New Gifting Opportunities Under the Tax Relief Act of 2010
Although most publicity surrounding The Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010 (2010 Tax Relief Act), which was signed into law in December 2010, focused on the income tax provisions, it also contains significant taxpayer-friendly changes for estate, gift and generation skipping transfers (GST) taxes.
As a result, the 2010 Tax Relief Act presents a unique window of opportunity for individuals to make meaningful transfers of wealth without being subjected to transfer taxes.
Under the sunset provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), had Congress not taken action, the gift, estate, and GST tax provisions would have returned to the pre-2002 law on January 1, 2011. This pre-2002 law imposed much more onerous taxes on transfers of wealth. Without the passage of the 2010 Tax Relief Act, the gift, estate, and GST tax exemption in 2011 would have been limited to $1 million; with any transfers above this exemption amount subject to a transfer tax with a top tax rate of 55% (plus a surcharge of 5% on transfers between $10 million and $17,184,000).
The 2010 Tax Relief Act provides for an estate and GST tax exemption of $5 million for 2011 and 2012, with a tax rate of 35%. The lifetime gift exemption, which was $1 million in 2010, was also increased under the 2010 Tax Relief Act at $5 million for 2011 and 2012. This is a much more generous gift exclusion than most practitioners anticipated. Under the 2010 Tax Relief Act, an individual who already made gifts exceeding the old $1 million exemption, may now give an additional $4 million gift tax free. However, it is important to note that, absent any future legislative action, most of the estate, gift, and GST tax provisions of the 2010 Tax Relief Act expire after 2012, including the $5 million exemption. Under the 2010 Tax Relief Act, in 2013 there will be a reinstatement of the harsh pre-2002 transfer tax provisions discussed above. As such, the time to take advantage of the higher exemption may be limited.
The $5 million lifetime gift exemption in 2011 and 2012 ($10 million, if spouses gift-split), used in conjunction with other estate planning strategies, allows an individual to transfer substantial wealth gift tax free. While there were many proposed changes to limit the benefits of various estate planning techniques looming throughout 2010, they never came to fruition. For example, proposals to eliminate certain valuation discounts for transfers of family controlled entities were not included in the 2010 Tax Relief Act. As such, individuals may continue to take advantage of discounts for lack of control and/or lack of marketability in valuing transfers of family limited partnerships, limited liability companies and other closely-held entities. Since future legislation may again target certain valuation discounts, the window of opportunity to take advantage of these valuation discounts may soon be closing.
Various legislative proposals mandating minimum ten-year terms for grantor retained annuity trusts (GRATs), which would have reduced the planning opportunities associated with this wealth transfer technique, did not make it into the 2010 Tax Relief Act. Zeroed-out GRATs have the advantage of allowing transfers of future appreciation without incurring gift taxes and are frequently set up with short terms (e.g., two or three years). GRATs are particularly effective when interest rates are low, such as now, and individuals should consider establishing short-term GRATs while they are still tax advantageous.
The benefit of techniques like GRATs is derived from the growth in the value of assets contributed in excess of an interest rate that is determined by Internal Revenue Service based on the prevailing rates on treasury securities. Those rates have been at all time lows but are beginning to increase. The end result is that there has never been a better time to use a wide variety of wealth transfer techniques.
For the estates of decedents who passed away in 2010, the 2010 Tax Relief Act reinstated the estate tax retroactively to January 1, 2010, with a rate of 35%. However, for 2010, executors have the choice to opt-out of the provisions of the 2010 Tax Relief Act and instead file a return under the EGTRRA tax regime. This regime provided for no estate tax in 2010 along with modified carryover basis rules for assets that are transferred to beneficiaries. The determination as to whether to opt-out of the estate tax in 2010 is rather complicated and is dependent on the estate's particular facts.
The 2010 Tax Relief Act also introduces the concept of "portability" to the $5 million exemption, whereby the surviving spouse's estate has the ability to utilize any unused exemption remaining at the death of the first spouse. Portability is great in theory as it eliminates the potential for the wasting of the unused exemption of the first spouse to die. Unfortunately, the portability provisions also sunset after 2012 and thus add uncertainty to the estate planning process.
As a result of the 2010 Tax Relief Act and the lack of clarity with regard to future transfer tax changes, existing wills and trust documents should be reviewed to ensure that bequests still conform to the individual's objectives. In addition to federal transfer taxes, many states impose separate transfer and inheritance taxes that can be substantial and should be considered as part of any estate plan. Therefore, the 2010 Tax Relief Act creates favorable tax planning opportunities, which may be available for a very limited time.