2010 Tax Act—How it Affects Estate and Gift Taxes

The Federal government enacted a new tax act at the end of December 2010. This is an important law in many ways. It extends the 2001 and 2003 income tax “cuts” until the end of 2012. It also made some significant changes to the estate and gift tax laws.

The very good news is that almost all of the estate and gift tax changes are favorable. However, these changes are only temporary and will expire at the end of 2012 unless Congress enacts other legislation. Because relying on the Congress to do the “right” thing is risky, we think it unwise for clients to plan for the long run based upon these temporary law changes. Nonetheless, these changes suggest that all clients review their estate plans. Also, the temporary changes provide significant planning opportunities.

In 2001 the federal estate tax exemption amount was $675,000, increasing over time so that by 2009 the exemption amount was $3,500,000. In 2010 there was no federal estate tax. Absent action by Congress, the exemption amount would have been $1,000,000 in 2011 and future years. The 2010 Act set the estate tax exemption at $5,000,000, but again only for 2011 and 2012. Under the law as written, this exemption will drop to $1,000,000 after 2012. These differences in exemption amounts can have a significant impact on your estate plan. In order to maximize the federal estate tax exemption and minimize federal estate tax, many clients have used estate plans with a “Trust B” configuration, or what is also sometimes referred to as a “Credit Shelter Trust” or “Family Trust.” The trade off is that the Trust B arrangement can reduce the amount of assets that the surviving spouse receives outright. Given the changes to the federal estate tax, it would be wise for clients to consider whether the “Trust B” arrangement is still appropriate or should be eliminated or modified.

The 2010 Act allows a surviving spouse to inherit the unused estate tax exemption of the first spouse to die – so-called “portability” of unused tax exemptions. Some articles in the popular press have contended that this opportunity simplifies estate tax for all but the most wealthy of Americans. That simply is not true. The law that allows for the portability of the exemption for use by the surviving spouse expires at the end of 2012. So relying on it may not be warranted.

Further complicating matters is the fact that although the federal estate tax is affecting fewer people, Indiana still has an inheritance tax which operates separately from the federal estate tax. Although under Indiana law a person can leave an unlimited amount of assets to their spouse without incurring Indiana inheritance tax, once the surviving spouse passes away, there is only a $100,000 Indiana inheritance tax exemption per child or other descendant. As a result of the changes to the federal estate tax and the continued presence of the Indiana inheritance tax, your estate planning documents should be reviewed to ensure that they reflect your wishes no matter what the estate exemptions are.

In addition to the estate tax exemption amount, the 2010 Act made significant changes to the gift tax exemption amount. Even though the estate tax exemption amount increased over time to $3,500,000 by 2009, the amount of money that a person could gift during their lifetime remained at $1,000,000. The 2010 Act increased the gift tax exemption amount to $5,000,000 as well, but again only for 2011 and 2012. We think that it is appropriate for clients to consider using their increased gift tax exemptions soon. Obviously, for many people, a lifetime gift of $5,000,000 is much too large. However, a smaller gift using a part of the larger exemption may be wise to consider.

Another significant development relates to the estate, gift and Generation Skipping Transfer (GST) tax rates. The top estate, gift and GST tax rates will be only 35% for this year and next year. Beginning after 2012, the rates are scheduled to increase to 55% (and 60% for some). The effective rate of estate and GST taxes also can result in significant changes in what each of your family members receives. We think it is appropriate for you to review your plans for the disposition of your property whether the rates of tax are very high or not.

Finally, we oftentimes focus on tax issues involving estate planning. Estate planning is more than just about taxes. Among other things, it also involves making sure that your loved ones are provided for, that any special needs or circumstances of your loved ones are considered and that any charitable intent that you have is carried out. As such, even if the estate tax is not an issue for you, other circumstances may have changed such that your estate planning documents should be reviewed.

Our estate planning services are designed for the orderly transfer of wealth, taking into consideration each client's individual goals and circumstances. We stay current on changing tax laws and techniques to best accomplish a client's objectives. For assistance in Estate Planning matters, please contact John Hegeman, Mark Samila, Allison Comstock or Alan Shovers at 812.423.3183.

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