The Amusement of Estate Tax Reform: Are We There Yet?

The newest thrill ride is Estate Tax reform.

In 2001, Congress passed a law reforming what many thought was an outdated estate tax system. This “2001 Tax Act” gradually increased the estate tax exemption from $600,000 (and as high as a 55% tax rate on the excess), to a $3.5 million exemption in 2009 (with a 45% tax rate on the excess) and an ultimate repeal of the estate tax altogether starting in 2010. Strap in. The ride begins.

Although the Senate had enough votes to pass the 2001 Tax Act, the votes were insufficient to make the estate tax repeal permanent. As a result, the 2001 Tax Act would “sunset” and the repeal would itself be repealed come January 1, 2011. In short, the “outdated,” pre-2001 estate tax system would come back into effect starting in 2011. A loop-de-loop.

For nearly a decade, everyone thought that Congress would take action to correct the looming uncertainties. It didn’t. Nobody thought that a one-year repeal of the estate tax in 2010 would actually happen. It did.

At the start of 2010, as if the unexpected would somehow undo itself and return to the expected, many assumed Congress would take immediate action to reinstate the estate tax retroactively. It didn’t. As 2010 began to wind to a close, many resigned themselves to the anticipated reality that Congress would not take any action and that we would have repeal for 2010 and then return to the old system for 2011 and beyond. But it did! A corkscrew turn.

Just prior to Christmas 2010, Congress passed and the President signed a new tax law with the “short title” of the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.” Short title indeed. We’ll call it the “2011 Act.” So where are we in this ride and what did the 2011 Act actually do with respect to the estate tax?

For starters, the 2011 Act actually reinstated the estate tax for 2010. Yes, a bit of a surprise turn for the heirs of decedents who died in 2010. But the potential backlash from this group was avoided because the estates of decedents dying in 2010 are permitted to elect out of the estate tax if a certain form is filed with the IRS. Granted, this election does have some potentially negative capital gains tax ramifications, but at least the estate has the option.

So is the ride really over? Not quite. The 2011 Act is only effective until the close of 2012. And then, yes, we start this ride all over again. But in the meantime, here is a list of the other 2011 Act highlights effective through 2012:

The estate tax exemption is increased to $5 million per person, and indexed for inflation after 2011.
The estate tax rate is decreased from 55% to 35%.
Starting in 2011, the lifetime gift exemption is reunified with the estate tax exemption and thus increased to $5 million. This does not mean you can gift $5 million without any tax ramifications. It simply means that you can gift $5 million during your life without actually paying any immediate gift tax. However, the amount used during life effectively reduces the estate tax exemption amount available to you at the time of your death. For 2010, however, the lifetime gift exemption remains at $1 million even though the estate tax exemption is $5 million for 2010.
The annual gift tax exclusion remains at $13,000, but is indexed for inflation. This amount is available for each donee of every donor and does not reduce the lifetime gift exemption amount of the donor.
The Generation Skipping Transfer Tax or “GST” Tax exemption is similarly increased to $5 million.
In addition to their own estate tax exemption, a surviving spouse may use a predeceased spouse’s unused estate tax exemption, but only for the predeceased spouse that they were last married to at the time of their own death.
The basis of an asset (other than “income in respect of decedent” assets—i.e., assets that have not yet been subject to income tax, such as retirement accounts and annuities) is adjusted to the value of the asset as of the decedent’s date of death. This has potential significant capital gains tax advantages.

But like any good ride, it seems too short and it always comes to an end. The 2011 Act is no exception. All of these new rules expire at the end of 2012. In other words, the “sunset” of the 2001 Tax Act is simply pushed back a couple of years. Starting January 1, 2013, we are slated to return to the “outdated” estate tax system as it existed a dozen years earlier.

It is critical to point out that all of these new estate tax changes are federal law changes that have no effect on the Oregon estate tax laws. Oregon’s inheritance tax exemption will remain at $1 million for 2010 and beyond. Your estate planning should take this fact into account.

And finally, the charitable ribbon on this 2011 Act gift package is the extension of the “Charitable IRA Rollover.” Although scheduled to expire at the end of 2010, Congress permitted the continuation of the Charitable IRA Rollover for 2011 only.

This provision allows individuals who are aged 70½ and older to give up to $100,000 directly to public charities from their Individual Retirement Account (IRA) without the distribution being treated as a taxable withdrawal by the individual. Such distributions can be made retroactively for 2010 if completed by the end of January 2011.

Happy New Year. Enjoy the ride.

Jeffrey G. Moore
Attorney
Saalfeld Griggs PC

Circular 230 Notice: The Internal Revenue Code Circular 230 requires a disclosure that this article is not a reliance opinion. This is not intended or written to be used, and it cannot be used, for the purpose of avoiding penalties that may be imposed on you or another taxpayer, and you should consult directly with your tax professional.