Now Law: Estate Tax Rate and Exclusion

I have previously written on my amazement that Congress allowed the estate tax to lapse last year and of the many plans put forth to reinstate the death tax. With the signing of The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the estate tax has been reinstated for 2011 and 2012 at a maximum rate of 35% with a $5 million per person exemption. In 2009, a 45% maximum tax rate was accompanied by a $3.5 million exclusion. Beginning in 2013, however, the exclusion drops to $1 million per person and the estate and gift tax rate increase to 55% – that is, of course, unless further legislation is enacted.

Interestingly, the new law retroactively reinstates estate taxes for 2010 at the rate of 35%. However, executors of estates of decedents who died in 2010 are permitted a taxation choice. They can distribute assets to heirs estate-tax-free but with a carryover basis (generally the original purchase price), or step up the basis to the market value (generally at time of death) and pay the current 35% rate on anything above the $5 million exemption. A step-up in basis means the value of an appreciated asset is readjusted at a higher market value for tax purposes upon inheritance versus what the value of the asset was when it was originally purchased.

Because this is a complex decision for estates over $5 million with highly appreciated assets, be sure to contact your financial advisor, attorney, or tax advisor for advice.

Other notable estate tax changes for 2011 include:

• New portability rules that allow any unused exemption to be passed to a surviving spouse. Therefore, a married couple can exempt up to $10 million.
• A new lifetime gift tax exemption of $5 million per person ($10 million per couple.) Taxable gifts made in 2011 and 2012 will be taxed at the rate of 35%.
• A generation skipping transfer tax (GSTT) exemption of $5 million per person ($10 million per couple) with a 35% tax rate. Note: The GSTT is not portable.

If you are unsure if the new law impacts your estate plan, you should consult your attorney to determine whether your estate plan needs to be updated or modified.