FEDERAL ESTATE, GIFT & GST TAX CHANGES

On December 17, 2010, Congress passed and President Barack Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Act”). We are pleased that the Act substantially increased the exemption amounts for federal estate, gift and generation skipping transfer (“GST”) tax. It also reduced the maximum federal rates for each of these taxes. However, the new Act is a stop gap, and unless further action is taken, the beneficial changes are set to expire after 2012 when the exemption amounts and tax rates will revert to 2001 levels. While the Act presents planning opportunities during the next two years, it also perpetuates the uncertainties in the laws faced since 2001. Moreover, during this period, Maryland estate taxes remain unchanged and, as always, must be addressed in any plan.

The following is a summary of the new law, how it may impact your current estate plan and some of the potential planning opportunities available. There are many nuances to the Act and how it applies to your individual situation that can best be addressed one on one.

Summary of Federal Estate, Gift & GST Tax Laws for 2011 & 2012:

• $5 Million Federal Estate Tax Exemption: Individuals dying in 2011 or 2012 with assets valued at $5 Million or less will most likely not incur any federal estate tax.
• Reunification of Gift Tax Exemption: Individuals can make lifetime gifts of $5 Million (gifts in excess of $13,000 per donee/year and certain other gifts) without incurring gift tax. Gifts in excess of $13,000 per donee/year will reduce the $5 Million estate tax exemption available.
• $5 Million GST Tax Exemption: Individuals can make generation skipping transfers of $5 Million without incurring GST tax.
• 35% Tax Rate: Estate, gift and generation skipping transfers in excess of $5 Million will incur a tax (estate, gift or GST tax) equal to 35% of the amount over $5 Million. This is reduced from 45%.
• Deceased Spousal Unused Exemption Amount (“Portability”): A surviving spouse’s estate tax exemption is increased by the unused exemption amount of his or her predeceased spouse. For example: Husband, who is married to Wife, dies in 2011 with an estate of $2 Million; there is no estate tax on his death since his assets are less than $5 Million. He has an unused exemption of $3 Million. Wife dies in 2012. Her estate tax exemption is $8 Million (Wife’s $5 Million + Husband’s unused exemption of $3 Million). Portability is only from an individual’s last deceased spouse. Portability does not apply to the gift or GST tax exemptions.
• Step-up in Basis: All assets (except those in a bypass trust passing upon the survivor’s death) will receive a step-up in basis to the date-of-death value.
• State Death Taxes: State death taxes remain as a deduction against the assets of the estate.

Potential Federal Estate, Gift & Generation Skipping Transfer (“GST”) Tax Laws after 2012:

• $1 Million Estate Tax Exemption: Individuals dying after 2012 with assets valued at $1 Million or less will not incur any estate tax.
• $1 Million Gift Tax Exemption: Individuals can make lifetime gifts of $1 Million (gifts in excess of $13,000 per donee/year and certain other gifts) without incurring gift tax.
• $1 Million GST Tax Exemption: Individuals can make generation skipping transfer gifts of $1 Million without incurring GST tax.
• 55% Tax Rate: Estates, gifts and GSTs in excess of $1 Million will incur a tax (estate, gift or GST tax) equal to 55% of the amount over $1 Million.
• Portability: Portability will expire.

Impact on Your Current Estate Plan & Planning Opportunities:

• With Exemption amounts of $5 Million, can I rely exclusively on the increased Exemptions to avoid federal estate tax consequences? No. While the exemption amounts are high and the exemptions are now portable to your surviving spouse, there is no guarantee that the amounts will be maintained or portability will continue after 2012. After December 31, 2012, the exemption amount will revert to the 2001 level of $1 Million, a federal estate tax equal to 55% on the amount in excess of $1 Million will be imposed and portability will disappear. Also, planning done under prior law may have some unintended consequences because of the Act.
• Since my assets are substantially less than $5 Million, do I need an estate plan or do I need to review my existing plan? Yes. Planning remains important to minimize state death taxes. Individuals with a Maryland estate will have a Maryland death tax of up to 16% of assets valued over $1 Million imposed on their estates. Also, as set forth above, the new limits apply only to deaths occurring during the next two years. Most importantly, the new federal laws do not eliminate the non-tax factors of estate planning, such as providing for your loved ones, asset protection and reducing uncertainty. Having a comprehensive estate plan in place is vital to ensure that your estate passes to your beneficiaries as you intend and as efficiently as possible. Estate plans should be reviewed periodically to ensure that they take advantage of all the tax and planning benefits available. Proper planning will assist you in addressing the law as now in effect and possible changes in the future.
• What are the practical affects of the Act on an estate established in 2011 or 2012? Due to the tremendous reduction in taxable estates, the IRS’ capacity to audit estate tax returns increases dramatically. It is reasonable to conclude that the IRS will audit 100% of returns filed and may have additional resources to closely scrutinize gifts (taxable and non-taxable) made during life. Thus, it may become important for individuals to keep meticulous records of such gifts.
• Do I stop making annual gifts ($13,000, tuition and medical expenses) because the $5 Million exemption will mean that I will not have a taxable estate? While every situation is different, due to the uncertainty of the exemption amounts, it may still make sense to make such gifts. Further, Maryland only allows a $1 Million exemption and does not have a gift tax; thus, any gifts made will reduce Maryland death taxes, assuming your estate has assets in excess of $1 Million.
• Do I aggressively plan gifts (gifts in excess of $13,000 per year/donee) before the end of 2012 because the estate tax is set to revert to $1 Million? Again, every situation is different and requires careful thought, calculation and planning. Aggressive gifting may reduce state death taxes and potentially federal estate taxes, but will not allow the donee a step-up in basis (the recipient of the gift takes your tax basis). Further, non-tax factors, such as your current financial position and the impact possible market plunges may have on your assets, should also be weighed and considered.

While the Act affords individuals new planning options, most obviously with lifetime gifts, it does not eliminate or even reduce the need for effective estate planning. The new law creates both risks and opportunities that must be weighed and considered with care and thorough evaluation.

For further information regarding the new laws or to review your current estate plan, please contact Andrew R. Sandler, Sidney Weiman, Mayer E. Guttman or Sean K. Elavia at (410) 321-0600.