Estate Tax in 2011

On December 17, 2010, President Obama signed into law the Middle Class Tax Relief Act of 2010, bringing into effect one of the most significant changes to the estate tax in decades.  Effective January 1, 2011, estates of single people worth less than $5 million or of couples worth less than $10 million will escape estate tax.  These exemption amounts are to be indexed for inflation, and could increase.  Estates that are liable for estate tax will pay a maximum rate of 35%.  The law is good until the end of 2012.

The new law also “reunifies” the estate tax with the gift and generation skipping transfer taxes, so that the exempted amount for each is $5 million.  This is a major change for the gift tax which had remained at $1 million, and offers a great opportunity to make gifts during lifetime or for charitable planning.

 With proper planning, married couples can leave $10 million in assets to their heirs.  The executor of the estate of the first to die can use as much of the $5 million per person exemption as necessary, and pass any unused exemption to the survivor.  This only applies to those dying in 2011 or later, and only applies to the last deceased spouse, so that a survivor who remarries can no longer take advantage of the unused estate tax exemption of the previous spouse.  The exemption of the first spouse to die is not indexed for inflation, and so does not achieve the same tax advantage as the common “credit shelter/bypass” trust featured in complex wills or revocable living trusts.

For those who die in 2010, there is an option to go by the rules of 2010 or 2011.  Under the former, there is no estate tax, and the estate foregoes the benefits of an unlimited step-up in basis for income tax purposes.  Assets passing to a non-spouse are entitled to a step-up in basis of $1.3 million, with an additional allowance of $3 million for a surviving spouse.  Heirs take on the carryover basis of the decedent, and are subject to capital gains tax at the then-going rate, upon sale or transfer of the inherited assets. 

With the vastly increased tax exemptions, why should anyone pay an attorney for estate planning?  For most people, estate planning is much more than tax planning.  Estate planning involves planning for incapacity by designating a financial agent under a power of attorney and a health care agent under a medical power of attorney, as well creating a living will to express one’s preferences on health care treatment if unable to communicate on one’s own.  It also means naming guardians of minor children.  Post mortem planning is very important if an heir receives government benefits because of a disability and could be disqualified by directly receiving an inheritance.  An heir might also need to be protected from his creditors or ex-spouse.  In the case of a second marriage with children from a prior marriage, it is far better to plan who should receive what.  The government has a default plan, but it may not fit your needs or preferences, and could cause or exacerbate tensions within the family.