New Tax Act and Estate Planning


On December 17, 2010 President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the "Act"). On December 21, 2010, we published a newsletter dealing with many of the tax aspects of the Act.  In this blog, we want to zero in on how the Act changes the federal estate tax landscape, which can impact estate planning for many of our clients, and present significant estate planning opportunities. Please note that this blog only summarizes the Act's key changes and provides you with our observations about the Act's impact from an estate planning perspective.   This blog is not intended to give tax advice regarding any person's particular situation.


Estate Tax

Before the Act, the federal estate tax was gradually reduced over several years and then eliminated for decedents dying in 2010. Prior law provided that the estate tax, with a maximum tax rate of 55 percent and a $1 million applicable exclusion amount, would be reinstated after 2010. Additional changes scheduled for years after 2010 affected the gift and generation- skipping transfer ("GST") taxes.

The Act reinstates the estate tax for decedents dying during 2010, but at a significantly higher applicable exclusion amount of $5 million, and a lower maximum tax rate of 35 percent, than under prior law. This estate tax regime continues for decedents dying in 2011 and 2012. Unfortunately, this new regime is itself temporary and will sunset on December 31, 2012 and the prior estate tax regime, with a 55 percent maximum estate tax rate and a $1 million applicable exclusion amount, is reinstated at that time.

The Act also eliminates the modified carryover basis rules for 2010 and replaces them with the stepped-up basis rules that had applied before 2010. Property with a stepped-up basis generally receives a basis equal to the property's fair market value on the date of the decedent's death. Under the modified carryover basis rules that applied during 2010 before the Act, executors could increase the basis of estate property only by a total of $1.3 million (plus an additional $3 million for assets passing to a surviving spouse, for a total increase of $4.3 million), with other estate property taking a carryover basis equal to the lesser of the decedent's basis or the property's fair market value on the decedent's death.

The Act gives estates of decedents dying during 2010 the option to apply (1) the estate tax based on the new 35 percent top rate and $5 million applicable exclusion amount, with stepped-up basis, or (2) no estate tax and modified carryover basis rules under prior law.

The Act also provides for "portability" between spouses of the estate tax applicable exclusion amount for estates of decedents dying in 2011 and 2012 if both spouses die before 2013. Generally, portability allows surviving spouses to elect to take advantage of the unused portion of the estate tax applicable exclusion amount (but not any unused GST tax exemption) of their predeceased spouses, thereby providing surviving spouses with a larger exclusion amount.   Special limits apply to decedents with multiple predeceased spouses.

To preserve the first deceased spouse's unused applicable exclusion amount, the executor for such spouse must file an estate tax return and make an election on such return, even if such an estate tax return would otherwise not be required.

Gift Taxes

For gifts made in 2010, the maximum gift tax rate is 35 percent and the applicable exclusion amount is $1 million. For gifts made in 2011 and 2012, the Act limits the maximum gift tax rate to 35 percent and increases the applicable exclusion amount to $5 million.   As discussed below, this change provides an opportunity to move significant amounts of wealth free of estate and gift taxes.

Donors continue to be able to use the annual gift tax exclusion before having to use any part of their applicable exclusion amount. For 2010 and 2011, the annual exclusion amount is $13,000 per donee (married couples may continue to "split" their gift and may make combined gifts of $26,000 to each donee).

Generation Skipping Transfer ("GST") Tax

The Act provides a $5 million GST exemption amount for 2010 (equal to the applicable exclusion amount for estate tax purposes) with a GST tax rate of zero percent for 2010. For transfers made after 2010, the GST tax rate would be equal to the highest estate and gift tax rate in effect for the year (35 percent for 2011 and 2012). The Act also extends certain technical provisions under prior law affecting the GST tax.



Generally, the estate and gift tax provisions of the Act are very favorable to taxpayers because of the substantial increase in the applicable exclusion amount, to $5 million, and the lower maximum estate and gift tax rate of 35 percent. The Act also addresses several technical estate, gift and GST tax issues in a manner that is favorable to taxpayers (e.g., the impact of the lapse of the estate tax, including the application of basis rules, on decedents passing away during 2010). 

Temporary Fix

The Act is a temporary fix, which sunsets on December 31, 2012, immediately after the next election cycle.  It is impossible to predict whether it will be extended in either its current or some modified form, especially given the fact that it is a hot button issue with both major political parties.  If Congress fails to act, the Act will lapse and the estate tax will revert to what it would have been under prior law (i.e., $1 million applicable exclusion amount and 55 percent maximum estate and gift tax rate). 

Increased Gift Tax Applicable Exclusion Amount

From 2001-2010, the applicable exclusion amount for gift tax purposes has been $1 million.  The Act increases this to $5 million, or $10 million per married couple.  This change provides an unprecedented opportunity to move substantial amounts of wealth out of individuals' estates.  There are several techniques that individuals can use to leverage this $5 million applicable exclusion amount, to move substantially more wealth out of their estates. 

To illustrate, individuals can now make a gift of up to $5 million to a trust, remove all growth from such gift out of their estate, and provide asset protection for trust assets at little or no gift tax cost.  In addition, the increased gift tax applicable exclusion amount increases the amount of assets that individuals can transfer via an installment sale to a dynasty/grantor trust.  Under this estate planning technique, individuals can now make an initial gift of as much as $5 million ($10 million per married couple) to a dynasty trust, and then transfer as much as $45 million ($90 million for a married couple) to such dynasty trust in exchange for an installment note.  This technique works especially well for family businesses that are expected to grow significantly in value over time.  

Given the fact that the Act will sunset without further Congressional action in 2012, it might be appropriate to consider these or other techniques before the December 31, 2012 sunset date.

State Estate Taxes

Many states have separate estate tax regimes with lower applicable exclusion amounts than the federal applicable exclusion amount. These include the District of Columbia, Maryland, New Jersey, and New York, among others.  It is critical that the estate plans of individuals living in or owning property located in such states address such estate tax exposure. 


One of the more notable provisions contained within the Act is the "portability" provision, which provides in general terms that if one spouse does not fully utilize his/her entire $5 million applicable exclusion amount, the unused portion can be used by the surviving spouse's estate.  This provision is intended to avoid the need for credit shelter trusts in estate planning documents. Unfortunately, both spouses must die before 2013 in order to benefit from the portability provision.

In addition, credit shelter trusts continue to provide significant additional benefits beyond just the use of each spouse's applicable exclusion amounts. These include the following:

  • Ensuring that assets contained in the credit shelter trust pass to children of the couple and not to any new spouse of the surviving spouse.
  • Ensuring that appreciation on the assets contained within the credit shelter trust, which may exceed the applicable exclusion amount at the surviving spouse's death, are not subject to estate tax at that time.
  • Protection of assets in the credit shelter trust from creditors of the surviving spouse, including any marital claims of future spouses.

Given the fact that the portability provision will sunset in 2012, as well as for the reasons stated above, it may be advisable to continue to use estate plans that incorporate credit shelter trusts.

Things Not In the Act

There are two key provisions that many commentators feared would be in the Act, but which were not included in it.  Specifically, there have been several proposals to place limits on Grantor Retained Annuity Trusts ("GRATs"), which allow individuals to transfer wealth out of their estates with as little as a zero estate or gift tax cost that would have made GRATs less valuable from an estate planning perspective.  There have also been several proposals to limit valuation discounts in connection with certain estate planning techniques such as family limited partnerships. There were no such provisions included in the Act.  Therefore, these techniques continue to be available to move wealth to lower generations.