As a result of the recent Jobs Creation legislation in December of 2010, individuals now have lifetime gift tax exemptions of $5,000,000 through 2012. In addition, the Generation Skipping Tax (GST) and estate tax exemptions have increased to $5,000,000 through December 31, 2012. Without any additional legislation, the gift and estate tax exemptions are scheduled to return to levels of $1,000,000 on January 1, 2013, though the GST will be indexed for inflation at $1,400,000.
It is uncertain whether the $1,000,000 exemption will return after 2012; however, a case could be made to use the $5,000,000 levels as quickly as possible. Once a complete and proper transfer is made, and the assets are not includable in the transferor’s estate , the property transferred plus all income and growth, escape later estate, gift and GST tax.
Another reason to act now is valuation discount reduction legislation. This type of legislation has been previously discussed by Congress, but has not yet been enacted. Such legislation could be enacted retroactively to the beginning of a tax year, and work to eliminate or reduce certain estate planning vehicles which utilize discounts.
A number of vehicles could be used to take advantage of the newly increased exemptions. Some options Individuals could utilize are Grantor Trusts, Self-Settled Trusts, GST Trusts, and through transfers in real estate such as a Qualified Personal Residence Trusts (QPRT).
There is, however, the potential for technical issues to arise when the federal estate tax is calculated. An estate could be required to pay estate tax on the gifts that used the additional $4,000,000 exclusion. This “claw back” was likely not intended by Congress. However, it is unclear how this will play out if Congress fails to act and make the $5,000,000 gift tax exemption permanent.
A new concept introduced in this legislation is portability. Portability is when the surviving spouse inherits a pre-deceased spouse’s unused exclusion amount, effectively sheltering both the survivor’s gift and taxable estate. This is where the idea of the Deceased Spouse Unused Exclusion Amount (DSUEA) comes into play. The DSUEA is the amount of exclusion which the decedent did not utilize at their death, which could be passed along to their surviving spouse. The survivor could theoretically have up to a $10,000,000 gift and estate tax exclusion, and the full exclusions could be used by the survivor.
However, there are issues arising with portability. Portability does not reduce the need for a credit shelter trust and it is scheduled to expire in 2013. Both spouses have to die between January 1, 2011 and December 31, 2012. Additionally, an estate tax return must be filed at the time of the first spouse’s death so the surviving spouse can claim the unused exclusion, regardless of the estate’s size. There is no inflation adjustment for the unused exclusion. There is no portability in New York, New Jersey or Connecticut. Another limitation concerns remarriage. If the surviving spouse remarries, he/she loses the exemption of the first spouse, and gets (for better or worse) any remaining exemption from the second spouse.
There are unresolved issues relating to the DSUEA and gifts made when the exclusion is $5,000,000, but deaths occurred in years when the exclusion is less. The “claw back” issue arises again.
As the case can certainly be made for taking advantage of the estate tax savings under this new legislation, we await further guidance from Congress and the Internal Revenue Service, as some aspects of this law still lack clarity.