Walter | Haverfield LLP
Client Alert from the Federal, State and Local Tax Law Group - March 2011

2010 Tax Relief Act Changes Impacting Estate Planning

By Christy Corrao

On December 17, 2010, President Obama signed "The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010" ("The Tax Relief Act"). All of the amendments of the Internal Revenue Code ("Code") discussed below will sunset in two years on December 31, 2012.

Estate Tax, Gift Tax and Generation Skipping Transfer Tax

The Tax Relief Act retroactively reinstates the estate tax for 2010. Thus, the carryover basis regime that previously applied for 2010 is no longer applicable, unless otherwise elected (as described below). The exemption is $5,000,000 (indexed for inflation using 2010 as the base year, beginning in 2012) with a maximum tax rate of 35%. The estate tax is set to return to a 55% tax rate on taxable transfers in excess of $1,000,000 after 2012 unless further legislation provides otherwise.

The gift tax exemption remains at $1,000,000 for 2010. However on January 1, 2011, the gift tax exemption is reunified with the estate tax exemption and increases to $5,000,000. The gift tax rate for 2010 through 2012 is 35%.

With the return of the estate tax, the Tax Relief Act repeals Code Section 2511(c) which provided that, unless otherwise provided in the Treasury Regulations, post-2009 transfers to a trust that was not a wholly-owned grantor trust, were gifts. Because a transfer to a trust can be complete for income tax purposes but incomplete for gift tax purposes (as the grantor had retained certain powers), higher income taxpayers would have been able to avoid gift tax and shift income tax liability to lower bracket taxpayers, and the repeal of the estate tax created incentive to do so. Code Section 2511(c) was enacted as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") repeal of the estate tax to avoid this income-shifting. The repeal of Code Section 2511(c) is retroactive so it is effective for gifts made after December 31, 2009.

The Tax Relief Act also did not make any changes to the grantor retained annuity trust ("GRAT"). Earlier proposals included prohibiting GRATs with terms shorter than 10-years. This was designed to prevent a technique known as the "Rolling GRAT." This change may still appear in future proposals.

The Generation Skipping Transfer Tax ("GST") has been retroactively re-enacted for 2010 so transfers made by gift or from estates in 2010 are subject to all the GST rules that previously existed. For transfers after December 31, 2009, the GST exemption will be $5,000,000. This increased GST exemption can be allocated to transfers made in 2010, 2011 or 2012. Although the GST has been retroactively reinstated, those who made GST transfers in 2010 are not penalized as the Tax Relief Act provides that the GST tax rate for 2010 is zero. For 2011 and 2012, the GST tax rate is 35%.

Portability of Unused Exemption Between Spouses

The Tax Relief Act also offers portability of the estate tax exemption between spouses if the first spouse to die does not use all of his or her exemption. The "deceased spouse's unused exclusion amount" is available for the surviving spouse to use in addition to the surviving spouse's exclusion but only if an election is made on a timely filed (including extensions) estate tax return of the predeceased spouse, regardless of whether the predeceased spouse is otherwise required to file an estate tax return.

"Deceased spouse's unused exclusion amount" is defined as the lesser of: (i) $5,000,000; or (ii) the unused exclusion of the last deceased spouse over such spouse's taxable estate. Therefore, a surviving spouse cannot combine unused exemptions from multiple deceased spouses. This limitation can be illustrated by the following examples:

Example 1: Assume that Husband 1 dies in 2011 having made no taxable gifts and with a taxable estate of $2,000,000. Wife (who has also made no taxable gifts) makes a timely election to use Husband 1's deceased spousal unused exclusion amount which is $3,000,000. Thereafter, her applicable exclusion is $8,000,000 (the $5,000,000 available to her, plus the $3,000,000 unused by her deceased spouse) which she may use for lifetime gifts and transfers at death.

