The world of estate planning has had a chaotic year throughout 2010 because of the shifting sands of the estate tax. Over recent months, the lurking date of January 1, 2011 caused some hysteria in estate planning circles reminiscent of Y2K. Just like that moment turned out to be a non-occurrence of the Al Capone vault variety, this one is shaping up as somewhat anti-climactic as well.
Last week, a new tax bill finally passed both chambers of Congress and was signed into law by President Obama on Friday December 17.
A brief review of the strange recent history of estate tax:
2009: Last year, in Aught 9, estates worth less than $3.5 million estates were exempt from federal estate taxes. At the time that was the highest exemption in the history of a tax that has continually been part of the Internal Revenue Code since 1916. The highest rate was 45%.
2010: This year, the estate tax disappeared. By picking a spectacular year to die, Dan Duncan’s family saved quite a few dollars on his $9 billion dollar estate, as did George Steinbrenner’s on his $1 billion estate. Elsewhere electrical plugs are in readiness to be pulled in the coming days. Suicide, assisted or otherwise, may still loom for the uber-wealthy, because…
In 2011, federal estate taxes return, though not with the vengeance that would have ripped into many middle class estates had the Washington power structure not reached a last minute deal. The estate tax, dead all of this year, will return to life like a zombie on New Year’s Day, but at a higher exemption/lower top rate than ever before. The exemption, through 2012, will be $5 million per person, affecting only the top ¼ of 1% of wealthy Americans. The top rate will be 35%.
Without the December political compromise (or capitulation, depending upon your viewpoint) all estates greater than $1 million for people dying on or after 1/1/11 could have faced taxes as high as 55%. As it is, the estate tax moment of trust has simply been delayed for two years.
I would say to the wealthy people who followed their planners’ advice and made gifts in excess of their lifetime exclusion of $1 million (“because the top bracket is never going to be this low again”): though you have to write an IRS check this coming April, and if you gifted appreciated assets your heirs may have to pay a higher capital gain someday than they otherwise would have, take solace in the fact that all growth in the amount you divested will, in fact, take place outside of your estate. It is possible that eventually your estate will save taxes overall, especially if the gift was made to grandchildren.
State estate taxes will also return to many states on 1/1/11. In Illinois, the exemption threshold will probably, though not necessarily, be the same as the 2009 level, $2 million per person. This could mean that, without the proper “Q-Tip” language in a shelter trust (or the ability to use a disclaimer to effectuate the equivalent of a Q-Tip trust), over the next two years a fully funded shelter trust of $5 million for a first-to-die spouse who is an Illinois resident will result in the surviving spouse paying a state estate tax in excess of $350,000. Granted that the Illinois estate tax bracket, for estates in that range is between 8% and 12%, far less than the prospective federal rate of those same assets with appreciation added in, but writing checks to pay taxes sooner rather than later is generally not a very appealing prospect.
Between now and 2013, there will continue to be debate on the whole range of tax issues. President Obama will then either begin his second term in office with a new public mandate or he won’t. There is no doubt that the newest estate tax is a direct manifestation of the midterm election’s national lurch rightward, for better or worse. What happens with estate taxes in 2013 and thereafter is anyone’s guess, but without a new law prior to that, the reset goes back to the $1 million per person exemption and 55% top bracket.
A few other points in the new estate tax law:
*The 2010 capital gains treatment on basis step-up can result in greater taxes than the estate tax would have been had it not disappeared. the new tax agreement provides that these 2010 estates, usually worth somewhere between about $1.3 million and about $4 million, will be given an election to pay the lesser tax, whichever one that may be.
*The GST tax exemption will continue to be equal to the transfer tax exemption in 2011-2012, as it has for the past decade. This allows families to push more money into future generations without the punitive generation skipping tax being assessed.
*The estate tax exemption will be “portable” in 2011-2012, so that any unused exclusion following the death of the first-to-die spouse will be added to the surviving spouse’s exclusion by an election made in the federal estate tax form 706 of the first-to-die spouse. The complicating feature of portability is the reality of the multiple divorce and marriage cycle, though in its final form, a surviving spouse can only use the most recent spouse’s unused credit. This provision may make the division of some married couple’s assets for estate tax planning unnecessary.
*The lifetime gift exemption in 2011-2012 will be raised from $1 million to equal the applicable exclusion amount of $5 million for the next two years. This is a similarity to the old “unified” estate and gift exemption that existed prior to the 2001 Tax Act.
*Inflation adjusters are built into the exclusion amount, with increments being rounded to the nearest $10,000 per year. This is only important for one year, 2012, and only then if there is much inflation in 2011.