2010 Tax Act: Selected Trust & Estate Concerns

By Jan P. Myskowski


December 2010

If deferring the uncertainties surrounding the federal estate tax for another two years can be considered “relief,” then we can be thankful for Congress’s holiday season gift of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (which we will shorthand as the “Act” ). You are undoubtedly receiving volumes of material regarding this omnibus legislation, so my discussion below assumes a baseline exposure to the fundamental provisions of the Act that deal with federal gift, estate and GST taxation (e.g., I won’t provide a chart of the new exemption figures). My objective here is to offer a brief discussion of issues that may not get attention elsewhere (or at least not for a while). I will undoubtedly write more on topics related to the Act. The following are simply the concerns that struck me as having the most immediacy.

Gift and Estate Tax Reunification

Perhaps the biggest surprise in the Act was the re-unification of the federal gift tax exemption and the federal estate tax exemption, resulting in an increase in the gift tax exemption from $1 million to $5 million. Unlike the federal estate tax exemption, however, which the Act increases to $5 million retroactively to January 1, 2010, re-unification, and the resulting $5 million gift tax exemption, will not go into effect until January 1, 2011. Many people have contemplated taxable gifts in 2010 to take advantage of the 35% rate that was imposed under the provisions of EGTRRA. While paying an out-of-pocket gift tax at a temporarily reduced rate made good sense, waiting until January 1 will now likely mean avoiding an out-of-pocket gift tax altogether. In addition, there is little incentive to rush the analysis since the Act extends the 35% rate through 2012.

Conversely, because re-unification and the increased gift tax exemption are currently set to sunset at the end of 2012 (without further action by Congress, the gift tax exemption will return to $1 million for 2013), the incentive to make large-scale gifts during 2011 and 2012 will be at a premium.

GST Tax-Free Direct Skips for 2010

One of the many clouds hanging over the tax landscape for 2010 was whether or not contributions to GST trusts during 2010 would be eligible for allocation of GST exemption, which would usually be desirable to preserve a zero inclusion ratio in future years during which a GST tax might be in effect. Under EGTRRA there was no GST tax in 2010, and hence no exemption to allocate. To cure this problem, the Act imposes the GST tax retroactively to January 1, 2010, but sets the GST tax rate at zero percent for 2010 only. The tax exists, and exemption may be allocated, but no tax can be paid even if exemption is either unavailable or not allocated. This means that for skip gifts made by December 31, 2010 no GST tax will be due and no GST exemption will have to be utilized to achieve that result. This provides a tremendous incentive to make year-end direct skip gifts. However, since GST trusts will be subject to the GST tax after 2010 (at least for 2011 and 2012), in most cases exemption will be allocated to 2010 indirect skip gifts to trusts to preserve a zero inclusion ratio for future years.

Basis Reporting for 2010

Another (larger and darker) cloud was the uncertain procedure for allocating basis to assets passing as a result of deaths occurring in 2010. The Act makes carryover basis optional and requires an affirmative election to opt in to carryover basis. Absent such an election, the traditional automatic basis step up rules will apply to assets passing as a result of deaths occurring in 2010. In order to allow estate representatives time to evaluate the impact of the competing tax regimes for 2010, the due date of estate tax returns for decedents dying between January 1 and December 16, 2010 is extended to September 17, 2011 (nine months from December 17, 2010). For deaths on or after December 17, 2010, the return is due nine months from the date of death. The procedure and due date of the affirmative election to be taxed under the carryover basis regime is subject to further rulemaking by the IRS, but presumably the due date for such elections will not be any earlier than the due date for estate tax returns. Estate representatives who believe their decedent’s estate may want to opt in to carryover basis should watch this issue closely, however. Under EGTRRA, basis allocation returns were due by April 15th of the year following the year of the decedent’s death, and nothing in the Act requires the IRS to extend the due date beyond that provided by EGTRRA.

State-Level Sponge Taxes

EGTRRA repealed the state death tax credit and replaced it with a state death tax deduction for purposes of computing federal estate tax liability. This had the effect of negating state sponge tax statutes. However, sponge taxes remain on the books in many states (including New Hampshire), and those statutes may have been resurrected by the sunset of EGTRRA and the corresponding return of the state death tax credit. The Act preempts this concern (temporarily) by expressly stating that the repeal of the state death tax credit is extended through 2012. It is worth noting that New Hampshire’s legislature has narrowly defeated a decoupled state-level estate tax in the last two legislative sessions, and we expect to see it on the agenda again this year.

Drafting for a Portable Exemption

Last but not least on our list of concerns of most immediacy is the question of how to draft estate planning documents in the face of a temporarily portable federal estate tax exemption. We anticipate strongly recommending that clients establish and properly fund revocable trusts incorporating traditional bypass trust/marital trust schemes during 2011 and 2012 (and very likely beyond that as well). There are several reasons for this. First and foremost, portability is temporary until Congress has clarified what happens after 2012. In addition, under the Act, portability is not automatic. The deceased spouse’s estate representative must make an affirmative election of portability on a timely-filed estate tax return. That could be an expensive “check the box” mistake. Third, the GST exemption is not portable, and the only way to coordinate the spouses’ respective GST exemptions with their respective estate tax exemptions will be through dynamic trust planning.

Finally, the Act contains provisions requiring a surviving spouse who has multiple predeceased spouses to reduce his or her portable exemption to the lower of the unused exemptions of his or her prior deceased spouses. A properly drafted, funded and administered bypass trust has more permanent insulation from future estate taxation. It will also be critical to properly fund bypass trusts of spouses dying in 2010 since portability does not commence until 2011.

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