The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312 (2010 Tax Relief Act), which President Obama signed into law on December 17, 2010, makes significant changes to the gift tax.
Different Years, Different Rules
The 2010 Tax Relief Act keeps the gift tax rate and exemption the same as it was under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA): 35% tax rate and $1 million exemption for individuals.
2011 and 2012
The 2010 Tax Relief Act keeps the gift tax rate at 35% for 2011 and 2012, but the gift tax will be significantly different in 2011 and 2012.
(1) Higher exemption. The gift tax exemption for 2011 and 2012 is increased from $1 million to $5 million for individuals. So, individuals who used their entire $1 million gift tax exemption prior to 2011 will be able to gift an additional $4 million in 2011 and 2012 without incurring a gift tax.
(2) Unified exemption. The gift tax exemption will be reunified with the estate tax exemption, starting 2011.
(3) Indexed for inflation. Starting 2012, the gift tax exemption will be indexed for inflation.
(4) Portable. In 2011 and 2012, the gift tax exemption will be portable. Portability allows a surviving spouse to use the amount of estate and gift tax exemption not used by the decedent spouse. For an explanation, see Deborah L. Jacobs, Married Couple’s Guide To The New Estate Tax Law, Forbes, Dec. 23, 2010.
Gift Tax Strategies
The changes that the 2010 Tax Relief Act has a number of implications for estate planning.
(1) Changes year-end planning.
Many older, wealthy people were waiting until the end of the year to make large taxable gifts. Under EGTRRA, there was no estate tax in 2010, but it was scheduled to return in 2011 with an exemption of $1 million and a tax rate of 55% (60% in some cases). Also, under EGTRRA, the gift tax rate was scheduled to jump from 35% in 2010 to 55% in 2011 (with an exemption of $1 million). The idea was to make large taxable gifts and pay a gift tax of 35%. A transfer in 2010 under EGTRRA would have saved at least 20% compared to a transfer (either during life or upon death) under the rules that were scheduled for 2011. A 20% tax savings is significant.
The 2010 Tax Relief Act changes this year-end planning. Taxable gifts for clients in the $5 to $10 million dollar range probably should not be made in 2010. The reason for this is that the exemption under the 2010 Tax Relief Act jumps from $1 million in 2010 to $5 million in 2011. So, by waiting just a few days, money can be transferred by gift without incurring a gift tax.
(2) Limits the 2010 GST tax opportunity.
As I wrote in an earlier post, Congress provided the wealthy a tremendous generation-skipping transfer tax opportunity just for 2010. The 2010 Tax Relief Act reinstated the GST tax in 2010. But Congress is providing a GST tax “holiday” because the GST tax rate in 2010 is 0%.
The $1 million gift tax exemption in 2010 acts as a limit or cap to the 2010 GST tax opportunity. At a minimum, it makes decisions regarding whether to take advantage or pass on Congress’ 2010 GST tax gift more complicated.
Still, distributions in 2010 from non-exempt GST tax trusts can generally be made without incurring a gift tax. (If you have further questions about the GST tax opportunity in 2010 and whether it is right for you, you should consult your estate planning advisor immediately. Time is of the essence as this opportunity is only around for a few more days.)
(3) Creates gifting opportunities in 2011 and 2012.
The gift tax in 2011 and 2012 will be levied at a rate of 35% and with an exemption of $5 million that is portable.
(a) People who were once limited by the $1 million gift tax exemption will be able to gift up to the new limit.
(b) The $5 million exemption can be stretched with proper estate planning. Congress did not change the rules for grantor retained annuity trusts or for valuation discounts. It had been threatening to significantly restrict these estate planning tools. So, they can be used in 2011 and 2012 (so far). (Further, planners who make seed gifts before selling to intentionally defective grantor trusts will use the higher exemption to transfer tremendous amounts of wealth. I am planning to discuss this strategy in a separate post.)
•Deborah L. Jacobs, How the New Tax Law Affects Your Estate Plan, Estate Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide (Update 2) (a summary that everyone can understand).
•Joint Committee on Taxation, Technical Explanation Of The Revenue Provisions Contained In The “Tax Relief, Unemployment Insurance Reauthorization, And Job Creation Act Of 2010″ Scheduled For Consideration By The United States Senate (JCX-55-10) (summarizing H.R. 4853; providing a plain English explanation of the law before EGTRRA, under EGTRRA, and as reformed by H.R. 4853).
•Steve R. Akers, Estate, Gift and Generation-Skipping Transfer Tax Provisions of “Tax Relief… Act of 2010,” Enacted December 17, 2010, ACTEC, Dec. 21, 2010 (a technical discussion of the changes; cites to the 2010 Tax Relief Act).
•Hani Sarji, Gift Tax: Changes Made by the 2010 Tax Relief Act (visually presenting the changes that the 2010 Tax Relief Act makes to the gift tax, IRC § 2505).