Estate and Gift Tax Update

December 22, 2010

Christmas came a little early for many taxpayers in the enactment last week of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010(the "Act"), which extended the Bush tax cuts for two years. The Act also erased much of the uncertainty regarding the fate of the federal estate and gift taxes that we have written about.

Estates created in 2010 have not been subject to a federal estate tax. A gift tax with a rate of 35% applies to gifts made in 2010, but donors have a credit of one million dollars against the gift tax. Before the Act, in 2011 the estate tax was to be reenacted with a $1 million credit (which is shared with the credit against the gift tax and is commonly referred to as the "unified credit") and a maximum rate of 55%. The gift tax would have had the same maximum rate.   

The Act has made several changes to this plan. For one thing, the unified credit against the estate and gift taxes is being raised to five million dollars per person. Thus, a married couple will collectively be able to shield ten million dollars of their estate from federal gift and estate taxes. Additionally, in a bold departure from prior law, the Act allows surviving spouses to use the unused portion of their deceased spouses’ unified credit.

The Act also cuts the maximum rate for estate and gift taxes by a whopping 20% and allows beneficiaries to receive a stepped up basis in the items they inherit. In 2010, there were strict limitations on how much basis could be allocated to certain beneficiaries thus, in many cases, a step up in basis was either severely limited or outright prohibited. Because a lower basis likely leads to more gain when an inherited item is sold, the 2010 scenario subjected beneficiaries to more capital gains tax. Now that basis in the items can be stepped up to current values, beneficiaries face less gain and thus less capital gains tax. However, 2010 estates need not fear — under the Act, the estate can elect to pay all applicable estate taxes, after the application of the five million dollar unified credit, and its beneficiaries can fully utilize the step up basis.

While the Act answers many questions about the estate and gift tax, it is only applicable for two years. Thus, we will likely be facing similar uncertainties when the end of 2012 approaches. We will monitor any developments before then and let you know when they occur.