Congress Brings Back Federal Estate Tax, Raises Exclusion to $5 Million, Lowers Rate to 35%
In December 2010, Congress reenacted the Federal Estate Tax (aka "Death Tax") as part of the tax legislation compromise between Congress and President Obama. This legislation is effective for only two years, set to expire on December 31, 2012.
The new law provides for an individual exclusion amount of $5 million and a tax rate of 37%. Many expected the Estate Tax to return in 2011 with a much lower exclusion level and possibly higher tax rates.
Had Congress not taken any action in December, the old Estate Tax laws would have come back into effect. The exclusion amount per person would have been just $1 million with a tax rate as high as 55%.
While many hoped that Congress would simply extend, or make permanent, the 2010 Estate Tax repeal, the provisions of the legislation provide for many planning opportunities for individuals and families.
Proper planning and consideration is now more important than ever before.
Individual Gift Tax Lifetime Exemption Raised to $5 million, Gift Tax Rate fixed at 35%
While Congress reenacted the Federal Estate Tax, it also provided for a large increase of the Federal Gift Tax Lifetime Exemption. The new lifetime exemption is $5 million.
Until now, the Federal Gift Tax was assessed against an individual (or that person's estate) if there were lifetime gifts in excess of $1 million. Gifts less than the annual gift exclusion amount were exempt.
Like the Estate Tax provisions, this increase is set to expire on December 31, 2012 unless Congress takes action by that time. If Congress fails to take action by the end of 2012, then the lifetime exemption will decrease to $1 million. The Gift Tax rate would also increase.
Families wishing to preserve significant wealth should consider taking advantage of this potential opportunity to shelter assets from Estate and Gift taxation while this lifetime exemption remains at an all time high.
New Tax Law Allows Portability of Unused Estate Tax Exclusion Among Spouses
While Congress disappointed many by not permanently repealing the Federal Estate Tax, Congress did add a new portability feature to the Estate Tax that will benefit married couples.
The new legislation provides each individual with a $5 million individual exclusion. Under prior law, if the individual did not use his or her entire exclusion amount, that unused exclusion amount was lost. Previously, the surviving spouse and the children were unable to later use that unused exclusion to shelter assets upon their later deaths.
Pursuant to the new legislation, a surviving spouse may use his or her deceased spouse's unused exclusion amount in addition to the surviving spouse's exclusion. To qualify however, certain tax elections and filings must be made upon the first spouse's death. Otherwise, this benefit is lost.
For example, if Husband and Wife's combined estate is valued at $10 million and Husband leaves everything to his wife upon Husband's death in 2011, no Federal Estate Tax is paid at the time of his death because there is an unlimited marital deduction allowing him to leave his entire estate to his wife (and vice versa) upon the first death.
Upon Wife's death, assuming Husband's estate timely filed the appropriate election, Wife's estate would pay no Federal Estate Tax estate tax on $10 million (Husband's unused $5 million exclusion + Wife's $5 million exclusion = $10 million). Without portability, Wife's estate would have to pay Estate Tax on $5 million.
This portability option is only available to married couples. It also requires proper planning and tax filings in order to maximize the tax savings.
Favorable Capital Gains Treatment Returns to Inherited Property
The December 2010 tax compromise legislation also saw the return of more favorable capital gains tax rules. Persons inheriting property from someone (as opposed to receiving it as a lifetime gift) will once again receive a "stepped-up" basis in the capital asset for purposes of capital gains tax.
This rule becomes particularly advantageous for families that may not necessarily exceed the Federal Estate Tax Exclusion amount ($5 million) but have one or more highly appreciated capital assets.
This rule applies to any capital asset: real estate, equipment, marketable securities, closely held business interests, collectibles, art, and any other capital asset.
A gift during the donor's lifetime of a capital asset will continue to be taxed at the original owner's tax basis. Therefore, very careful consideration must be given when deciding upon how to transfer a highly appreciated capital asset.
For example: Father purchased a parcel of real estate in 1975 for $25,000 and it is now worth $500,000. He desires to give it to his two children. If he gives the property to them during his lifetime, they will assume his tax cost basis in the property ($25,000). Assuming they sold the property at its current value immediately upon receiving the gift, the two children would be taxed on the capital gain of $475,000 ($500,000 less the cost basis of $25,000).
If Father instead named the two children as transfer on death beneficiaries of the real estate, and he died in 2011, the two children would receive an adjusted tax basis in the property equal to the value on the date of Father's death. Assuming the current value was $500,000 and the children immediately sold the property after Father's death for that amount, the children would not be taxed on any capital gains because their basis was adjusted at the time of Father's death.
This favorable capital gains treatment is available to all individuals. Therefore regardless of whether or not a person's estate will face any Federal Estate Tax liability, an estate plan should take advantage of the stepped up basis rules.
Highlights:
· Estate, Gift, and Generation Skipping Transfer taxes are all unified with a $5 million lifetime exclusion and rate of 35%
· Unused exclusion amounts are portable among spouses
· Return of favorable stepped-up basis for capital gains
· 2011 Gift Tax Annual Exclusion $13,000 per individual
· Direct payments of beneficiary's tuition and medical expenses still exempt from Federal Gift Tax
