Three Steps to Understanding Estate Tax Relief

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 took trust and estate lawyers largely by surprise when it was enacted last December, as it contained several unexpected changes.

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 took trust and estate lawyers largely by surprise when it was enacted last December, as it contained several unexpected changes. However, the Act, which gives clients the opportunity to transfer wealth to their descendants without gift and estate tax consequences, is effective only until December 31, 2012. We have highlighted some of the important provisions of the Act that clients should consider.



The estate tax exemption was increased from $3.5 million to $5 million, retroactive to January 1, 2010. The generation-skipping transfer (GST) tax exemption was also increased to $5 million, effective January 1, 2010. The GST tax applies to transfers — either during life or at death — to grandchildren or more remote descendants.


Effective January 1, 2011, the gift tax exemption was also increased to $5 million, resulting in a reunification of the gift and estate tax exemptions for the first time since 2003. Donors can now make lifetime gifts of up to $5 million ($10 million for a married couple) to beneficiaries without incurring gift tax. Prior to the Act, the gift tax exemption was limited to $1 million. The Act continues the reduced maximum gift tax rate of 35 percent that became effective January 1, 2010. In addition, the maximum estate tax and GST tax rates were reduced to 35 percent from 45 percent in 2009.


Beginning in 2011, if a decedent does not use his or her full estate tax exemption, the unused balance can be added to the surviving spouse’s estate tax exemption, giving the surviving spouse a larger exemption that can be used either during life or at the surviving spouse’s death. A simple example illustrates this concept:

Assume a husband dies in 2011 with a $3 million estate. No estate tax would be due because of the $5 million exemption, but the husband will have used only $3 million of his $5 million exemption.

Therefore, the husband’s unused exemption balance of $2 million can be transferred to his wife. Upon the wife’s later death, assuming she made no lifetime use of her exemption and did not remarry, her estate tax exemption would be $7 million. There are, however, some important points to keep in mind about the deceased spouse’s unused exemption.

First, if the surviving spouse remarries and her new husband predeceases her, she will be limited to the unused exemption of the last deceased spouse. So under the above example, if there is an unused exemption of $1 million, the surviving spouse’s exemption will then be decreased to $6 million.

Second, the portability of the deceased spouse’s unused exemption does not apply to any unused GST tax exemption. So the GST tax exemption remains a “use it or lose it” proposition. Finally, the ability to use the first deceased spouse’s unused exemption is not automatic, but rather must be elected. It remains to be seen whether a decedent’s personal representative will have to file an estate tax return for the purpose of electing to use the deceased spouse’s unused exemption.


While specific advice can only be made based on the circumstances of a client’s individual situation, general recommendations to consider include the following:


Due to the increase in the gift tax exemption from $1 million to $5 million, clients should consider
making lifetime gifts of up to $5 million ($10 million for a married couple). Using the lifetime exemption now may preserve the benefit of the current exemption from later reductions by future tax laws.


It is possible to leverage a gift and produce significant transfers of wealth for the benefit of the donor’s family by combining it with traditional estate planning strategies, such as irrevocable life insurance trusts (ILITs) and generation-skipping trusts.

For example, assume a donor makes a $5 million gift to an ILIT, to which his $5 million lifetime gift exemption is applied. The ILIT funds are used to purchase a life insurance policy on the donor’s life with a death benefit of $35 million. At the donor’s death, the result is that $35 million will be held in trust for the donor’s family. Also, if the donor applies his GST exemption, the ILIT benefits can be multiplied over several generations.

Of course, donors who live or own real estate in states that still have state gift and estate taxes must carefully weigh the state tax ramifications of any lifetime gifts.

So is there any downside to the lifetime use of the $5 million exemption? If the exemption is later
reduced by future legislation, it is not clear whether the previously used exemption will be subject to
estate tax in the donor’s estate. In that event, the donor should owe no more tax than if the donor had
not made the gift. In fact, the donor may actually owe less if the gifted assets appreciated significantly
between the date of the gift and the date of the donor’s death, because the appreciation would not
be subject to estate tax in the donor’s estate.


When a complete repeal of the estate tax was contemplated prior to 2010, many people assumed that the need for estate planning would decrease significantly. The increase of the estate tax exemption to $5 million may have the same practical effect for clients with smaller estates. Set free from the burden of paying estate tax, these clients can now focus instead on creating a plan that will work best for them and their families, without regard to estate taxes.

For clients with larger estates, the opportunity to gift up to $5 million now ($10 million for married couples)can result in significant estate tax savings at death. For all clients, engaging in the appropriate planning during life still is still the best way to make sure that wealth transfer goals will be achieved.

But keep in mind that the new law expires on December 31, 2012. If Congress fails to enact new tax legislation, we will be right back where we were in December 2001, with a $1 million exemption and a
55 percent maximum estate tax rate. We advise you to consider taking advantage of the opportunities
presented by the Act while you can.

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