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2010 Tax Relief Act Contains Estate, Gift and Generation-Skipping Transfer Tax Changes

December 29, 2010

On December 17, 2010, President Barack Obama signed the "Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the "Tax Relief Act"). The Tax Relief Act makes significant but temporary changes to the estate, gift and generation-skipping transfer ("GST") taxes. Without the Tax Relief Act, starting in 2011 the estate tax would have applied to estates worth over $1 million and the maximum tax rate would have been in excess of 55 percent.

Estate Tax Changes for 2010. For individuals who die during 2010, the estate tax is retroactively reinstated with a $5 million exemption, a 35% tax rate, and an unlimited step-up in basis for income tax purposes. However, an estate may elect to avoid the estate tax and accept the modified carryover basis rules that existed in 2010 before the adoption of the Tax Relief Act. If the modified carryover basis rules are elected, the estate would not be subject to estate tax but would only be eligible for a $1.3 million basis increase (with an additional $3 million basis increase available for property passing to a surviving spouse).

Planning Consideration. This results in a significant savings for many estates. For estates of less than $5 million, there will be no estate tax under either choice, but the unlimited step-up in basis is of greater value than the application of the modified carryover basis rules. For estates in excess of $5 million, the decision whether to remain under the estate tax regime and receive a full basis increase or to avoid estate taxes and only receive a partial basis increase will need to be determined on a case-by-case basis. If there is a surviving spouse and an ongoing trust, opting out of the estate tax regime may produce spectacular results for larger estates.

GST Tax Changes for 2010. For 2010, the GST tax is retroactively reinstated but with a tax rate of zero. The GST exemption amount is also set at $5 million. Prior law stating that the GST was to have no effect in 2010 caused uncertainty regarding how to handle transfers in trust (or in UTMA accounts) for grandchildren and did not permit the allocation of GST tax exemption.

Planning Consideration. Gifts in trust or UTMA accounts for grandchildren may now be safely made. GST tax exemption may be allocated to transfers made in 2010.

Gift Tax in 2010. Remains the same: $1 million exemption and a 35 percent tax rate.

Estate, Gift and GST Tax in 2011–2012. The taxes are fully unified with a $5 million exemption and 35% tax rate. The $5 million exemption for estate and gift taxes is indexed for inflation starting in 2012 (the $5 million GST tax exemption is not indexed).

Planning Concern. Trust Agreements (or Wills) of married couples often divide the estate of the first spouse to die into two portions. One portion is equal to the deceased spouse's unused estate tax exemption. The remaining assets comprise the other portion and are protected from estate tax by the marital deduction on the first spouse's death. Under this type of plan, estate tax can be avoided entirely on the first death, and the estate tax exemption portion also escapes estate tax at the death of the surviving spouse. In some estate plans, the entire exemption portion passes to persons other than the surviving spouse (for example, to the children). If the Trust or Will formula for dividing the estate would allocate all of such a decedent's exemption portion to other beneficiaries when the estate tax exemption is $5 million, provisions for a surviving spouse could be significantly reduced or even eliminated.

Planning Opportunity. The ability to make gifts of up to $5 million ($10 million for married couples) is tremendous. Transferring $5 million to a dynasty trust could serve as the starting point for estate, gift and GST tax-free transfers totaling up to $50 million through a technique called a sale to a defective grantor trust. It should also be noted that important tax planning opportunities were not affected by the Tax Relief Act. First, GRATs or grantor retained annuity trusts may still be created for as short as two years. (Discussions in Congress to require a 10 year minimum term did not result in any changes being made to current law.) Second, discounts for minority interests or lack of marketability were not limited or eliminated by the Tax Relief Act.

Portability. In addition, a surviving spouse may use his or her predeceased spouse's unused exemption if: (i) the predeceased spouse died in 2011 or 2012; (ii) an estate tax return was filed for the predeceased spouse; and (iii) an election is made on the predeceased spouse's estate tax return. Only the unused exemption from the "last surviving spouse" is available. Thus, portability could be lost if the taxpayer remarried and outlived the second spouse.

Planning Consideration. Although the portability of the surviving spouse's exemption is useful, credit shelter or exemption trusts will frequently still make sense in many cases. For example, the deceased spouse's unused exemption is not indexed for inflation and does not shield appreciation from taxation. Moreover, the GST tax exemption is not portable. Thus, credit shelter or exemption trusts will still be necessary for couples with combined assets approaching $10 million, those wishing to engage in establishing trusts for their grandchildren, and those wishing to protect assets (or the additional exemption if the surviving spouse remarries. Finally, because portability is set to expire in 2013, the possibility that portability may not be extended should be considered in deciding whether to use credit shelter trusts.

2013 and Beyond. If not extended, in 2013 the estate, gift and GST taxes revert to their 2001 form with a $1 million exemption and a maximum tax rate in excess of 55%.

Our Tax and Estate Planning attorneys, are listed to the side. We welcome your call on this or any other tax-related matter.


Although this communication may address certain tax matters, U.S. Treasury regulations provide that it cannot be relied upon to avoid any tax penalties.

As part of our service to you, we regularly compile short reports on new and interesting developments in taxation and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Readers should seek specific legal advice before acting with regard to the subjects mentioned here. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments on this newsletter, or any Dykema publication, are always welcome. © 2010 Dykema Gossett PLLC.

As part of our service to you, we regularly compile short reports on new and interesting developments and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments are always welcome. © 2017 Dykema Gossett PLLC.