Example 2: Assume the same facts as Example 1, except that Wife remarries Husband 2. Husband 2 also predeceases Wife, having made no lifetime gifts with a taxable estate of $4,000,000. Wife makes a timely election on Husband 2's estate tax return. While, the combined unused exclusions of Husband 1 and Husband 2 are $4,000,000, the Wife may only use $1,000,000 (the unused exclusion of Husband 2). The election with respect to Husband 2 trumps the election previously made with respect to Husband 1.

Example 3: Assume the same facts as Example 1 and 2, except that Wife predeceases Husband 2. She dies with a taxable estate of $4,000,000 having made no lifetime taxable gifts. Thus, her deceased spouse unused exclusion is $4,000,000, calculated by the lesser of: (i) $5,000,000; or (ii) her $8,000,000 applicable exclusion amount less her taxable estate of $4,000,000. Husband 2 may make an election on her estate return to use her deceased spouse's unused exclusion of $4,000,000.

Example 4: Assume the same facts as Example 3, except that Wife has a taxable estate of $2,000,000. Her deceased spouse unused exclusion is $5,000,000, calculated by the lesser of: (i) $5,000,000; or (ii) her $8,000,000 applicable exclusion amount less her taxable estate of $2,000,000. Husband 2 may make an election on her estate return to use deceased spouse's unused exclusion of $5,000,000.

Portability applies only where the predeceased spouse dies after December 31, 2010 and only to the unified credit exemption equivalent and not the generation-skipping tax exemption.

Portability is helpful for those couples who have neglected to plan their estates or have reasons to not split assets between the spouses. For those couples with estates of ten million or less, portability makes it unnecessary for spouses to use credit shelter trusts solely to preserve federal exemption amounts. Before portability, couples typically took advantage of both exemptions by using credit shelter trusts. A credit shelter trust works by funding a family trust up to the exemption amount at the death of the first spouse. The trust distributes income and principal to the survivor or sometimes to other family members or both. At the death of the surviving spouse, the family trust passes the remaining principal to the family. Because the family trust is covered by the exemption amount, it is not taxed when the first spouse dies. It is also not considered part of the survivor's estate so it is not subject to tax when the survivor dies.

However, this does not mean that the use of credit shelter trusts is now obsolete for couples with smaller estates. First, portability only applies to deaths in 2011 and 2012 so unless it is made permanent, many will not be able to take advantage of it. Second, while a married couple can exempt up to $10,000,000 of estate and gift transfers, a couple relying on portability can only exempt $5,000,000 on death from the GST unless the GST exemption is used during their lifetimes. Third, if a couple lives in a state with an estate tax, failure to plan and take full advantage of state exemptions may subject a couple to unnecessary state estate taxes. This is particularly true in Ohio which has a stand-alone estate tax and a quirk in the law known as the Life Estate Marital Deduction. Another consideration is that having assets in a credit shelter trust ensures that the assets plus any appreciation of those assets held in the family trust will not be included in the spouse's estate. Leaving such assets outright will subject the appreciation of those assets to estate tax for the heirs of the survivor. There are also many other non-tax reasons for planning with trusts that should also be considered, such as asset protection, ability to control disposition of assets after death, and probate avoidance.

Modification to Account for Difference in Tax Rates

The Tax Relief Act also clarifies the rules on the computation of estate and gift taxes to reflect differences in the unified credit resulting from different tax rates. It provides that, for purposes of computing the estate tax with respect to gifts, the tax rates in effect at the time of a decedent's death, instead of the rates applicable at the time of such gifts, will be used to compute both the (i) gift tax imposed with respect to the gifts; and (ii) gift tax unified credit calculated under Code Section 2505, (both the applicable credit for the current year and the amounts allowed as a credit for the preceding periods). Previously, the tentative estate tax was reduced by the total gift tax that would have been payable with respect to gifts made by a decedent if the rate schedule in effect at the time of death had been applicable at the time of gifts. However, the unified credit used to compute the gift tax payable was the unified credit that would have been available in the year of the gift. If the gift tax rates decreased, as they did in 2010, certain donors would not have full use of the unified credit exemption equivalent.

