Estate Planning Under the New 2010 Tax Act: Key Changes and Notable Impacts

January 4, 2011

On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the Act). The Act significantly changes the federal estate tax, which impacts estate planning for many of our clients and presents significant estate planning opportunities. This alert summarizes the Act’s key changes and provides you with our observations about the Act’s impact from an estate planning perspective. Please note that there are several other important changes made by the Act unrelated to estate and gift tax planning that this alert does not summarize.


Estate Tax
Before the Act, the federal estate tax was gradually reduced over several years and then eliminated for those who died in 2010. Prior law provided that the estate tax, with a maximum tax rate of 55 percent and a $1 million applicable exclusion amount, would be reinstated after 2010. Additional changes scheduled for years after 2010 affected the gift and generation-skipping transfer (GST) taxes.

The Act reinstates the estate tax for those who died during 2010, but at a significantly higher applicable exclusion amount of $5 million, and a lower maximum tax rate of 35 percent, than under prior law. This estate tax regime continues for those who die in 2011 and 2012. Unfortunately, this new regime is itself temporary and will expire on December 31, 2012. The prior estate tax schedule, with a 55 percent maximum estate tax rate and a $1 million applicable exclusion amount, will be reinstated at that time.

The Act also eliminates the 2010 modified carryover basis rules and replaces them with the stepped-up basis rules that had applied before 2010. Property with a stepped-up basis generally receives an income tax basis equal to the property’s fair market value on the date of the property owner’s death. Under the modified carryover basis rules that applied during 2010 before the Act, executors could increase the basis of estate property only by a total of $1.3 million (plus an additional $3 million for assets passing to a surviving spouse, for a total increase of $4.3 million), with other estate property taking a carryover basis equal to the lesser of the decedent’s basis or the property’s fair market value on the decedent’s death.

The Act gives estates of those who died during 2010 the following options: (1) pay retroactive federal estate taxes based on the new 35 percent top rate and $5 million applicable exclusion amount and receive stepped-up basis, or (2) pay no federal estate tax and elect the modified carryover basis rules that existed for 2010 under prior law. Estates of those who died in 2010 have until September 2011 to choose one of these two options.

The Act also provides for "portability" between spouses of the estate tax applicable exclusion amount for estates of those dying in 2011 and 2012, if both spouses die before 2013. Generally, portability allows surviving spouses to elect to take advantage of the unused portion of the estate tax applicable exclusion amount (but not any unused GST tax exemption) of their predeceased spouses, thereby providing surviving spouses with a larger exclusion amount. Special limits apply to decedents with multiple predeceased spouses.

To preserve the first deceased spouse’s unused applicable exclusion amount, the executor for such spouse must file an estate tax return and make an election on such return, even if such an estate tax return would otherwise not be required.

Gift Taxes
For gifts made in 2010, the maximum gift tax rate is 35 percent and the lifetime applicable exclusion amount is $1 million. For gifts made in 2011 and 2012, the Act limits the maximum gift tax rate to 35 percent and increases the lifetime applicable exclusion amount to $5 million to match the estate tax exclusion amount. As discussed below, this change provides an opportunity to move significant amounts of wealth free of estate and gift taxes.

Donors may continue to use the annual gift tax exclusion before having to use any part of their applicable exclusion amount. For 2010 and 2011, the annual exclusion amount is $13,000 per recipient (married couples may continue to "split" their gift and may make combined gifts of $26,000 to each donee).

Generation Skipping Transfer (GST) Tax
The Act provides a $5 million GST exemption amount for 2010 (equal to the applicable exclusion amount for estate tax purposes) with a GST tax rate of zero percent for 2010. For transfers made after 2010, the GST tax rate would be equal to the highest estate and gift tax rate in effect for the year (35 percent for 2011 and 2012). The Act also extends certain technical provisions under prior law affecting the GST tax.


Generally, the estate and gift tax provisions of the Act are favorable to taxpayers because of the substantial increase in the applicable exclusion amount, to $5 million, and the lower

maximum estate and gift tax rate of 35 percent. The Act also addresses several technical estate, gift and GST tax issues that favor taxpayers (e.g., the impact of the lapse of the estate tax, including the application of basis rules, on those who passed away during 2010).  

Temporary Fix
The Act is a temporary fix that expires on December 31, 2012, immediately after the next election cycle.  It is impossible to predict whether it will be extended in either its current or modified form, especially given that it is a hot button issue with both major political parties. If Congress fails to take action, the Act will lapse and the estate tax will revert to what it would have been under prior law (i.e., $1 million applicable exclusion amount and 55 percent maximum estate and gift tax rate).  

Increased Gift Tax Applicable Exclusion Amount
From 2001-2010, the lifetime applicable exclusion amount for gift tax purposes had been $1 million. The Act increases this to $5 million, or $10 million per married couple. This change provides an unprecedented opportunity to move substantial amounts of wealth out of individuals’ estates. There are several techniques that individuals can use to leverage this $5 million lifetime gift tax applicable exclusion amount in order to move substantially more wealth out of their estates.

