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2-year window of opportunity: Big estate-planning changes thru 2012

April 1, 2011
By Jeremy Noetzel and Marvin Hills, Crowe Horwath LLP
The scheduled expiration of the 2001 and 2003 tax cuts at the end of 2010 generated considerable uncertainty last year. When Congress eventually acted on the issue in mid-December, the outcome was a surprise to almost everyone. The new law retroactively institutes a 35 percent estate tax with a $5 million exemption, and allows a “step-up” in basis. It also gives executors of decedents who died in 2010 the ability to opt out of paying estate tax in exchange for accepting a “modified carryover” basis in the estate’s assets.
Equally surprising was the fact that the lower-than-expected rates and higher-than-expected exemptions also apply for gift tax purposes. But the advantages of this situation are tempered by the fact that these provisions are once again only temporary and due to expire at the end of 2012.
For this reason, the next two years will offer dealers with sizable estates some significant but time-limited estate-planning opportunities. Even those with modest-sized holdings should begin re-examining estate plans immediately to determine how best to respond.
Most of the headlines generated by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Act) revolved around the extension of Bush-era income tax rates. For automobile dealers and other business owners with estate-planning concerns, however, the changes to the federal wealth transfer tax system, including changes to estate and gift tax regulations, can be even more significant than the income tax rate extensions.
Here are some key provisions:
Estate Tax. The 2010 Tax Act established a new top estate tax rate of 35 percent, a sizable cut from the top rate of 45 percent that was in effect in 2009. It also increased the amount that can pass estate-tax-free from $3.5 million to $5 million. In addition, any unused estate tax exemption amount of one spouse can be transferred to a surviving spouse. This new “portability” rule is confusing but basically allows spouses to take full advantage of each party’s full estate exclusion amounts, even when one spouse does not have $5 million of personally owned assets.
Gift Tax. The 2010 Tax Act extended the 35 percent gift tax rate already in effect for two more years. It also increased the gift tax exemption amount from $1 million to $5 million, unifying both the lifetime gifting exemption and the death-time estate exemption for the first time since 2003. The increased gifting exemption provides new opportunities for taxpayers to make lifetime transfers without incurring gift tax.
Generation-Skipping Transfer Tax. The GST rate was also cut to 35 percent (down from the 45 percent rate in effect in 2009) and, like the estate and gift tax exemptions, the lifetime GST exemption was also increased, from $3.5 million to $5 million. Unlike the estate and gift tax exemptions, though, the new law does not provide portability for the GST exemption.
Uncertainty After 2012
Going forward, these new tax rules only apply to wealth transfers made in 2011 and 2012. Unless Congress acts, however, on Jan. 1, 2013, the tax laws will revert back to their 2001 provisions, which included a top rate of 55 percent for estate, gift, and GST taxes, a $1 million estate and gift tax exemption, and a GST tax exemption of $1 million adjusted for inflation.
The increased gift and GST tax exemption amounts for 2011 and 2012 create some important new opportunities to transfer wealth out of your estate and achieve significant savings in future estate taxes. Specifically, for the next two years, in addition to any unused portion of the former $1 million gift tax exemption that still exists, you can now transfer an additional $4 million without incurring gift tax. For married couples, that presents an opportunity to transfer as much as $10 million out of their estate.
Even more important than the actual transfer amount, such lifetime gifts also remove all future appreciation in the transferred property from the donor’s taxable estate, which could result in even greater estate tax savings over time. But because there is no certainty that the increased exemption amounts will extend beyond 2012, it is important to take advantage of this wealth transfer opportunity now.
Although transferring as much as $5 million out of a donor’s estate—or $10 million out of a couple’s estate—will produce obvious and significant estate tax savings, the direct transfer of wealth is only the beginning of the opportunity.
Even greater savings can be achieved by compounding the effects of the increased transfer tax exemptions through the use of other estate planning techniques.
One frequently used technique for taking advantage of the gift and GST tax exemptions is to create an irrevocable trust that intentionally, and legally, violates the income tax “grantor trust” rules of the Internal Revenue Code, a technique commonly referred to as an intentionally defective irrevocable trust. Because the trust will violate the grantor trust rules, the Internal Revenue Service will treat the trust as if it does not exist for income tax purposes.
For estate and gift tax purposes, however, the IRS will treat the trust as if it does exist. To employ this technique you would give cash or other assets to the trust in an amount usually equal to 10 percent of the value of the assets that you intend to sell to the trust.