Modifications to US Federal Estate, Gift, and Generation-Skipping Transfer Taxes

On 18 December 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Tax Relief Act”). Title III of the Tax Relief Act, titled “Temporary Estate Tax Relief,” includes provisions that will modify certain currently existing rules on US Federal Estate, Gift, and Generation-Skipping Transfer (“GST”) taxes (collectively, “Transfer Taxes” and individually, “Transfer Tax”).

Unless extended by Congress, the Transfer Tax provisions amended or added by the Temporary Estate Tax Relief provisions will sunset after 31 December 2012.

This article summarizes the main points of the Temporary Estate Tax Relief provisions with respect to each of the three Transfer Taxes. It is not intended to be a comprehensive analysis of these provisions.

The 2010 Option of No Estate Tax and No Carry-Over Basis or an Estate tax and a Step-up:

The US Federal Estate Tax and the “step-up in basis at death rules” are reinstated retroactive to 1 January 2010. The Prior law repealing the US Federal Estate Tax for year 2010 and providing for the “modified carryover basis rules” is treated as if it had never been enacted.  However, notwithstanding the reinstatement of the US Federal Estate Tax, an executor of an estate of a decedent dying in 2010 may elect to treat the estate under the rules providing for no estate tax and modified carryover basis. The manner and time to make such an election is to be provided by the secretary or his delegate. Once made, the election is revocable only with the consent of the secretary. For US person decedents with small estates that would not be subject to tax with the new exemptions, executors will want to make sure a basis-step up is achieved. For non-US person decedents, the desired result will depend on the specific needs of the relevant family. Generally, for families with no US person heirs but US situs assets, it will be incumbent to ensure that the no estate tax election is made. For families with non-US decedents and US family members and US situs assets, case specific analysis is required.

Estate Tax

The US Federal Estate Tax and the “step-up in basis at death rules” 46 are reinstated. The prior law repealing the US Federal Estate Tax for year 2010 and providing for the “modified carryover basis rules” is treated as if it had never been enacted.

The reinstated US Federal Estate Tax includes the following features, which apply to estates of decedents dying after 31 December 2009, unless noted otherwise:

- Maximum 35 per cent rate: the maximum estate tax rate is 35 per cent.

- $5,000,000 exclusion amount: the applicable exclusion amount is $5,000,000.

 This amount is indexed for inflation after 2011.

- Addition of deceased spouse’s unused exclusion amount: for decedents dying after 31 December 2010, the applicable exclusion amount of the surviving spouse includes the “basic exclusion amount” of $5,000,000, which is indexed for inflation after 2011, and the deceased spouse’s unused exclusion amount. The surviving spouse may not use the deceased spouse’s unused exclusion amount unless the executor of the deceased spouse makes an election on a timely filed estate tax return, regardless of whether such return is required to be filed. Once made, the election is irrevocable.

Notwithstanding statutory limitation periods, the Secretary of the US Treasury (the “Secretary”) may examine at any time the deceased spouse’s estate tax return in order to determine the proper unused exclusion amount. The secretary is expected to issue regulations to implement these provisions. Notwithstanding the portability of the deceased spouse’s unused exclusion amount, an estate tax return is required to be filed for any decedent if the gross estate exceeds the basic exclusion amount ($5,000,000 in 2011).

- Extended time to file return, pay tax, and disclaim: for decedents dying after 31 December 2009 and before the date of enactment of the Tax Relief Act, time is extended to file the estate tax return, pay the estate tax, and make qualified disclaimers. The extended due date for such acts is nine months after the date of enactment of the Tax Relief Act.

- Computation of Tentative Estate Tax: for purposes of computing the tentative estate tax, the amount of gift taxes payable on and unified credit against such gifts made by the decedent after 1976 is computed by using the estate tax rate in effect on the date of the decedent’s death (rather than at the time of the gifts).

Unless noted otherwise, the amendments or additions to the US Federal Gift Tax by the Tax Relief Act apply for transfers made after 31 December 2010.

The key provisions are as follows:

- Maximum 35 per cent rate: the gift tax and the unified credit against the gift tax are computed by using the estate tax rate schedule, which has a top rate of 35 per cent. For purposes of determining the unified credit against the gift tax, the previously used credits are computed by using the gift tax rates in effect in the year of the gift.

- $5,000,000 exclusion amount and deceased spouse’s unused exclusion amount: the applicable exclusion amount for gifts is at least $5,000,000. The unused exclusion amount of a deceased spouse is portable with respect to the US Federal Gift Tax.

GST Tax

The reinstated US Federal GST Tax, as amended by the Tax Relief Act, is effective after 31 December 2009. As a result of the reinstatement, the Tax Relief Act includes several important clarifying and conforming amendments to the US Federal GST Tax, including the following:

- Zero tax rate in 2010: the tax rate for GST transfers in 2010 is zero. For GST transfers in 2011 and 2012, the maximum tax rate is 35 per cent.

- Maximum $5,000,000 exclusion, deceased spouse’s unused exclusion amount not portable: for purposes of computing the GST exemption amount, the exclusion amount is $5,000,000. The deceased spouse’s unused exclusion amount it not portable with respect to GST transfers.

- Extended time to file return and make elections: for transfers made after 31 December 2009 and before the enactment of the Tax Relief Act, time is extended to file a return to report GST transfers and make any election required to be made on such return. The extended due date for GST transfers after 31 December 2009 is nine months after the date of enactment of the Tax Relief Act.

- GST Tax Applies in 2010 even if an executor makes the election: the election by an executor of an estate of a decedent dying in 2010 for no estate tax and carryover basis is not taken into account in determining whether the decedent is the transferor of property for GST purposes. Further, the election does not affect the continued applicability of the GST tax.

Comments

Several general comments on the Temporary Estate Tax Relief provisions can be made. First, the provisions appear to have simplified the transfer taxes with a unified applicable exclusion amount and the same rate schedule. The applicable exclusion amount is $5,000,000 and can be increased up to $10,000,000 for US Federal Estate and Gift Taxes. Thus, estate balancing will no longer be needed and will drafting became simpler.

Second, the estate tax exemption rate for non-US persons remains $60,000.

Third, the Temporary Estate Tax Relief provisions offer flexibility. The election afforded to executors of estates of decedents dying in 2010 permit the estates to choose between the alternate regimes of not paying the estate tax and deferring built-in gain or paying estate tax now and having no built-in gain as of the date of the decedent’s death. Generally, estates worth no more than $5,000,000 may not find it worthwhile to make the election because of the step-up in basis at death. The extended due date for certain acts, such as filing the estate or GST returns, is another example of the provisions’ flexibility.

Finally, the provisions clarify that the US Federal GST Tax scheme applies in year 2010, although the tax rate in such year is zero. This means certain GST transfers from a trust funded in 2010 may still be subject to GST tax, although with a GST exempt amount of $5,000,000, the tax may not be common.