To illustrate, individuals can now make gifts of $5 million to trusts governed by the laws of certain states, such Delaware and Alaska, move all growth in such wealth out of their estates, provide a significant amount of asset protection for such assets, and the transferor may continue to be a discretionary beneficiary of such trusts, without any gift tax cost.

In addition, the increased gift tax applicable exclusion amount increases the amount of assets that individuals can transfer via an installment sale to a dynasty/grantor trust. Under this estate planning technique, individuals can now make an initial gift of as much as $5 million ($10 million per married couple) to a dynasty trust, and then transfer as much as $45 million ($90 million for a married couple) to such dynasty trust in exchange for an installment note. This technique works especially well for family businesses that are expected to grow significantly in value over time.   

Given that the Act will expire in 2012 without further Congressional action, we are advising clients that it would be prudent to implement estate planning techniques utilizing lifetime gifts before the December 31, 2012 end date.

State Estate Taxes
Many states, including Massachusetts, have separate estate tax regimes with lower applicable exclusion amounts than the federal estate tax laws, making it critically important to coordinate the state gift and estate taxes and how they affect your estate plan. For example, in Massachusetts, there is no gift tax, and the estate tax exemption remains at $1 million. Also, if you own real estate in more than one state, or you are domiciled in a state other than Massachusetts, it is essential that you coordinate the multiple state gift and estate taxes.

One of the more notable provisions contained within the Act is the "portability" provision, which provides, in general terms, that if one spouse does not fully utilize his or her entire $5 million applicable exclusion amount, the unused portion can be used by the surviving spouse’s estate. This provision is intended to avoid the need for credit shelter trusts in estate planning documents. Unfortunately, both spouses must die before 2013 in order to benefit from the portability provision.

In addition, credit shelter trusts continue to provide significant additional benefits beyond just the use of each spouse’s applicable exclusion amounts. These include the following:

  • Ensuring that assets contained in the credit shelter trust pass to children of the couple and not to any new spouse of the surviving spouse.
  • Ensuring that appreciation on the assets contained within the credit shelter trust, which may exceed the applicable exclusion amount at the surviving spouse’s death, are not subject to estate tax at that time.
  • Protection of assets in the credit shelter trust from creditors of the surviving spouse, including any marital claims of future spouses.

Given that the portability provision will expire in 2012, as well as for the reasons stated above, we are advising clients to continue to use estate plans that incorporate credit shelter trusts.

What’s Not Included in the Act
There are two key provisions that many observers feared would be in the Act, but which, ultimately, were not included. Specifically, there had been several proposals to place limits on Grantor Retained Annuity Trusts (GRATs). GRATs allow individuals to transfer wealth out of their estates with as little as a zero estate or gift tax cost, which would have made GRATs less valuable from an estate planning perspective. 

There were also several proposals to limit valuation discounts in connection with certain estate planning techniques such as family limited partnerships, but those provisions were not included in the Act either. Therefore, these techniques remain available to move wealth to lower generations.

For estate tax purposes, temporary relief does not extend to non-U.S. citizens who are not U.S. residents.The Act reinstates federal estate taxes on United States-situs property of non-U.S. citizens who are not residents, so the increased applicable exclusion of $5 million per person does not apply to those individuals. U.S. Situs property exceeding $60,000 in value is again currently subject to U.S. estate taxes at graduated marginal rates beginning at 18 percent. Accordingly, it is critically important to exercise vigilance in structuring the acquisition of U.S. assets such as real property, so as to avoid the imposition of U.S. estate taxes at pre-2010 levels.

The Act makes significant changes to estate and gift taxes, including:  

  • The federal estate tax exclusion amount increases to $5 million per person for 2010 through 2012
  • The maximum estate and gift tax rate is reduced from the 55 percent maximum rate under prior law to a maximum estate and gift tax rate of 35 percent for 2011 and 2012
  • A "portability" provision is included, which allows surviving spouses to use any applicable exclusion amount that is not used by the first spouse to pass away
  • The GST exemption amount is increased to $5 million for 2010 through 2012
  • The Act expires at the end of 2012, thus these changes are all temporary

As always, Prince Lobel recommends that clients review their estate plans periodically and/or whenever a significant life event occurs (e.g., birth of a child, death of a spouse, purchase of new home, etc.). For clients with substantial amounts of wealth and with closely held businesses, we highly recommend that you consider using lifetime gifts to take advantage of the current $5 million lifetime gift tax applicable exclusion amount, which will expire at the end of 2012, absent further Congressional action.

Please do not hesitate to contact us with any questions that you might have. If you would like to have your estate plan reviewed in light of this new Act, please contact us and ask that we send you an estate planning questionnaire to complete so that we can review your current plan in conjunction with your current assets and values.

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