As a special note, this data was compiled as of February 8, 2011, and is informational only and not intended as legal advice. Further changes, particularly at the state level, could occur. Any comments on our information or new developments that should be reflected may be sent to Info@ExecutorsResource.com.
On December 17th, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act. It extends the sunset provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), but only through December 31, 2012.
There are several key aspects of the law that apply to the federal estate tax. Some are retroactive back to January 1, 2010, meaning that they apply to the estates of those individuals who died in 2010.
To Be Applied Retroactively from January 1, 2010 through December 31, 2012 (with the option to elect out of the estate tax in 2010):
$5 million personal exemption
For persons who die in 2010, 2011 and 2012, and have a taxable estate of less than $5 million, there is no applicable federal estate tax.
For deaths in 2010, 2011 and 2012, with a taxable estate of more than $5 million, a 35% federal estate tax will be applied to the portion of the taxable estate that exceeds $5 million.
This compares with a $3.5 million exemption and a 45% top rate in 2009. As a reminder, EGTRRA gradually increased the federal estate tax exemption in stages from 2002 through 2009, and eliminated the estate tax for 2010, until this recent law passed.
Overall estate tax liability is determined by taking the gross estate, subtracting any debts, expenses, deductions or charitable transfers to calculate the taxable estate, and applying the estate tax rate to the portion of the taxable estate that exceeds $5 million.
Here’s an example:
John Sample, a single person, passed away on January 16, 2011. His gross estate is worth $7 million, and his debts, expenses, deductions and charitable transfers are $1 million, making his taxable estate $6 million. Thanks to the new law, his estate tax can be calculated as follows (although under the Internal Revenue Code the mechanics are different):
$6 million taxable estate - $5 million estate tax exemption = $1 million estate subject to tax
John’s estate has to pay a 35% federal estate tax, so money owed would be:
$1 million x 35% = $350,000
To Be Applied from January 1, 2011 through December 31, 2012:
Portability Provision for Married Couples
This provision must be elected by the executor or personal representative of the estate of the first spouse that dies.
Remember, married couples also get an estate tax deduction for any assets transferred upon death to a surviving spouse. This is the “unlimited marital deduction”. During the years 2011 and 2012, assets transferred to the surviving spouse do not reduce the exemption amount available to the surviving spouse under the “portability” provisions.
Let’s look at an example of how this portability provision for married couples can work:
Samuel Hypothetical passed away on February 1, 2011. His gross estate is worth $3 million, his wife Mary is the executor of his estate, and all of his assets pass to Mary. The attorney who is assisting Mary in settling Samuel’s estate advises her to elect to add Samuel’s unused personal exemption of $5 million to her own exemption. If Mary dies in 2011 or 2012, the total amount of personal exemption available to Mary’s estate would be a generous $10 million.
There are some additional complications if the surviving spouse remarries, which is why it is important to work closely with a professional to ensure that your plans are structured in an appropriate way.
Still a Moving Target, but Estate Planning is NOT Just About Taxes
The provisions of the recent law passed are only temporary. If Congress fails to act before December 31, 2012 the federal estate tax will revert back to 2001/2002 levels (i.e., $1 million exemption, 60% maximum tax rate1) with no portability provision. While this can make planning a challenge, keep in mind that estate planning isn’t just about taxes. It’s about ensuring that your instructions and wishes can be identified and honored.
Conclusion
The death tax, as it’s called, has always been and continues to be a controversial subject. To date, the U.S. House of Representatives has introduced five bills to repeal federal estate taxes, and there are likely more proposals to come.
So what does all this change mean to the average person? Now, more than ever, is the right time to update or create your estate plan. It’s the smartest way to be prepared for change. Here’s our list of 4 must-do action items:
1) Get organized. Now, more than ever, it is essential to inventory what you have, where it’s located, and who to contact so that you have a better understanding of what changes will impact you. It only takes a little work initially, and on an ongoing basis to keep up-to-date. You’ll see the value of having everything important at your fingertips, and so will your future executor. You can check out how our EstateLogic program can help you here.
2) Get your legal documents in place. If you don’t have the necessary legal documents (e.g., will, power of attorney, etc.), don’t wait. While it’s true that these legal documents identify how you want your assets distributed at your death, they also capture your wishes and instructions on a host of other, likely more important things. For example, who should be appointed guardian of your minor children, who should make health care decisions in the event you are incapacitated, etc.
3) If you have a plan, update it. If you haven’t looked at your will, trust agreements, or powers of attorney documents in more than two years, don’t wait. Life changes and so too should your legal documents. Now is the perfect time to review your documents to ensure that your current wishes and instructions are still reflected.
4) Check your beneficiary designations and how your assets are titled. Still have your former spouse as the beneficiary of your 401(k) plan? Did you buy your car 5 years ago when you were single and subsequently get married? Many people falsely believe that estate planning legal documents such as a will or trust agreement will override out-of-date beneficiary designations and title paperwork. Don’t make this mistake. Check your beneficiary designations and how your assets are titled annually.
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1 The nominal tax rate is 55%. There is an additional surtax for estates over $10 million, making the total maximum tax rate 60%.
