Highlights of the New Estate Tax Legislation

On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. We’ll cover here just some of the highlights as it relates to the estate tax.

The most newsworthy change is the increase in the federal estate tax exemption. Your estate will have to pay federal estate taxes if its net value when you die is more than the exempt amount in effect at that time. For 2010, 2011 and 2012, the individual exemption is now $5 million and the tax rate is 35%. So if someone dies in 2010, 2011 or 2012 and their taxable estate is less than $5 million, no estate taxes will be due. If their estate is greater than $5 million, the excess will be taxed at 35%.

There are two important points to remember: These changes are only effective for the next two years. If Congress does not act again before the end of 2012, on January 1, 2013, the estate tax exemption will drop to $1 million (adjusted for inflation) with a top tax rate of 55%. Also, Ohio does have its own estate tax at this time, so your estate could be exempt from federal estate tax but still have to pay Ohio estate tax.

The current estate tax law, both federal and Ohio, provides an unlimited deduction for assets left to a surviving U.S. citizen spouse. So the first spouse who dies can leave everything to the surviving U.S. citizen spouse and there will be no estate taxes due. However, this may result in a problem upon the second death because at that time the estate tax exemption that could have been used at the first death is not available to shield assets in the surviving spouse’s estate.

For those couples in which both spouses die between January 1, 2011 and December 31, 2012, the Congress added a “portability” provision to the new law. This means that if one spouse dies in 2011 or 2012, the Executor of that spouse’s estate may transfer any unused federal estate tax exemption to the surviving spouse by making the election on a timely filed federal estate tax return. But the transferred exemption must be used before December 31, 2012 or it is lost. Also, only the most recent deceased spouse’s unused exemption may be used by the surviving spouse, which could impact a survivor’s decision to remarry.

Even with the portability provision available, relying on the unlimited marital deduction can cause other problems. For example, by leaving everything to your spouse, you have no control over how your share of the estate is managed or distributed. That surviving spouse can do whatever he or she wants with the assets, including disinheriting any children you may have from a previous marriage. Also, any growth in the assets will be included in the surviving spouse’s estate when he or she dies and will be taxed at the rate in effect at that time.

By planning with the typical Marital and Family trusts (also known as A-B trusts), you can make sure you use both exemptions, and you can control how your half of the estate is managed and ultimately distributed. The assets from your estate can still be available to your spouse for his or her use, depending on your wishes.

Another important provision in the new tax law is that for 2011 and 2012 the gift tax exemption is $5 million per person ($10 million for a married couple), with the tax rate above the exemption at 35%. This exemption is unified with the estate tax exemption, so that any unused amount can be transferred to your surviving spouse under the portability provision.

You can still make the annual tax-free gifts of $13,000 to as many individuals as you wish. To the extent you give more than that to someone, the excess is considered a taxable gift and goes against your lifetime gift/estate tax exemption.

Finally, the generation skipping transfer tax exemption is $5 million for 2011 and 2012 as well. A generation skipping transfer occurs when some or all of your estate goes directly to a grandchild or a non-relative who is more than 37.5 years younger than you. If that transfer becomes subject to the GST tax, that tax is equal to the highest federal estate tax rate in effect at the time of the transfer and is in addition to the federal estate tax. The purpose of this tax is to tax assets that are transferred at each generation. So if you skip a generation, you don’t skip the taxes that would have been paid.

The 2010 Tax Act provides tremendous opportunities to transfer vast amounts of wealth for families with estates of all sizes, but the opportunity expires on December 31, 2012. At the same time, individuals with estates of $5 million or less can focus on planning that concentrates on family goals and objectives without having to worry about federal estate taxes, at least for the next two years. (Remember you still must consider Ohio estate taxes.)

It’s a good time to take a look at your estate plan and see if you can take advantage of these planning opportunities. In any event, it never hurts to review to make sure your personal concerns are still addressed in your estate plan.