Estate and Gift Taxation in the 21st Century – LIVING WELL Magazine
From Living Well Magazine
First, a bit of history in the event you have managed to escape the estate and gift tax debacle of the past decade! At the beginning of the century, a decedent’s estate that was exempt from estate taxation at death was limited to $675,000, which was increasingly affecting the middle class, as all assets an individual owns at death (including retirement accounts, IRAs and life insurance) are included in the gross estate subject to the estate tax. In addition, any taxable gifts the decedent made during life are added back into the taxable estate. This relatively small exemption was particularly onerous as the first dollar in excess of $675,000 was taxed at a rate of 37% and the highest marginal rate was equal to 55%.
The 2001 Tax Act attempted to address these issues (but also created the beginning of a decade of uncertainty in planning for estate and gift taxation) by phasing in both (i) an increase in the exemption and (ii) a reduction in the top marginal rate. More specifically, the law increased the exemption amount incrementally over the decade from $1,000,000 to $3,500,000, it decreased the top marginal tax rate from 55% to 45%, and eliminated the estate tax in 2010. Although this was a “pro-taxpayer” change, it also led to a decade of uncertainty, which has continued to date.
The issue created by the 2001 Act was two-fold. Although, (i) the act provided for the repeal of the estate tax (but not the gift tax) for decedent’s dying in 2010, (ii) in order to satisfy budgetary requirements (i.e., the Congressional Budget Act of 1974), the changes to the law (including the repeal) made by the 2001 Act were scheduled to “sunset” after 2010. This meant that the law beginning in 2011 would return to the law in effect immediately prior to the 2001 Act. Thus, the exemption amount was scheduled to revert to $1,000,000 with a top marginal tax rate of 55% in 2011.
Almost all believed that subsequent legislation would modify the result, as it would certainly seem to be adverse to public policy to have repeal of the tax in 2010, but an exemption of $1,000,000 and a 55% top rate the succeeding year (thus “encouraging” 2010 deaths). Consider for example a $5 million estate and the range of estate tax imposed for deaths in
2009 – 2011:
$5 Million taxable estate
Decendent’s Year of Death Estate Tax Imposed
As the decade progressed, subsequent legislation was not forthcoming and the unthinkable occurred on Jan. 1, 2010. Congress’s inability to agree on an extension or modification of the 2001 Act caused the estate tax to be “repealed.” Some members of Congress believed a final decision regarding the estate taxation of deaths occurring in 2010 could be delayed until Oct. 1, 2010 (the date the estate tax return for a decedent dying on Jan. 1, 2010 would be due), thereby permitting legislation to be enacted later in 2010 to retroactively repeal the law and reinstate the estate tax effective as of Jan. 1, 2010. However, as the year progressed without an agreement in Congress, the constitutionality of imposing a “retroactive” estate tax became an increasing issue of debate.
Not until Dec. 17, 2010, when President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (generally referred to as the “2010 Tax Relief Act” or “2010 TRA”) did the estate tax law for deaths occurring in calendar year 2010 become known. However, this did not bring “relief” to the uncertainty in the estate and gift tax law or in the difficulties in planning for estate and gift taxation, as the 2010 TRA merely postponed the final decision by enacting a two-year extension of the 2001 Act (with some modification).
The 2010 TRA retroactively reinstated the estate tax for all 2010 decedents. However, to address the constitutionality issue of a retroactive tax, the Act permits the estate’s executor to choose whether to subject the estate to (i) the estate tax regime (with a $5 million exemption and a 35% tax rate), or (ii) the carry-over basis regime (the law that had been in effect for 2010 prior to the TRA). The “carry-over basis regime” did not impose an estate tax at death, but the beneficiaries receive a “carry-over” basis in the assets equal to the decedent’s basis at death (2010 TRA does include provisions for the allocation of a specific amount of “general” and “marital” basis step-up). Conversely, under the estate tax law, the estate is exposed to taxation, but the beneficiaries receive a new basis in the assets equal to the value at the decedent’s death. Thus, a beneficiary under the carry-over basis law may subsequently pay more in taxes (i.e., capital gain taxes) when the inherited asset is sold.
For 2011 & 2012, the $5 million exemption and the 35% tax rate apply to decedents’ estates. But again, the 2010 Tax Relief Act only extended the sunset provisions of the 2001 Act for two years. Thus, in 2013, the law is scheduled once again to revert to the pre-2001 Tax Act law imposing estate tax on decedents’ estates in excess of $1 million at a top rate equal to 55%.
The uncertainty in the estate and gift tax law beyond 2012 does not mean that estate and gift tax planning should be ignored or delayed until after 2012. A competent estate tax planning attorney should be able to draft flexibility into your estate planning documents so that any taxes imposed upon your estate and the disposition of your assets at death will be in accordance with your desires. Furthermore, there are significant opportunities for gift tax planning in 2012, as the gift tax exemption is $5 million with a historically low 35% applicable tax rate. In addition, the currently low interest rates provide an advantageous environment for many gifting techniques.
Jennifer K. Huckfeldt is a shareholder in the law firm of Carnahan Evans Cantwell & Brown, PC. She received her law degree from the University of Missouri – Columbia in 1991, her LL.M. in Taxation from New York University School of Law in 1992, and she was elected as a fellow of the American College of Trust and Estate Counsel in 2011. Ms. Huckfeldt has nearly 20 years of experience in estate and gift tax planning and is a frequent lecturer and writer for the Missouri Bar. She concentrates her practice in the areas of estate, gift and fiduciary income taxation, planning with retirement benefits, and post-death trust administration and taxation matters. You may reach Ms. Huckfeldt at 417-447-4400.