O'Flaherty Heim Birnbaum Kirchner & Curtis Ltd.

Estate and Gift Tax Changes

By:  Gerard O’Flaherty

The Two-Year Tax Relief Act signed into law on December 17, 2010 made sweeping changes to many tax provisions and includes significant developments in estate planning tax law.  Each person will have a $5 million “portable” unified exclusion from estate and gift tax, with any excess taxed at a 35% maximum rate.

The portable $5 million exemption permits a married couple to share $10 million combined exemption.  When the first spouse dies any unused amount goes to the surviving spouse and can be used at his or her death.  Under earlier law, married couples often lost the value of one exemption if the first-to-die spouse left everything to the survivor and did not include a “Bypass” Trust.  However, if an estate plan included a Bypass Trust, it is especially important to review the funding formula or method so as to avoid problems with over funding the Family Trust and under funding of the spouse’s Survivor’s Trust or outright share.  Moreover, individual retirement accounts, primary residences and other assets that should not be in the trust for income tax reasons could be automatically sucked in to the Family Trust if the funding provisions in the Trust are not drafted correctly.

But don’t be too quick to write off all trusts.  Couples in a second marriage will want a fixed amount in a bypass trust to make sure kids from their first marriages aren’t stiffed.  A bypass trust can also provide valuable asset protection—a consideration if, for example, the surviving spouse is an architect, obstetrician or some other professional who could face big legal claims.

Many couples in stable first marriages might sensibly opt to leave everything to each other outright and include a backup “disclaimer” trust for the kids.  With this setup, at the death of a spouse the surviving widow or widower can decide, based on the laws and the couple’s assets at that time, which assets, if any, to disclaim (turn down) and divert into the kids’ trust.

PLAN FOR STATE TAXES

 Currently 21 states have estate or inheritance taxes, or both, in place for 2011.  Estate taxes are levied on any amount above an exemption-typically $1million—left to someone other than a spouse.  Inheritance taxes are based on who gets the cash and can hit the first dollar of a bequest.

Bottom line: Couples worth $2 million or more living in Minnesota, which has $1 million state estate tax exemptions, will still want to put at least $1 million in a bypass or disclaimer trust at the first spouse’s death.

GIFT TAX PLANNING

 As in past years you can make annual gifts of up to $13,000 to as many people as you want without worrying about gift taxes.  If you want to give even more, there is a lifetime gift tax exemption that jumps to $5 million in 2011 and 2012, up from $1 million in 2010. (The estate tax lapsed in 2010, but the gift tax didn’t.)  Any gift tax exemption used reduces an individual’s estate tax exemption.  The generation-skipping transfer tax, an extra tax on gifts and bequests to grandkids if their parents are still alive, also now has a $5 million exemption, up from $1 million in 2009.

When the $5 million gift/GST exemption is leveraged with sophisticated wealth-transfer techniques as grantor-retained annuity trusts and installment sales to trusts, the wealthy will be able to transfer huge sums, tax free, to trusts for their kids, grandkids and generations beyond. (Dynasty trusts, they are called.)  Since GRATs and other techniques could be restricted when Congress finally goes into deficit-cutting mode and since the gift and GST tax exemptions are not portable between spouses, lawyers are advising to begin transferring assets in 2011.

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