It is finally here. On December 17, 2010 the President signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act (2010 Act) which makes changes to the estate, gift and generation skipping-transfer tax laws for the next two years. The good news is the estate tax exemption has been raised from the $1,000,000 it was to become on January 1st. The bad news is the law is for only two years which makes planning difficult if you do not intend to die during the next two years.
The new law provides that from January 1, 2011 until December 31, 2012 the estate tax exemption will be $5,000,000 per person, or $10 million per couple. The estate tax rate has been reduced from 45% to 35% on amounts in excess of the exemption. The amount an individual can make as lifetime gifts is also increased to the $5,000,000 from the $1,000,000 which it has been for the past several years. The generation skipping transfer tax exemption has also increased to the $5,000,000 per person. This will allow for substantial gifting to grandchildren. The new law will allow nearly everyone in the U.S. to pass their entire estate without any federal estate taxes. States have the right to establish their own inheritance taxes. The State of California does not have an inheritance tax so each California resident can leave an estate of $5,000,000. without any estate taxes.
Part of the 2010 Act addressed the estates of those individuals who died during 2010. The prior law permitted an individual to pass unlimited amounts of assets without any estate tax. However, there would be a very limited “step-up” basis to the fair market value on the assets which would result in capital gains in a modest estate. For instance, prior to 2010 if an individual died with their primary asset as their residence having a $1,000,000 fair market value and a purchase price plus improvement (tax or cost basis) of $325,000 then the amount included as the value of the residence for their estate was $1,000,000 and the new tax basis became the $1,000,000 fair market value. If the spouse sold the residence a few years later for $1,200,000 the tax basis was $1,000,000 and the spouse had their $250,000 exclusion for the sale of the residence and no capital gains taxes were due. Without the step-up in basis the capital gains tax would have been the $1,200,000 sale price minus the original basis of $325,000, minus the $250,000 exclusion so there would be capital gains of $156,250 ($625,000 taxable amount @ 25% for federal and state combined). The 2010 Act reinstates the federal estate tax for 2010 with an exemption of $5,000,000 and the step-up in basis on assets or to elect out of the estate tax and into a modified carryover.
If you have a larger estate……..more than $5,000,000 or if you wish to plan for your grandchildren the next two years are the time to take action. There continues to be numerous reasons to implement and review your estate plan for your family, and often times our clients are NOT doing their estate plan because of estate taxes. There are other factors to keep in mind, such as the California probate process, which remains time-consuming and expensive, or naming guardians for minor children. While we wait and see how the new law is going to play out keep in mind estate taxes are just a small piece of an estate plan.