What Impact Will the Recent Tax Legislation Have on Your Estate Plan?

Private Clients, Trusts and Estates Update

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The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “TRA 2010”), which President Obama signed on December 17, 2010, may have a significant impact on your current estate planning. The TRA 2010 clarifies the estate, gift and generation-skipping transfer (“GST”) tax rules for 2010 and makes important changes to those tax rules for 2011 and 2012. The changes enacted in the TRA 2010 include the following:

  • 2010 Estates. Congress provided an option for the estates of decedents dying in 2010. The federal estate and GST taxes are reinstated and applied retroactively to January 1, 2010, and the rules for the traditional step up in basis of assets (to fair market value at the time of death) will apply. Congress has generously allowed an estate exclusion of $5,000,000 and tax rate of 35%, rather than the exclusion of $3,500,000 and rate of 45% which applied in 2009. However, an election may be made by the estates of decedents dying in 2010 to avoid the application of the estate tax to those estates, but then to subject those estates to the carryover basis regime which applied in 2010 prior to Congress’s recent action. This election out of estate tax will be advantageous for larger estates (such as that of George Steinbrenner) of decedents dying during 2010. The time for filing estate and GST tax returns and paying estate and GST taxes without penalties is extended to no less than nine months after the date of enactment. The time for filing disclaimers is similarly extended. The legislation is not clear on how the election out of estate taxes is actually to be made, and further guidance from the IRS will be required.
  • 2011/2012 Estates. For decedents dying in 2011 and 2012, the estate exclusion and GST tax exemption will continue to be $5,000,000 and the tax rate will be 35%. The exclusion amount will be indexed for inflation beginning in 2012.
  • Portability. In a new development, the exclusion will be “portable” between spouses, which means that any exclusion not used at the death of the first spouse will be available to augment the exclusion for the surviving spouse. However, portability applies only to the last deceased spouse’s exclusion, so that if a widow remarries but survives her second husband, she is entitled to claim any unused exclusion only from the estate of the second husband. Interestingly, the GST exemption is not portable between spouses. For this and a number of other reasons, it is more advantageous to fund a trust at the first spouse’s death using the deceased spouse’s exclusion than to rely on portability.
  • Lifetime Gifts. The gift tax exclusion also increases to $5,000,000 for gifts made in 2011 and 2012. Previously, the lifetime exclusion for gifts was only $1,000,000. This significant increase in the amount of lifetime gifts that can be made (along with the increase in the GST exemption) will permit you to make additional lifetime gifts without paying gift tax. Because the increased exclusion sunsets in 2013 and it is uncertain whether it will be extended, many clients should plan to use the increased exclusion over the next two years.
  • Impact on Estate Planning Documents. The increases in the estate tax exclusion and the GST exemption may change the amount distributed to certain trusts or beneficiaries to the extent such gifts are tied to the exclusion or exemption amount.
  • Income Tax Rates. The TRA 2010 also extended through 2012 the current income tax rates, which were scheduled to expire at the end of 2010, including the top rate of 15% on capital gains and qualified dividends.
  • IRA Distributions to Charity. Moreover, IRA owners over the age of 70½ will continue to be able to pay up to $100,000 from their IRAs in 2010 and 2011 to qualified charitable organizations without taking the charitable distributions into income (although no charitable deduction is allowed either). And such IRA distributions can be used to satisfy the IRA owner’s minimum distribution requirements. A special rule permits charitable distributions for 2010 to be made in January 2011.
  • GRATs. It was widely anticipated that Congress would impose a minimum term limitation of ten years on Grantor Retained Annuity Trusts (GRATs) as part of any comprehensive tax bill, but that did not happen in the final legislation. Because such legislation would be a “revenue raiser,” it likely will appear in future legislation. Thus this might be a last “window of opportunity” to establish short-term GRATs.
  • State Death Taxes. Similarly, the legislation retains a deduction for state estate and inheritance taxes paid at death, rather than reinstating the credit for state estate and inheritance taxes (which credit would have reinstated estate taxes in many states). For example, the Illinois estate tax after 2009 would apply only if there is a federal credit for state death taxes. Thus under current Illinois law, the TRA 2010 results in no Illinois estate tax. The TRA 2010 has no impact on New York estate tax; New York will continue to impose an estate tax equal to the former federal credit for state estate and inheritance taxes.
  • Stay Tuned. The changes made by the TRA 2010 to the estate, gift, GST and income taxes are effective only for two years. If Congress fails to act by the end of 2012, the tax rules effective prior to 2001 will then control. The debate over taxes will undoubtedly be a central issue in the general election of 2012.

The foregoing discussion is intended only as a broad summary of the TRA 2010 and not as legal advice on any particular client situation. As the old adage goes, “the devil is in the details” many of which will await the publication of IRS guidance or Regulations.

Private Clients, Trusts and Estates Practice of Sidley Austin LLP

Sidley Austin LLP’s Private Clients, Trusts & Estates lawyers provide comprehensive tax and estate planning advice to individuals, fiduciary counsel to banks, trust companies and financial services institutions, and advice to charitable entities. We draw on the resources of the firm’s tax, corporate, real estate and litigation lawyers to provide customized, cost-effective legal services to our individual clients.

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This Sidley update has been prepared by Sidley Austin LLP for informational purposes only and does not constitute legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers.

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