Important Facts About the New Estate Tax Law Which You Need to Know

by Larry Greenwalt, CPA and Marie Jett, CPA

If you have been following our newsletters, you are aware that the new estate tax law raised each individual’s lifetime exemption to $5,000,000. Less understood by many is the fact that under old law, each person was limited to a lifetime exemption of only $1,000,000 before incurring a gift tax (excluding individual annual gifts of $13,000 or less). Under the new law, the lifetime exemption is increased to $5,000,000.

Thus families with net assets greater than $10,000,000 may want to plan on making gifts of up to $10,000,000. Why? Two main reasons: 1) the new law expires at the end of 2012, and no one can accurately predict what will happen after that, and, 2) to remove appreciating assets from your estate. Obviously many of us would have concerns about placing that much wealth in the hands of the younger generation, but there are a number of ways in which to accomplish this, including setting up a family LLC so that the beneficiaries do not have direct control or access to those assets. Your estate and tax planning advisors can help you evaluate the best approach for you and your situation. A word of caution about making large gifts-check to make sure that you know whether your state of residency taxes gifts. Currently Indiana does not.

Also, with respect to large estates, there may be a bit of a trade off in gifting up to the $10,000,000 mark-there is no “step up” in basis to fair market value of the assets gifted, so the basis of the donor carries over to the donee. From a state tax standpoint, most states don’t tax gifts, but many have an “inheritance” tax (Indiana) or their own form of estate tax, so gifting in advance could save on state estate/inheritance taxes.

There is a new wrinkle in the new estate law for which little has been written-the new law makes the increased, unused exemption portable, which means a surviving spouse can add any unused exemption of his/her newly deceased spouse to their own $5,000,000 exemption.  For the surviving spouse to receive the unused exemption, an election must be made on the deceased spouse’s estate tax return. This can potentially change the way that those who have estates between $5 and $10 million plan, because if avoiding estate tax was the only reason for creating a “by-pass” (ie credit shelter) trust, they may want to retain direct control of the assets, and potentially have their assets receive an even larger step up in basis at their death.  With the new $5,000,000 exemption and a bypass trust in place, too many assets can be placed into the trust and not enough assets are left for the surviving spouse, which is often not the desired end result. These are complex decisions, but they do create opportunities, which means it is important to consult with your tax and estate planning advisors now.

The new law sets the maximum Federal estate tax rate at 35% for 2011 and 2012 versus the 55% that it will increase to if Congress does not act before the end of 2012. It would be nice to have a crystal ball, but for now, there are some great tax planning opportunities to take advantage of if your situation warrants.