While (i) above restates the law as it was previously in effect, (ii) is a change to Code Section 2505 that fixes prior law which affected those who had made gifts before 2010 that were subject to a rate higher than 35% (gifts over $500,000). In 2009, the credit against gift tax was $345,800 but in 2010 the same donor only had $330,800 of credit available in order to exempt $1,000,000 from gift tax. If a donor made $750,000 of gifts in 2009, he would use $248,300 of his $345,800 credit. However, if he wanted to make another $250,000 of gifts in 2010, he would only have a remaining credit of $82,500. This credit at a 35% rate only protects about $235,700 from gift tax. The change in rates would not allow a donor to exempt a full one million from gift tax. The amended Code ยง2505 now provides that the amount of credit available for the 2009 gift is calculated using 2010 rates. In the prior example, the gift of $750,000 would have only used a credit of $243,300 so the remaining credit for 2010 is $87,500 which exempts $250,000 from gift tax.

While this change prevents any disadvantage to a taxpayer for making prior gifts at higher rates, it will also prevent a taxpayer from receiving any windfall if rates increase. It applies to gifts, generation skipping transfers and estates of decedents dying after December 31, 2009.

Extension of Certain Filing Deadlines

The Tax Relief Act provides additional time for Personal Representatives/Executors and Trustees of estates of persons dying after December 31, 2009 and before the enactment of the Tax Relief Act to make certain elections and file certain returns. The due date for: (i) filing an estate tax return; (ii) making the payment of estate tax; (iii) filing disclaimers under Code Section 2518(b); and (iv) any return required for a generation skipping transfer is not earlier than the date which is nine months after the date of the enactment of the Tax Relief Act (December 17, 2010). This extension may not be very helpful, as most states have their own deadlines for filing estate tax returns and making disclaimers. Disclaimers can be especially problematic because, generally, disclaimers are only valid for federal gift and estate tax purposes if they are valid under local law. However, if the disclaimer satisfies the requirements of Code Section 2518(b), it can be a qualified disclaimer even if it fails to satisfy local law. Therefore, it is possible for clients to make qualified disclaimers for federal estate and gift tax purposes even if they are beyond the deadline for making the disclaimer under local law. States may also adopt remedial legislation so that their filing deadlines track the federal filing deadlines.

Election for Those Dying in 2010

For decedents who died during 2010, the Personal Representative/Executor of the estate may make an election to apply the Code as if the Tax Relief Act had not been enacted. Thus, instead of the rules described above, the prior law (modified carryover basis) may be applied. The timing and manner of the election will be determined by the Secretary of the Treasury. It is revocable only with the consent of the Secretary of the Treasury. The election has no effect on the GST.

The prior law (which may be utilized in 2010 by election of the executor) provided for a modified carryover basis regime under Code Section 1022. Under the carryover basis rules, a recipient of property acquired from a decedent at the decedent's death would receive a basis equal to the lesser of: (i) the decedent's basis in the property; or (ii) the fair market value of the property on the date of the death. The regime also allows for certain limited increases in basis. An executor of a decedent's estate may allocate an aggregate increase to the basis in assets owned by the decedent and acquired by beneficiaries at death up to $1,300,000. The $1,300,000 can be increased by the amount of unused capital losses, net operating losses, and other built-in losses under Code Section 165 on the decedent's personal tax return for the year of death. In addition to this basis increase, the basis of property transferred to a surviving spouse may have an aggregate basis increase of an additional $3,000,000. The surviving spouse basis increase applies to outright transfers to the surviving spouse and qualified terminable interest property (QTIP). For purposes of Code Section 1022, QTIP has a similar meaning as QTIP for purposes of the determining the marital deduction under Code Section 2056.

This means that Personal Representatives/Executors can choose whether the estate/trust is: (i) subject to the estate tax and receive a full step-up (or step-down) in basis; or (ii) subject to a carryover basis for the decedent's assets (subject to a limited amount of step-up), whichever the Personal Representatives/Executors deem most beneficial. Generally, if the estate is less than $5,000,000, it would probably be beneficial not to make the election because there is no estate tax and no limitation on the amount of basis step-up. But if some assets have gone down in value, the answer is less clear.

