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What The New Estate-Planning Provisions Really Mean

The AALU has played a leading role in pushing for permanent estate tax reform that is fiscally sustainable to enable clients to plan with certainty. Reunification was enacted in December as part of the Tax Relief, Unemployment Insurance Authorization and Job Creation Act of 2010, which is examined in this article.

Effective Dates of Estate and GST Tax Increased Exemptions; Carryover Basis Option.

The increased ($5 million) estate and GST exemptions and 35 percent rate were effective Jan. 1, 2010 (making them the default option for 2010, i.e., the increases are retroactive to the beginning of 2010), but the proposal allows an election to choose between the 2010 law (no estate tax and modified carry-over basis) or the 2011 law ($5 million, 35 percent and step-up in basis) for estates of decedents dying on or after Jan. 1, 2010, and before Jan. 1, 2011. No matter which option is chosen, the decedent could still treat any testamentary generation- skipping transfer, as having a "transferor" for GST tax purposes. For example, the "move down" rule, which moves the transferor of any GST transfer down one generation for the purpose of determining the taxability of future distributions and terminations, would apply. For executors for decedents who died during 2010 with very large estates, the option to apply the carry-over basis and avoid the estate tax may be an easy decision. Executors for those decedents who died with estates closer to the $5 million mark, however, may have a difficult decision to make, as the complications of the carry-over basis may incline them to pay a small estate tax in exchange for a full step-up.

Reunification of the Estate and Gift Taxes.

Under EGTRRA, the estate and gift taxes were "decoupled," so that, by Dec. 31, 2009, the estate and GST tax exemptions were equal to $3.5 million per person ($7 million per couple), while the gift tax exemption remained at $1 million per person ($2 million per couple). The new law reunified the estate and gift taxes, effective for gifts made after Dec. 31, 2010. Even if the "reunification" ends on schedule on Dec. 31, 2012, there will be a two-year window to transfer up to $10 million per couple during life without further tax.

Portability of Unused Exemption.

Under the law as it existed on Dec. 31, 2009, in order to take full advantage of a husband's and wife's combined $7 million estate tax exemption, the first spouse's exemption amount would have to be held in a "credit shelter" or "bypass" trust, thus requiring complicated estate planning. The new law allows the executor of a deceased spouse's estate to transfer any unused exemption to the surviving spouse without creating a trust. The portability provision applies only with respect to "the last such deceased spouse of [the] surviving spouse," thus eliminating the possibility of accumulating exclusion amounts from serial marriages. The portable amount is also not indexed for inflation. Planners should be aware, however, that a bypass-type trust may still be useful for sheltering appreciation in assets placed in the trust, as well as for all the reasons that trusts are typically used, such as creditor protection and divorce/second marriage protection. For these reasons, among others, a bypass trust should always be included as an option that can be elected, via disclaimer, even with portability. We note that the "portability" election must be made on a return, which means that even estates that are not subject to tax will probably want to file a return to make the election.

"Pay-Fors." The legislation contained none of the revenue offsets that have been included in previous bills, such as limitations on GRAT terms and remainders, restrictions on discounts for family-held entities, and uniformity of basis for estate and income tax purposes. This will make the heretofore uncertain advantages of short-term GRATs in the current lowinterest- rate environment more certain, and hence more appealing. It should also increase the availability of other "freeze" transactions, such as sales to intentionally defective grantor trusts, that rely heavily on valuation discounts.

GST Tax Allocation Issues. Virtually all the GST tax allocation issues for transfers to life insurance trusts during 2010 are resolved satisfactorily by the inclusion in the Revenue Code of Section 2664 ("This chapter shall not apply to generation-skipping transfers after Dec. 31, 2009."). That section was added to the Code by EGTRRA, in the group of provisions that are "reinstated" to read as if their amendment by EGTRRA "had never been enacted." The "reinstatement" of pre-EGTRRA law in this regard is effective for "estates of decedents dying, and transfers made, after Dec. 31, 2009." This means that the ability to allocate exemption (and to opt out of the automatic allocation of exemption) to 2010 transfers is reinstated as well.

In Hunt for Revenue, Congress Targets GRATs [email protected].

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