The New Estate Tax Legislation and What it Means to You!

On Friday, December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Act) into law. For 2011 and 2012, the Act effectively reinstated the estate and generation-skipping transfer (GST) taxes and fixed the federal estate tax exemption amount at $5 million per person with a maximum estate tax rate of 35 percent. The Act also increased the lifetime gift tax exemption from $1 million to $5 million, unifying the gift tax with the federal estate tax exemption. The provisions of the Act cover 2011 and 2012 only. Thus, they are only temporary and push the fate of the federal estate tax regime to be decided in 2012, a presidential election year. 

Historical Perspective:

The modern estate tax dates back to 1916, when a tax rate of 10 percent was imposed on the portion of estates in excess of $50,000.  Since then, rates and exemption amounts fluctuated, eventually reaching a high of 77 percent from 1941 – 1976 with an exemption of $60,000. 

More recently, in 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), commonly known as the “Bush tax cuts.”  EGTRRA gradually increased the applicable exclusion amount, lowered the maximum estate tax rate and repealed the estate tax completely for decedents dying in 2010. 

2009 and 2010 proved to be critical years in the estate tax regime at the federal and state levels. Specifically, for residents of Illinois, the estate tax exemption at the state level differed from the estate tax exemption at the federal level. Thus, for many residents of Illinois, this “decoupling” (divergence of the Illinois estate tax exemption and the federal estate tax exemption) may have resulted in $209,124 of Illinois estate tax at the first spouse’s death. On January 13, 2011, SB 2505 was signed into law by Governor Pat Quinn, which fixed the Illinois estate tax exemption at $2 million and effectively “decoupled” the Illinois estate tax exemption from the federal level once again.  This new legislation may result in $352,158 of Illinois estate tax at the first spouse’s death. However, the imposition of this tax can be avoided with proper planning. (See “Illinois Decoupling” discussed below.)    

Similarly, 2010 proved to be a watershed year as the federal estate tax exemption amount was unlimited. As a result, commentators joked that 2010 was a wonderful year to die. However, for many clients who died in 2010, the income tax consequences were severe as decedents were not granted the traditional “step-up in basis” for all assets. Rather, the 2010 regime required beneficiaries to take the decedent’s “carry-over basis," subject to certain exceptions. As a result, some existing trusts prevented beneficiaries from maximizing the allocation of basis and resulted in tremendous unexpected income taxes. 

New Legislation and What it Means to You

Return of the Estate Tax: The new law brings back the federal estate tax with an exemption amount of $5 million per person in 2011 (and the 2012 exemption will be indexed for inflation).  In addition, the federal estate tax rate is only 35 percent, its lowest rate since 1931.

New Rules Regarding Gift Tax:  For gifts made after December 31, 2010, the estate and gift tax exemptions will be reunified with a $5 million federal estate tax exemption, a $5 million gift exemption and a $5 million generation skipping transfer (GST) exemption.  Furthermore, for transfers made in 2011 and 2012, the gift tax rate and GST tax rate will be 35 percent. In contrast, in 2009, the federal estate tax exemption was $3.5 million and the lifetime gift exemption was only $1 million. Similarly, in 2009, the gift tax and GST tax rate were significantly higher. Therefore, the Act provides a unique opportunity for creative transfers of wealth across multiple generations.

Options for 2010 Decedents: For decedents who died in 2010, the Act allows those estates the option to either (i) apply the estate tax based on the new $5 million exemption and 35 percent estate tax maximum rate, with stepped-up basis, or (ii) apply rules under EGTRRA with no estate tax and modified carryover basis rules. Thus, the executors of estates for decedents who died in 2010 should analyze which option would maximize the transfer of wealth. 

Portability: The Act allows for “portability” between spouses of the maximum exclusion after December 31, 2010. Specifically, a surviving spouse is able to elect to take advantage of the unused portion of the federal exemption of his or her predeceased spouse, thereby providing the surviving spouse with a larger exclusion amount. However, the deceased spousal exclusion amount would only be available to the surviving spouse if an election was made on a timely filed estate tax return. However, if the surviving spouse is predeceased by more than one spouse, the exclusion amount available would be limited to the lesser of $5 million or the unused exclusion of the last deceased spouse. Furthermore, it is uncertain whether the tax regime for 2013 and beyond will allow for such portability. Clients are still encouraged to utilize traditional estate planning tools to leverage use of each spouse’s federal exemptions.

Illinois Decoupling: Illinois estate tax law has typically followed the federal law, with some exception. In 2010, when there was no federal estate tax, there was also no Illinois estate tax (that may not be the case for residents of other states, or people owning property in other states). However, as previously noted, in 2009 the state and federal exemptions “decoupled” - the Illinois estate tax exemption had been limited to $2 million per person while the federal exemption was $3.5 million. As a result, absent proper planning, an Illinois estate tax may have been due on the first spouse to die, even if no federal estate tax was due. With the recently enacted Illinois legislation, the Illinois estate tax reappears but, as was the case in 2009, with only a $2 million exemption (compared to the federal exemption of $5 million). We have developed a solution to prevent these types of unintended tax consequences by allowing the executor to make a marital deduction election as to a portion of the credit shelter trust for Illinois purposes only. For example, for decedents who die in 2011, the credit shelter trust would be fully funded with $5 million and qualify for the federal estate tax exemption amount. The executor then made an election as to assets worth $3 million in the credit shelter trust to qualify for the marital deduction only for Illinois purposes. This allows our clients to maximize the federal and Illinois exemptions without being subject to either federal or Illinois estate tax on the death of the first spouse. This “decoupling” requires some documents to be updated to allow for special marital trust planning in Illinois and provides an example of how updating your existing documents may result in $352,158 of estate tax savings. 

 Call to Action

These recently enacted laws and historical perspective provide tremendous insight on the importance for estate planning documents to have the flexibility to weather the storm of the changing tax regimes. It is critical that you have your documents reviewed to ensure they contain these tools. Similarly, other circumstances may warrant updating your documents – birth of children, grandchildren, marriage, divorce, asset protection concerns for beneficiaries, acquisition of additional assets, or new philanthropic intentions.

We would be happy to review your existing documents in light of the new laws and changes in  circumstances. Please contact us to make certain your estate plan accurately reflects your testamentary intentions and incorporates the necessary tools to maximize the transfer of wealth.

Authored by: Lindsey Paige Markus and Mitchell D. Weinstein, Attorneys at Law, Chuhak & Tecson, P.C.