A Summary of the "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010"

23 May 2011

On December 17, 2010, the "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010," which modifies various income, estate, and gift tax provisions, was signed into law.  In general, the Act extends the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), which was originally scheduled to expire at the end of 2010, until December 31, 2012, although with substantial modifications.

Non-Transfer Tax Provisions

Highlights of the non-transfer tax provisions of the Act include:
1.   No increases to current income tax rates;
2.  Continuation of the maximum 15% rate on long-term capital gains and qualified dividends;
3.  Reduction of the payroll tax by 2%; and
4.   Reenactment of the income tax exemption for certain IRA distributions to public charities by persons who have attained age 70½.
Estate Tax Provisions
The most basic modification made by the Act with regard to federal wealth transfer taxation is the application of the federal estate tax at historically low rates. Although the estate tax had been repealed for the year 2010 under EGTRRA, it was scheduled to be reinstated at much higher rates than what are imposed by the Act.

From 2009 levels, the Act both raises the estate tax exemption to $5 Million (indexed to inflation) and lowers the top tax rate to 35%. In contrast, in 2009, the most recent year in which an estate tax was imposed, there was a $3.5 Million exemption and a top tax rate of 45%. This means that amounts included in a decedent's estate in excess of $5 Million in 2011 will be subject to federal estate tax at a 35% rate. Therefore, the $10 Million estate of an unmarried person, which in 2009 would have had a federal estate tax liability of $2.925 Million, would in 2011 be liable for only $1.75 Million in federal estate taxes. If the same $10 Million estate were owned by a married couple, the estate tax in 2011 and 2012 would be reduced to zero.
For the estates of decedents dying in 2010, the Act retroactively imposes the 2011 exemption and rate but also allows the personal representative of an estate to elect into the regime that was previously created by EGTRRA (that is, no federal estate tax but limited carryover basis). Further, the deadline for filing, paying tax, and making elections for estates of decedents dying in 2010 is extended to no sooner than the date that is 9 months after the date of enactment of the Act. Since the Act was signed on December 17, 2010, the due date will be September 19, 2011 (the first business day after September 17, which is a Saturday).
The Act also establishes a new portability provision, which allows a surviving spouse, upon his or her death, to use a predeceased spouse's unused estate tax exemption.  This provision provides some backstop for married persons who fail to establish an integrated estate plan, although it should not be considered as a replacement for a carefully drafted estate plan.

For such couples, if the first spouse to die fails to utilize his or her available estate tax exemption, the executor may elect to allow the surviving spouse to make use of the unused portion.  A surviving spouse may only use the unused exemption of his or her most recently deceased spouse, which means that exemptions may not be accumulated from multiple predeceased spouses. 

The portability provisions attempt to replicate the basic estate plan in which the exemption amount of the first spouse to die is utilized by transferring his or her assets into a credit shelter trust that may be used to benefit the surviving spouse but which would not be included in his or her estate. The benefits derived from a credit-shelter trust, however, are substantially greater that what may be achieved through reliance on the Act's portability provisions. Because only the unused exemption from the most recently deceased spouse may be used, a surviving spouse might not be certain of whether a predeceased spouse unused exemption would be available until his or her subsequent death. A credit shelter trust also allows for the accumulation of after-tax appreciation, while any assets transferred directly to the spouse would be fully taxed based on their values at the death of the surviving spouse (or at an earlier gift transfer).   Most importantly, though, by making use of a credit-shelter trust, a couple can remove the exempt portion of a decease spouse's assets from the estate tax regime without concern for future changes to the estate tax laws. Because portability is a creation of the Internal Revenue Code, its application or availability is liable to change in future years.
Gift Tax Provisions
The Act reunifies the estate tax exemption and lifetime gift tax credit, meaning that for 2011 and 2012 individuals may make gifts of up to a lifetime maximum of $5 Million free of gift tax.  As with prior law, such gifts will correspondingly decrease the amount of estate tax exemption available upon death.  The gift tax rate for amounts in excess of $5 Million is set at 35% (the same rate as in 2010, although lower than the 45% rate imposed in the years immediately prior).  
Because the current law is only temporary, there is some risk that gifts made in excess of $1 Million during either 2011 or 2012 may be subject to a clawback tax upon the death of an individual in a later year if the exemption reverts to $1 Million after 2012, as currently scheduled.  Any person wishing to gifts during 2011 and 2012 should discuss this risk with an estate planning attorney.
Generation Skipping Transfer Tax Provisions
The applicable exemption amount for generation skipping transfers in 2011 is equal to the $5 Million unified lifetime gift and estate tax exemption. This means that taxpayers can make lifetime gifts of up to $5 Million to grandchildren or more remote generations free of gift and generation skipping transfer taxes.
Provisions not included in the Act
Although it was much discussed, the final version of the Act contains no provisions limiting discounts for gifts of assets subject to control and marketability restrictions (such as gifts of family limited partnership interests) nor does it contain limitations on the duration of Grantor Retained Annuity Trusts.
Practical Planning Conclusions
1.  Very high-net-worth individuals may consider making gifts to grandchildren before December 31, 2010 in order to avoid the generation-skipping tax. Gift tax will be payable on these gifts to the extent they exceed the person's $1 million exemption.
2.  Individuals may consider making additional gifts in 2011 and 2012 to take advantage of the increased unified exemption.
3.  Short-term GRATs and family partnerships remain attractive estate planning techniques.
4.  Certain taxpayers may consider making a direct gift to charity from their IRAs before year-end. This decision can be made in January, 2011, with retroactive application.
5.  There is no need to accelerate income into 2010 returns, since the tax rates will remain the same for the next two years.
IRS CIRCULAR 230 NOTICE: This communication is not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on any taxpayer or promoting, marketing or recommending to another party any tax-related matters addressed herein.