EGTRRA Sunset Provisions

EGTRRA made the following additional changes to the estate, gift and GST taxes:

  1. repealed the state death tax credit for estates of decedents dying after 2004 (the state death tax credit was phased out by EGTRRA for estates of decedents dying in 2002, 2003, or 2004) and replaced it with a deduction for state death taxes;
  2. for purposes of the GST rules provided that:
    1. GST exemption will be allocated automatically to indirect skip transfers made during life;
    2. a retroactive allocation of the GST exemption may be made when there is an unnatural order of death, depending upon the circumstances;
    3. a trust that is only partially subject to GST tax can be treated as separate trusts for purposes of GST if it is severed in a "qualified severance"
    4. provided that a taxpayer demonstrating substantial compliance with the requirements for allocating the GST exemption will suffice to establish that the GST exemption was allocated to a particular transfer or a particular trust to produce the lowest possible inclusion ratio;
    5. the value of the property, for purposes of determining the inclusion ratio, is its finally determined gift or estate tax value, depending on the circumstances of the transfer but only in the case of timely and automatic allocations of the GST exemption; and
    6. granted extensions of time to make the election to allocate the GST exemption.
  3. for purposes of the installment payment of the estate tax attributable to a closely-held business interest:
    1. increased the allowable number of partners in a partnership and shareholders in a corporation that may be treated as a closely-held business from 15 to 45 partners/shareholders;
    2. provided that an estate with an interest in certain lending and finance businesses can be eligible for installment payments; and
    3. provided that, to qualify for installment payments, the stock of holding companies must be non-readily-tradable (this is not applicable to operating subsidiaries).
  4. repealed the qualified family-owned business interest deduction for estates of decedents dying after 2003; and
  5. expanded the availability of the estate tax exclusion for qualified conservation easements.

The EGTRRA sunset provision provided that all of the changes listed above would not apply after 2010. However, the Tax Relief Act extends the sunset provisions to the end of 2012. Thus, the above-listed continue to apply until December 31, 2012. Without any further legislation, they will no longer apply after 2012.

Planning Considerations and Quirks

While it is true that the increased unified credit exemption equivalent is said to be temporary (through the year 2012), it is our view that it is highly unlikely that the government will reduce it in the future. Here is an example of why doing so would create difficulties.

Example: Assume that it in 2013 the unified credit exemption is reduced from $5,000,000 to $2,000,000 and the estate and gift tax rate is 50%. Assume also that in 2012 a wealthy individual with a $7,000,000 estate gave $5,000,000 to his children leaving him with $2,000,000. The $5,000,000 was shielded by the $5,000,000 lifetime credit equivalent and no gift tax was paid. If the exemption is reduced to $2,000,000, then when the individual dies owning $2,000,000 the taxable estate would be $5,000,000 because the $2,000,000 would be supplemented by the $3,000,000 reduction in the unified credit exemption equivalent. At a 50% tax rate, the estate tax would be $2,500,000. The full brunt of that estate tax would be paid by the remaining ungifted estate which has only $2,000,000 and therefore there is no estate to pass to the beneficiaries. In fact, the estate is insolvent by $500,000. If it was the intent of the grantor to make a lifetime gift to one child and a gift at death to another child that result would not be accomplished. The child receiving the earlier gift will not bear any portion of the transfer tax and the child or children receiving the bequest at death will pay all of it. The government would not get all of its taxes because there is no transferee liability to the earlier gift recipient.

Another question arises as to whether the tax rate will change from the present 35% to something higher. It is unclear at this time whether if you make a gift currently and actually incur gift tax at 35%, if when you die the rate at that time applies to the prior gift. Again nothing is certain but there is a possibility that a gift made prior to death that incurs a gift tax at 35% will escape higher rates if they are changed at a later time. In addition, for wealthy individuals who know that there will be an estate tax applicable to them upon their death, paying gift tax early even if they do not get the benefit of the lower tax rate, will generally always be advantageous if the gift tax is payable more than three years prior to death. The reason is that the gift tax is removed from the estate of the decedent and so the estate escapes tax on the gift tax as well as on the appreciation on the gift tax. While it is hard to think of parting with gift tax early, in almost every case, it will turn out to be an advantage.

