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Impact of the December 2010 Federal Tax Deal on Estate Planning

On December 17, 2010, President Obama signed the Tax Hike Prevention Act of 2010 which extends and provides new tax breaks for individuals and businesses at an estimated cost of $858 billion.  Five provisions that are particularly significant for estate planning purposes involve the estate tax rate and exemption level, the portability of unused exemptions, the step-up in tax basis, the reunification of estate and gift taxes, and the extension of tax-free donations to charities from individual retirement accounts ("IRAs").  Below are detailed explanations of these provisions and highlights of other provisions of this legislation that affect individuals.

Federal Estate Tax Rate and Exemption Level

Prior to the enactment of this legislation, the federal estate tax was scheduled to be reinstated in 2011 at an exemption level of $1 million and a maximum tax rate of 55 percent.  This legislation increases the exemption level to $5 million and lowers the maximum tax rate to 35 percent for the next two years.  This means that, with proper planning, a married couple can pass $10 million to its heirs tax-free!

Step-up in Tax Basis

This legislation reinstates the unlimited step-up in tax basis for 2011 and 2012.  This means that when a person dies, his beneficiaries will get a step-up in tax basis to the date of death value rather than the date of purchase value for all of his assets.  As a result, when a beneficiary sells an inherited asset, he would only be required to pay capital gains on any increases in value since the date of death (not date of purchase).  As a practical matter, it is prudent to retain highly appreciated assets until death rather than selling or gifting them during one's lifetime.

When the estate tax was repealed for 2010, the step-up in tax basis was limited so that only $1.3 million of assets would be eligible for a step-up in tax basis to their date of death value.  The remaining assets would pass to beneficiaries with a date of purchase tax basis.  This legislation reinstates the step-up in tax basis for 2010, which will enable estates of individuals who died in 2010 to choose whether to be subject to the 2010 rules where there is no estate tax but limited ability to step-up tax basis or the 2011 rules where there is estate tax but unlimited ability to step-up tax basis on all estate assets.

Portability of Unused Exemptions

For married individuals who die in 2011 or 2012, the executor of a deceased spouse's estate will be able to transfer any unused exemption to the surviving spouse without the necessity of spousal trusts.  Until now, couples were required to engage in complex estate planning (that included trusts) in order to maximize the allowable exemption for each individual.  However, because this provision is not permanent, it would be prudent to continue to incorporate the option for spousal trusts in estate plans for married couples.

IRA Charitable Donations

This legislation allows seniors (age 70 1/2 and older) to transfer up to $100,000 per year directly from their IRAs to charities in 2011.  The withdrawal would be tax-free and would fulfill the requirements for required minimum distributions.  There would be no additional deduction for the charitable donation.  This provision is especially beneficial to those individuals who do not need the money from their required minimum distributions and who could be obligated to pay alternative minimum tax as a result of such distributions. 

This provision was originally part of the Pension Protection Act that expired on December 31, 2009.  The new legislation also allows donations in 2010 of up to $100,000 from IRAs to charities to be tax-free, and will allow donors to make such gifts through the end of January 2011 and have them treated as donations made in 2010.

Reunification of Estate and Gift Taxes

For the past several years, the lifetime gift tax exclusion amount remained at $1 million even though the estate tax exemption continued to rise.  The new legislation will increase the lifetime gift tax exclusion amount to $5 million, which will enable an individual to gift up to $5 million during his lifetime without paying any tax (and couples to gift up to $10 million).  These gifts, however, will reduce the amount that an individual could pass tax-free upon his death.  Because this increase is only effective for gifts made in 2011 and 2012, it is likely that there will be an increase in gifts made over the next two years.

Highlights of Other Provisions Affecting Individuals

This tax deal also:

  1. extends the Bush-era income tax rates and breaks for two more years;
  1. increases the amount of income that is exempt from the Alternative Minimum Tax for one year;
  1. reduces the Social Security payroll tax by two percent for one year;
  1. expands the child tax credit by retaining the $1,000 child tax credit and enables more people to claim the credit as refundable;
  1. extends unemployment benefits by 13 months;
  1. retains investment tax rates of 15 percent on qualified capital gains and dividends for two years (and a zero percent tax rate for low-income tax filers);
  1. relieves married couples from the "marriage penalty" by insuring that the standard deduction for married couples is double that of single filers and that a married couple's income eligibility for the 15 percent tax bracket is double the income eligibility for single filers; and
  1. retains the American Opportunity tax credit for for those paying college tuition.


Please contact an estates and trusts attorney of your choice to discuss how the new tax deal may impact your estate planning. 

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