Who said that there is nothing certain in life other than death and taxes? I do not know who originated this statement, but it continues to ring true. We went through almost twelve months of the repeal of the Federal estate tax and, at the last minute (December 15, 2010), the House and the Senate agreed to a compromise on the estate and gift tax until the end of 2012. I do think that we can comfortably continue to use this statement, as it seems that the estate and gift tax are not going away any time soon.
The Federal unified credit shields property from tax, regardless of whom such property passes to. The amount shielded by the unified credit is known as the “applicable exclusion amount.” For 2009, the applicable exclusion amount was $3,500,000. The estate tax was repealed on January 1, 2010. On December 15, 2010, Congress enacted new legislation which provides a $5,000,000 applicable exclusion amount with a 35% Federal tax rate for 2011 and 2012. It also provided an option for 2010 which is discussed below. It is advantageous for property to pass tax free as part of the applicable exclusion amount because the applicable exclusion amount escapes Federal estate tax at death. So we must plan for this amount, even if it is currently temporary until the end of 2012 and will change again.
The new legislation also reunified the gift tax exemption with the applicable exclusion amount. Our clients can now transfer up to $5,000,000 during their lifetime without paying a gift tax. This has opened up lifetime planning opportunities for many of our clients who had exhausted the old lifetime giving limit of $1,000,000.
We believe that the estate tax will remain for the foreseeable future for both Federal and State estate tax purposes. We also believe that a limit on lifetime giving will remain in effect as well. Therefore, there is still a need to address the estate tax in your lifetime planning and in the documents which take effect at death. Now, more than ever, you should focus on this planning to take advantage of the estate and gift tax exclusion amounts. The following are some of the issues the foregoing changes have caused:
During 2010 when the tax was repealed, there was no estate tax but there was also no step-up in the cost basis of the assets passing through an estate for income tax purposes. Therefore, the estate saves the Federal estate tax, but the beneficiaries of the estate will have to pay capital gains on all assets sold after death, to the extent the sale value exceeds the asset’s cost basis. This can be costly and is administratively cumbersome to keep track of.
The new legislation now provides an option for 2010 to use an applicable exclusion amount of $5,000,000 with a Federal tax rate of 35%, instead of the Federal tax repeal with no step-up in the cost basis of the assets. The Executor of an estate will need to analyze this option carefully with his, her or its advisors. There could be benefits and downfalls with each option.
After all the changes mentioned above, many states have created their own independent estate tax which is assessed on top of the Federal estate tax (which is an option in 2010 and is back in 2011 and 2012). The state tax for New Jersey is assessed on estates with a value in excess of $675,000. The tax rate starts at 6% and increases with the value of the estate. New York taxes estates with a value over $1,000,000 but their tax rate starts a little higher. The state tax may not sound like much on its own but, when added to the Federal tax of 35% on all assets in an estate over $5,000,000, our clients’ beneficiaries will be losing a portion of every dollar passing to them. If you add in the income tax bite of retirement assets, such as IRAs and retirement plans, the amount beneficiaries receive will be even be less.
This is an unfortunate consequence that came about due to the economic difficulties many states in our area were and are experiencing. While the Federal tax was being phased out to repeal and then sunset, the changes also eliminated the tax that the states collected from each estate. Therefore, many states including New Jersey, New York and Connecticut, among others, permanently decoupled from the Federal tax laws and created their own independent estate tax which remains in effect after the Federal estate tax returns.
Finally, legislators are attempting to raise additional funds due to a tremendous budget deficit. Therefore, we are now facing possible legislation and uncertain terms on lifetime planning techniques such as Grantor Retained Annuity Trusts (GRATs) and the continuation of valuation discounts in family entities, such as family limited partnerships, limited liability companies, s-corporations and fractional interest discounts in real property. GRATs will be discussed in more detail in another article in this publication. Given the low interest rate environment, GRATs can be a big “win” for a client’s estate plan.
Many clients have been much more receptive to attending to their estate planning even though many uncertainties exist in the law. Our clients now realize that it is very unlikely that the estate and gift tax will be fully repealed and that perhaps certain doors of opportunity in lifetime giving are closing. The dramatic market downturn in 2008 and 2009 caused some clients to adopt a wait and see approach, due to the trauma of watching their life’s work decline in value. No matter what you decide to consider in connection with your estate planning, some planning is better than no planning at all. Even if you decide to put “just” the basic documents in place, you are ahead of those who did not consider planning at all. In the end, you save your hard-earned money for your children, grandchildren, more remote generations or other beneficiaries!
AnnMarie Palermo-Smits is a Partner at WJ&L and serves as the Chairperson of the Tax, Trusts and Estates Department.