The portability provisions described above also create some interesting planning quirks and opportunities. Each spouse has a $5,000,000 lifetime unified credit exemption equivalent. And if an individual is married to someone who has less than $5,000,000 and that person dies after 2009, their unused credit is available to the surviving spouse and that credit is available for lifetime gifts. So if an individual with a $20,000,000 estate is married to someone with no assets and the poorer spouse dies first, the decedent's $5,000,000 of unused credit exemption equivalent is added to the exemption of the surviving spouse making the surviving spouse's exemption equivalent $10,000,000. The surviving wealthy spouse could then make a gift during lifetime of $10,000,000 without incurring a gift tax. That person could then remarry, transfer $5,000,000 to the new spouse and have the new spouse make an additional gift of $5,000,000 on their behalf. If that marriage does not work out, the wealthy spouse who is now divorced could remarry someone with no assets and gift away the remaining $5,000,000 by making a gift to the third spouse who then makes a gift on their behalf. It is highly unlikely that individuals will marry successively merely to take advantage of the transfer tax benefits but stranger things have happened.

In addition, an individual who has survived his spouse who died after 2009 and has added the deceased spouse's unified credit exemption equivalent to their unified credit exemption equivalent may not wish to make lifetime gifts. If not, they can make these transfers at death but if they remarry someone who has wealth and that person predeceases that individual, the prior unused credit of the poor first spouse is lost. This may cause wealthy individuals to not remarry later in life when they may otherwise wish to do so. The old adage that second time you marry for money may no longer be true.

What does this mean for your estate documents?

The new law does not change the fundamental structure of the estate tax. Therefore, old documents that have either formula clauses forcing the credit shelter amount into the family trust or our Clayton QTIP type documents which permit the surviving spouse to elect how much will go to the family and marital trust after the death of the first spouse, are unaffected. However, there may be situations such as second marriages where there are children of different marriages or even in first marriages where there is a desire on the first death to benefit children before the second spouse dies, that should be looked at again. If this is your situation you should call your attorney at our firm to discuss. Some documents are written such that the credit shelter amount goes to the children on the first death the remainder goes to the marital trust for the surviving spouse. When the credit shelter amount was lower than the current $5,000,000, an estate may have been large enough to accommodate both the children's gift and the surviving spouse's living requirements. Now that the exemption has risen to $5,000,000, and because the economy has suffered some in the recent past, these numbers may have changed.

In addition, where there are children of a prior marriage and possibly where there is a prenuptial agreement, there may be a plan to send the credit shelter amount to the children of the first marriage and provide the rest to the surviving spouse. Again the considerations are about the same and the surviving spouse could conceivably be disinherited or given a very low amount in the marital trust. Typically there is some sort of formula that prevents this from happening but it still bears looking at it again.

Many of our trust documents are written with powers of appointment such that under the prior law where a first spouse to die did not have enough assets to fund the credit shelter their trust would grab assets from the survivor's trust to use that credit shelter amount. These powers still have applicability and may in fact be an advantage under the new law but, the need in most cases to use this power of appointment or to try to equalize the estates of spouses in order to make sure that the unified credit is not wasted, has become either unimportant or less important.


The new law presents many new planning opportunities for wealthy individuals and if you are in that situation you should spend some time talking to us. There is probably no immediate need to make major changes to documents unless there are other life changes or financial changes that have occurred that may bear looking again.

The information in this Client Alert is a summary of often complex legal issues and may not cover all of the "fine points" of a specific situation or court jurisdiction. Accordingly, it is not intended to be legal advice, which should always be obtained in consultation with an attorney. The lawyers in Walter & Haverfield's Federal, State and Local Tax Law Group will be pleased to assist with any questions about this new development in the law.


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