Federal Estate, Gift, and GST Tax Update: A New York Perspective

On Dec.17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Act”).

The 2010 Act extends the sunset provisions of certain of the “Bush tax cuts” for two years, through 2012. In addition, the 2010 Act makes significant changes to the federal estate, gift, and generation-skipping transfer (GST) taxes for calendar years 2011 and 2012 and makes some changes to the federal estate tax for estates of decedents who died in 2010.

This advisory addresses the significant provisions of the 2010 Act, covers some important planning considerations, and provides a section focusing on estate tax issues in New York state.

Federal estate tax

During 2011 and 2012, the federal estate tax rate will be 35 percent and the federal estate tax exemption amount will be $5 million per decedent. Starting in 2012, the exemption amount will be indexed for inflation.

Federal gift tax

During 2011 and 2012, the federal gift tax rate will be 35 percent. The gift tax exemption amount will be $5 million per donor for gifts made during 2011 and 2012. This is a significant increase compared with present law.

GST tax

During 2011 and 2012, the federal GST tax rate will be 35 percent. The federal GST exemption amount will be $5 million per transferor.

Portable estate tax exemption

For calendar years 2011 and 2012, estates may elect to allow a decedent’s surviving spouse to use the first spouse’s unused federal estate tax exemption amount. Thus, a surviving spouse would have his or her own exemption plus the deceased spouse’s previously unused exemption amount.

Federal estate tax treatment of 2010 estates

For decedents dying in 2010, the estate will have the option to either (1) pay federal estate tax at a rate of 35 percent with an estate tax exemption of $5 million and receive a stepped up income tax basis on estate assets, or (2) pay no federal estate tax, but accept, for income tax purposes, the carryover basis rules which have been in effect in 2010.

The following table shows the federal estate, gift, and GST tax rates and exemption amounts under the 2010 Act:

*Based on an election available to an estate to use alternate carry-over basis rules.

Planning

The 2010 Act creates significant lifetime gifting opportunities during 2011 and 2012. An individual may, during 2011 and 2012, transfer assets with a fair market value of up to $5 million free of federal gift tax during his or her lifetime. For a married couple, each spouse has a gift tax exemption of $5 million or a total of $10 million. This exemption is in addition to the annual gift tax exclusion ($13,000 per recipient) and the exclusion for special gifts for medical and educational purposes. In addition, the exemption portability provision may also add planning opportunities for married couples.

A lifetime gift provides an additional estate planning advantage in that (1) the gifted asset has been removed from the donor’s estate, together with (2) all future appreciation in the value of that asset after the date of the gift.

It is important to note that these exemption and tax rate changes of the 2010 Act discussed above apply only to calendar years 2011 and 2012. After 2012 and absent further legislative action, federal estate, gift, and GST rates and exemption amounts are scheduled to return to 2001 levels. In addition, the portability provision of the 2010 Act will not be effective beyond 2012 without further legislative action.

New York state estate tax issues

The relationship between federal and state estate taxes is important to consider. For New York state residents, the New York estate tax rates and exemption have not changed. New York allows an estate tax exemption of $1 million. So an estate which is otherwise sheltered in whole or in part by a federal exemption of $5 million may incur a relatively significant New York estate tax, as illustrated below:

Since New York does not have a gift tax, lifetime gift transfers, which are otherwise sheltered by the federal gift tax exemption ($5 million or less), may be advisable.

The states of Connecticut and New Jersey also allow an estate/inheritance tax exemption, which is not as large as the federal amount. Therefore, in some cases, planning for smaller estates may focus on techniques to avoid the state estate tax.

Conclusion

Clients should consider the 2010 Act and its impact on their own estate planning structure. Many clients will need to review and perhaps revise their wills, trusts, and related documents in light of these changes.

In particular, any person whose will contains an estate tax exemption “formula” provision (sometimes referred to as a “credit shelter” or “bypass” trust) should arrange for a review of his or her documents, because an unintended or costly division of the estate assets may otherwise occur.

Please contact your Davis Wright Tremaine estate planner to discuss these matters.