5 Important Facts About the New Estate Tax

In December 2010 Congress enacted the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. This law created an entirely new estate tax regime. To understand the extent of the change, it is important to remember where we were prior to the new law.

In 2009, the maximum federal estate tax was 45 percent and the maximum amount that one person could give away without estate tax (exclusion amount) was $3.5 million. Estate planners believed that a new law would have been enacted before the end of 2009 because the then current federal estate tax law was due to expire by the end of the year. Congress did not act and, thus, in 2010 there was no estate tax. This meant that no matter how much money there was in the estate, there was no tax in 2010. No doubt this was good news for George Steinbrenner’s heirs!

So why did Congress finally enact a new law in 2010 – when they couldn’t seem to manage it in 2009? As opposed to the absence of an estate tax in 2010, the prior estate tax law was written in a way that would bring back more excessive estate taxes in 2011. If Congress failed to act in 2010, the maximum federal estate tax would be 55% (an increase from 45% in 2009) and the exclusion amount reduced to $1 million per person (from $3.5 million in 2009) beginning in 2011.

1. Change In Exclusion Amount

In 2011 the new exclusion amount ( the amount any one person can give away without estate tax) is now $5 million. This is a significant increase from both the 2009 level ($3.5 million) and the level we would have been at in 2011 had congress not acted ($1 million.)

2. Change in Tax Rate

The new maximum estate tax rate on the amount in excess of the exclusion is 35% in 2011. This rate is significantly reduced from 2009 (45%) and what it would have been without a new law (55%).

3. Portability of Spousal Exclusion

For the first time in the history of estate taxes, an unused spousal exclusion can be used at the second spouse’s death. Under estate tax law (both old and new), the exclusion amount does not apply to spouses. Thus, the first spouse to die can give all their property, no matter the amount, to his or her spouse without estate tax. This created a problem. The spouse that died first lost the ability to give away the exclusion amount because he or she had given away all of their property to their spouse.

This problem is better understood by example. Under 2009 law ($3.5 million exclusion), husband dies and gives $7 million to his wife. There is no estate tax because of the unlimited spousal exclusion. When wife dies, under 2009 law, she could give away $3.5 million tax free. Her estate will be subject to estate tax on the remaining $3.5 million (assuming she had not spent the $7 million of course). Under the new law, wife has the ability to use her husband’s unused spousal exclusion of $3.5 million when she dies. In this scenario, there would be no estate tax due.

Currently, estate planners use trusts to prevent the loss of the first-to-die spouse’s exclusion amount. These trusts are often referred to as bypass or credit shelter trusts. Should these portability provisions survive the test of time, the use of these trusts as tools to prevent the loss of the exclusion may decline.

4. Sunset Provision

Unfortunately, the new estate tax law (just like the prior version) has a sunset provision. If Congress does not enact a new estate tax law within two years, we return to a much more severe estate tax. Thus, in 2013, the maximum tax rate would be 55% and the exclusion amount would be $1 million. Importantly, the spousal exclusion portability provisions will also expire. Consequently, only if both spouses die in the next two years will they be able to take advantage of the new portability provisions.

5. Don’t Forget your State

Regardless of Congress’s actions (or inactions), both Maryland and the District of Columbia have their own state estate taxes. The exclusion amount in both jurisdictions is only $1 million. In our local area estate tax planning may still be needed regardless of the new federal estate tax provisions.