Estate & Gift Changes in the 2010 Tax Relief Act

(Last Updated On: January 24, 2017)

The 2010 Tax Relief Act (“the Act”) was signed into law in December of 2010.  Before the new law, there was no estate tax for 2010, but some beneficiaries could have faced higher taxes because there were less favorable income tax basis rules.

For example, heirs might face increased capital gains when they sold inherited assets.  Before the Act, estate and other transfer taxes were scheduled to rise substantially for post-2010 transfers.

Overview.  The Act provides temporary relief.  It reduces estate, gift and generation-skipping transfer (GST) taxes for 2011 and 2012.  It preserves estate tax repeal for 2010, but in a roundabout way:  estates wanting zero estate tax for 2010 must elect that option, along with the less favorable carryover basis rules that were set to apply for 2010.  Otherwise, by default, the estate tax is revived for 2010, but with a higher exemption and lower tax rate than heretofore, with a full step-up in basis.  Also, and for the first time, a deceased spouse’s unused exemption may be shifted to the surviving spouse.

Note, however, these generous rules are temporary—much harsher rules are slated to return after 2012.

Rates and Exemptions.  For individuals dying in 2009, the top estate tax rate was 45% and there was a $3.5 million exemption.  The top rate was to rise to 55% with a $1 million exemption for individuals dying after 2010.  Now, at least for 2011 and 2012, the top rate is reduced to 35% and the exemption increased to $5 million, with a further increase for inflation in 2012.  Again, however, these changes are temporary.  After 2012, the top rate is scheduled to be 55% with a $1 million exemption.  (The author of this article has officially now ceased speculating on what Congress might someday do.)

Gift Tax Changes.  For a number of years, the gift tax and the estate tax were unified—they shared a single exemption and were subject to the same rates.  This has not been the case since 2001.  For example, in 2010, while the estate tax vanished, the top gift tax rate was 35% and the exemption was $1 million.  For gifts made after December 31, 2010, the gift tax and estate tax are reunified and an overall $5 million exemption applies.

GST Tax Changes.  The generation-skipping tax is an additional tax on gifts and bequests to grandchildren when their parents are still alive.  The Act lowers GST taxes for 2011 and 2012 by increasing the exemption amount from $1 million to $5 million and reducing the rate from 55% to 35%.

New Portability Feature.  Under the 2010 Act, any exemption remaining unused as of the date of a spouse dying after 2010 and before 2013 is generally available for use by the surviving spouse in addition to that spouse’s own $5 million exemption for taxable transfers made during life or at death.  Under prior law, the exemption of the first to die would be lost if not used.  This could happen where a spouse with resources below the exemption amount died before the richer spouse.  One way to address that was to set up a trust for the poorer spouse or to transfer assets into his or her name.  Now, the portability may make setting up a trust unnecessary in some cases, and the need for direct inter-spousal transfers is obviated.

Note, however, there still may be reasons to employ the old “credit shelter” trusts.  For example, a trust may protect appreciation occurring between the death of the first spouse and the death of the second from being subject to estate tax.  A trust can also protect against creditors.  Also, the transferred exemption may be lost if the surviving spouse remarries and is again widowed.

Conclusion.  The estate tax relief in the new law is substantial, but it is temporary.  Sadly, estate planning to reduce taxes remains an important consideration.  Even if taxes are not a concern because an estate is below the exemption level, it is vital to have a proper estate plan to ensure that the needs of intended beneficiaries are met.