need for credit shelter or other trusts in wills, these trusts still have utility in a variety of circumstances. Importantly, these trusts may provide essential estate tax protection should the exemption decrease after the Act expires on December 31, 2012, and in the meantime, they can be an excellent vehicle to hold assets that will increase in appreciation and may also be useful for unmarried or same-sex couples. Regardless of the ultimate federal estate tax exemption, trusts may protect a surviving spouse from creditors or designing persons, and an appropriate trust can ensure that the deceased spouse’s wishes are honored, which is especially crucial in the instance of second marriages or where there are children outside of the marriage. These trusts may also be advisable as the practical application of the portability clause is subject to confusion among practitioners, and it is yet unclear as to
exactly how this provision will work.

The Act reinstated the popular “step-up” in basis for assets passing through a decedent’s estate, which generally means that an asset passes to the beneficiary with a basis equal to its fair market value as of the date of decedent’s death. This step-up is often fiscally advantageous for the estate beneficiaries from an income tax perspective, and it also avoids accounting headaches and delays for long-held stocks and assets for which the original basis is difficult, or even impossible, to determine. The Act also provided some clarity for executors of estates for decedents who passed away in 2010. The Act gives executors the choice of administering the estate under the Act or under the laws as they were in 2010, which essentially provided for no estate tax, with a carry-over basis.

It is important to realize that the Act is temporary. If Congress does not enact new legislation before the Act expires on December 31, 2012, then the law will revert to its state before the Economic Growth and Tax Reconciliation Act of 2001. That means the applicable exclusion amount would be reduced to $1 million per individual, and the maximum federal estate tax rate would increase to 55%. The interim nature of the Act present challenges in crafting appropriate estate plans, but techniques such as disclaimed property trusts are available that may fully utilize the current favorable laws, while also planning for the possibility of Congress’s
non-action before 2013.

As the Act becomes obsolete on December 31, 2012, taxpayers will await more permanent legislation regarding the federal estate, gift, and generation skipping transfer taxes. In the meantime, an estate plan should include flexibility in anticipation of various potential future scenarios, which may vary with the economy and political climate.

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