The Investment Scientist

The 2011 Estate Tax Changes

Posted on: March 21, 2011

[Guest Post by Christopher Guest] I guess I was slightly off on my prediction on what the 2011 estate tax environment would look like. On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, or TRUIRJCA, but I will call it the “tax compromise.” One thing I will discuss is that this estate tax regime only exists for 2011 and 2012 and the “old” 2011 rules that had many people indecisive in 2009 and 2010 returns in 2013.

Exemption Level and Rate

Since 2001, the federal estate tax exemption level has risen while the tax rate has dropped to the point where there was no federal estate tax in 2010. Without the tax compromise, the federal estate tax would have returned in 2011 with a federal estate tax exemption of approximately $1.0 million with a top end tax rate of fifty-five percent (55%). The tax compromise followed most of the “Lincoln/Kyl proposal” I described in my September Newsletter. The federal estate tax exemption level will be $5.0 million per person with a tax rate of thirty-five percent (35%) on estate assets above that level. The exemption level will rise with inflation. Many states have their own state estate tax that were not impacted by the tax compromise.

Click to get The Informed Investor: 5 Key Concepts for Financial Success.

Gift Tax Re-Unified with Estate Tax

When Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) was passed in 2001, the gift tax exemption levels were split from the estate tax exemption levels. While the estate tax exemption level eventually rose to $3.5 million and 45% rate, the lifetime gift tax exclusion remained at $1.0 million with a tax rate equal to the givers income tax rate and topping out at rate of thirty-five percent (35%). In other words, depending on a person’s financial situation people, under EGTRRA, it made economic sense for some to give gifts in excess of $1.0 million but for others it didn’t. The tax compromise changes that calculation and re-unifies the gift tax, generation skipping transfer (“GST”) tax 1 and estate tax. For 2011 and 2012, the gift tax exemption level is the same as the federal estate tax level of $5.0 million and with a tax rate of thirty-five percent (35%) for gifts above that amount.

Portability

While there has been talk about it in the past, one of the items in the tax compromise that shocked many estate planners was the applicability of portability between spouses of assets with respect to the federal estate tax exemption. For example, if Husband A dies using up only $2.5 million of their federal estate tax exemption, then the Wife has a $7.5 million exemption on the remaining assets – the wife’s $5.0 million exemption plus the remaining $2.5 million exemption from Husband A. This means a married couple can have $10 million in assets exempted from the federal estate tax.

There are a couple of caveats. First, an estate tax return must be filed with an election with the IRS to “preserve” the portability. Second, if the surviving spouse gets remarried and the second spouse dies prior to the surviving spouse then the surviving spouse will get the federal exemption level of the second dying spouse. From the above example, if Wife remarries to Husband B and Husband B dies before Wife and uses up $4.0 million of his federal estate tax exemption then Wife only has $6.0 million as portable because the exemption is keyed off of the amount of the federal exemption used by the last spouse.

In reality, portability has codified what many people already do in their estate planning by creating what are known as A/B trusts or “credit” shelter trusts though portability is not as flexible as a trust.

Click to get The Informed Investor: 5 Key Concepts for Financial Success.

What about 2010?

The tax compromise also impacted the non-existent estate tax of 2010. As I described in my May Newsletter, people inheriting property from a decedent dying in 2010 lost their step up in basis in the inherited assets for capital gains tax purposes. The tax compromise offers a choice for those dying in 2010:

  1. No estate tax, with modified carryover basis for inherited assets (the EGTRRA 2010 rule), or
  2. The estate tax in effect for 2011, with step-up in basis for inherited assets.

This allows a personal representative the option of selecting the estate tax system that provides a lower tax bill. For example, the Steinbrenner’s are going to choice option 1 because the carryover basis doesn’t occur until a sale. But, someone with $4 million estate comprised of assets with large capital gains, like a home owned for a long time, will choose option 2.

Only for Two Years

That’s right. All the politicians just kicked the estate tax can down the road for two more years. The entire estate tax regime only lasts for 2011 and 2012, and the entire tax world will be right back to the same level of uncertainty in the fall of 2012. With a Presidential election in 2012, I can’t foresee anything hindering the ability to resolve this, do you? I hope your sarcasm meter was on for the last sentence.

Regardless of the future, at least some direction is provided for people to plan their estate.

Click to get The Informed Investor: 5 Key Concepts for Financial Success.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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