Bush-Era Tax Cuts: Federal Estate, Gift, and GST Taxes

When Congress passed EGTRRA in 2001, many lawmakers believed that the federal estate tax would be permanently repealed after 2009 and its stepped-up basis rules would be replaced with a modified carried over basis regime. Instead, the 2010 Tax Relief Act revived the estate tax for decedents dying after December 31, 2009 (but gave estates of decedents dying in 2010 the option to opt out of the estate tax and apply EGTRRA’s rules). Because the 2010 Tax Relief Act is temporary, its estate tax regime is scheduled to expire after 2012.

Estate tax rates and exclusion amount

Under EGTRRA, the estate tax would have been abolished for decedents dying in 2010 and then revived at its pre-EGTRRA levels after 2010. The 2010 Tax Relief Act modified EGTRRA’s timeframe. First, the 2010 Tax Relief Act provides for a maximum estate tax rate of 35 percent for decedents dying after December 31, 2009, and before January 1, 2013, and an applicable exclusion amount of $5 million for decedents dying after December 31, 2009, and before January 1, 2013. Second, the 2010 Tax Relief Act allowed estates of decedent’s dying in 2010 to opt out of the revived estate tax. Estates of decedents dying after December 31, 2009, and before January 1, 2011 have the option to elect not to apply the estate tax regime under the 2010 Tax Relief Act. Estates may elect to apply either the estate tax based on the 2010 Tax Relief Act’s 35 percent top rate and $5 million applicable exclusion amount, with stepped-up basis, or no estate tax and modified carryover basis rules under EGTRRA.

Impact: Because the 2010 Tax Relief Act sunsets after 2012, indexing for inflation is only applicable to 2012 (the estate tax applicable exclusion amount for estates of decedents dying in 2012 is $5.12 million).

Impact: Absent extension, the maximum federal estate tax rate is scheduled to revert to 55 percent after 2012, with an applicable exclusion amount of $1 million (not indexed for inflation).

Comment: The election to opt out of the estate tax for 2010 is known as the Code Sec. 1022 election.

Comment: Property with a stepped-up basis receives a basis equal to the property’s fair market value on the date of the decedent’s death (or on an alternate valuation date). Under EGTRRA’s modified carryover basis regime for estates of decedents dying in 2010, an executor may increase the basis of estate property only by a total of $1.3 million, with other estate property taking a carryover basis equal to the lesser of the decedent’s basis, or the fair market value of the property on the decedent’s death. An executor may increase the basis of assets passing to a surviving spouse by an additional $3 million (for a total of $4.3 million).

Comment: President Obama has proposed extending the federal estate tax after 2012, with a top tax rate of 45 percent and an applicable exclusion amount of $3.5 million.

Portability

The 2010 Tax Relief Act introduced the concept of “portability” into the federal estate tax regime. Portability allows the estate of a decedent who is survived by a spouse to make a portability election to permit the surviving spouse to apply the decedent’s unused exclusion to the surviving spouse’s own transfers during life and at death. Portability is available to the estates of decedents dying after December 31, 2010 and before January 1, 2013.

Comment: The IRS described portability in Notice 2011-82, and updated its guidance in Notice 2012-21. The IRS explained that the estate of a decedent who is survived by a spouse will be deemed to have elected portability by the timely filing of Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, pending further guidance.

State death tax credit and deduction

Before 2005, a credit was allowed against the federal estate tax for state estate, inheritance, legacy, or succession taxes. EGTRRA repealed the state death tax credit for decedents dying after 2004 and replaced the credit with a deduction. The state death tax credit, as it existed pre-EGTRRA, was scheduled to revive after 2010. The 2010 Tax Relief Act extended the deduction through 2012.

More estate tax provisions

The 2010 Tax Relief Act also extended, through 2012, EGTRRA’s provisions affecting qualified conservation easements, qualified family-owned business interests, and the installment payment of estate tax for closely-held businesses for purposes of the estate tax. Additionally, the 2010 Tax Relief Act extended repeal of the 5 percent surtax on estates larger than $10 million through 2012. Absent extension, the pre-EGTRRA rules for these respective provisions will apply.

Gift tax

Under EGTRRA, the gift tax for 2010 was scheduled to be 35 percent with a $1 million applicable exclusion amount. After 2010, the pre-EGTRRA rules were scheduled to be revived. The 2010 Tax Relief Act provided a 35 percent tax rate and a $1 million exemption for gifts made in 2010. However, the 2010 Tax Relief Act also provided that, for gifts made after December 31, 2010, the gift tax is reunified with the estate tax, with a tax rate through 2012 of 35 percent, and an applicable exclusion amount of $5 million.

Comment: Before 2004, the estate and gift taxes were fully unified, such that a single graduated rate schedule and a single applicable exclusion amount of the unified credit applied for purposes of determining the tax on cumulative transfers made by a taxpayer during his or her lifetime and at death. The estate and gift tax continued to be determined using a single rate schedule for 2004 through 2009, but the estate tax applicable exclusion amount was higher than the gift tax applicable exclusion amount.

Impact: Some estate planners have recommended utilizing the full lifetime $5 million unified estate and gift tax exclusion before it may sunset at the end of 2012. While there is concern that any exclusion amount in excess of a future exclusion may be “clawed back” into an eventually taxable estate, the worst case in that situation will not prevent any appreciation within the gift from escaping estate tax at that later date.

Generation-skipping transfer tax

Under EGTRRA, the generation-skipping transfer (GST) tax was scheduled to be repealed for 2010, after which the pre-EGTRRA GST rules would return. The 2010 Tax Relief Act modified this timeframe. The GST tax applicable exclusion amount for decedents dying or gifts made after December 31, 2009, is equal to the applicable exclusion amount for estate tax purposes ($5 million for 2010), but the GST tax rate for transfers made in 2010 is zero. After 2010, the GST tax rate is equal to the highest estate and gift tax rate in effect for 2011 and 2012 (35 percent for each year). Under the 2010 Tax Relief Act, the pre-EGTRRA GST rules are scheduled to return after 2012.

Impact: If the GST provisions in the 2010 Tax Relief Act are not extended, there will be a 20 point difference between the 35 percent rate applicable to transfers in 2012, and the 55 percent rate that would apply after 2012.

More GST provisions

A number of other GST-tax-related provisions are scheduled to sunset after 2012. They include the GST deemed allocation and retroactive allocation provisions; clarification of valuation rules with respect to the determination of the inclusion ratio for GST tax purposes; provisions allowing for a qualified severance of a trust for purposes of the GST tax; and relief from late GST allocations and elections. The 2010 Tax Relief Act extended these provisions through 2012.

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Published: 5/10/2012