January 11th, 2011
The 2010 Tax Relief Act: How It Impacts You & Your Estate Planning
Recently, President Barack Obama executed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (“2010 Tax Act”). The emphasis of the new law is a temporary, two-year reprieve from the expiration of the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (“JGTRRA”), a/k/a the “Bush Tax Cuts”. Expiration of EGTRRA and JGTRRA would have resulted in substantial increases in income, estate, gift, and generation-skipping transfer taxes. The following is a summary of some of the pertinent portions of the 2010 Tax Act and the reminder of the need for Minnesota estate tax planning.
Temporary Changes to Income Tax Laws
Prior to passage of the 2010 Tax Act, the 10%, 25%, 28%, 33%, and 35% individual income tax brackets were set to expire at the end of 2010 and the rates were to become 15%, 28%, 31%, 36%, and 39.6% respectively. The 2010 Tax Act temporarily extends the 10%, 25%, 28%, 33%, and 35% brackets for an additional two years, through 2012.
The tax rate on capital gains and qualified dividends for taxpayers who were below the 25% individual income tax bracket was 0%, and 15% for those above the 25% tax bracket. These rates were set to rise to 10% and 20%, respectively, at the end of 2010, and dividends were to be subject to individual income tax rates. The 2010 Tax Act extended the 0% and 15% tax rates for capital gains and dividends for an additional two years, through 2012.
Temporary Changes to Estate, Gift, and Generation-Skipping Transfer Tax Laws
In 2001, President George Bush signed into law EGTRRA, which phased out estate and generation-skipping transfer taxes (“GST taxes”) so that they were fully repealed in 2010.
Beginning in 2011, transfers at death in excess of $1 million were to be subject to estate, gift and GST taxes with a top tax rate of 55%. However, inherited assets were to receive a new tax basis equal to the date of death value. The 2010 Tax Act changed the estate, gift, and GST tax laws as follows:
Generation-skipping Transfer Tax
To discourage people from attempting to skip estate tax liability in their children’s generation by transferring assets to grandchildren, a GST tax is assessed on transfers outright or to trusts for grandchildren or more remote descendants in excess of an amount set by Congress. The 2010 Tax Act sets the GST exemption amount at $5 million per person or $10 million per couple and the rate is 0%.
2011 and 2012 Estate Tax
The estate tax exemption in 2011 is $5 million per person and $10 million for married couples. The same exemption amounts are in effect for 2012 but the amounts are indexed for inflation. Assets in excess of the exemption amount are taxed at 35%. The basis of all inherited assets will be adjusted to their date of death values.
Under the previous laws, married couples engaged in estate planning to use each spouse’s exemption amount. The typical approach was to have assets worth up to the deceased individual’s estate tax exemption transferred tax-free to a trust, commonly referred to as a family trust or credit trust, on the first spouse’s death. The benefit of this approach is that the assets in the family trust and all appreciation on those assets are not subject to estate tax when the second spouse dies.
Under the 2010 Tax Act, the estate of a surviving spouse who dies in either 2011 or 2012 may utilize the unused exemption of the first spouse to die. For example, if Husband dies in 2011 or 2012, Wife will be able to transfer assets equal to her unused exemption amount (the “Portable Exemption”) and assets equal to her deceased Husband’s Portable Exemption (unused) amount estate-tax free. If Husband dies and Wife remarries, and Husband 2 also dies, Wife will be able to transfer assets equal to her Portable Exemption (the unused exemption) amount and assets equal to Husband 2’s unused exemption amount estate-tax free. If Wife dies before Husband 2, it is unclear as to whether Wife may use Husband 1’s unused exemption amount.
In order to be able to use the unused exemption of the first spouse to die, an estate tax return (Form 706) must be filed at the time of the first spouse’s death, a cost some may wish to avoid. In addition, if a family trust is created at the first spouse’s death, not only will the original assets transferred to the family trust escape estate tax but so will the appreciation on such assets. As a result, there is still good reason to use a family trust or credit trust at the first spouse’s death.
2011 and 2012 Gift Tax
The lifetime gift tax exemption is $5 million for a single person and $10 million for a married couple (indexed for inflation in 2012). Gifts in excess of the lifetime exemption are taxed at 35%. The gift tax exemption is also portable and any unused gift tax exemption may be used by a surviving spouse during 2011 and 2012.
2011 and 2012 GST Tax
The GST tax exemption amount is $5 million for a single person and $10 million for a married couple (indexed for inflation in 2012). GST transfers in excess of the exemption are taxed at 35%. The portability of a spouse’s unused exemption was not extended to the GST exemption. If a married couple wishes to engage in GST tax planning, a trust should be created upon the first spouse’s death to take advantage of the exemption of the first spouse to die.
Minnesota Estate Tax Should Be Addressed
A reminder: Minnesota has an estate tax on estates that have assets in excess of $1 million, including death benefits of life insurance policies, real estate, retirement assets and investments. This means that tax payers who now escape federal estate tax could still be subject to Minnesota estate tax. As a result, we recommend reviewing your estate circumstances to determine whether a bypass trust would be appropriate for you to preserve your $1 million State estate tax exemption and your spouse’s $1 million state estate tax exemption.
A bypass trust containing your estate plan works as follows:
At the death of the first spouse, assets go into a bypass trust (a/k/a “Credit, Family, “B” Trust”) that the surviving spouse can draw on if necessary. When the second spouse dies, the remaining assets in the bypass trust pass tax free to heirs, preserving the value of both individuals’ exemptions.
In other words, if a married couple lives in Minnesota with a $1 million individual exemption, a bypass trust would let them pass as much as $2 million tax-free to heirs. Without this bypass trust, a couple in Minnesota with a $2 million estate might pay an unnecessary $100,000 in Minnesota estate tax. Unlike the federal estate tax, any unused Minnesota estate tax exemption is not portable. The unused exemption at the first spouse’s death cannot be transferred to the surviving spouse. This $100,000 Minnesota estate tax can be avoided with the use of a bypass trust in your estate plan.
Estate, Gift and GST Tax Planning Opportunities and Need for Further Estate Planning
Contrary to the predictions of some observers, Congress did nothing to restrict the opportunity to leverage gifts during lifetime. Because we do not know what will happen in 2013, and because of the substantial increase in the gift, estate and GST tax exemption amounts, now is the perfect time to take advantage of many planning opportunities that are available to transfer wealth to your children or other heirs free of gift, estate or GST tax.
Previously discussed credit shelter/family trusts, bypass “B” trusts continues to be sound estate planning for the following reasons:
- To take advantage of both spouses’ Minnesota estate tax exemption.
- To fulfill the desired arrangement for second marriage situations.
- To shelter post-death principal appreciation and income accumulation from estate taxation at the death of the surviving spouse; electing portability will not.
- To provide professional management and asset protection.
- To protect the expectancy of children, especially in the cases of second marriages and blended families.
- To shelter intervening growth and value and accumulation from estate tax.
Our attorneys are monitoring developments in the estate, gift and GST tax laws. Should you have questions about your planning needs, please contact one of our attorneys: Craig W. Wendland, Mark E. Utz, David M. Pederson, and Christopher C. Wendland.