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Portability of Unused Estate Tax Exemption under TRA 2010

In December, 2010, the Tax Relief Act of 2010 (TRA) was signed into law.  While TRA extends many of the so-called Bush tax cuts, it introduces new concepts into the gift and estate tax law. One such concept is that of portability which permits the surviving spouse to take the unused portion of the last deceased spouse's federal exemption and aggregate it with the surviving spouse's unused portion.  For example, currently each living spouse has a lifetime exemption from gift and estate tax of $5M.  If Husband dies in 2011 with an estate of $3.5M which he leaves to Wife, there is no estate tax because of the marital deduction.  But Husband has not used any of his $5M exemption (assuming he made no taxable gifts in previous years).  Wife dies in 2012 with an estate of $7M.  The executor of Wife's estate may have available all of the Wife's exemption of $5M and Husband's unused portion needed to reduce the federal estate tax to zero.  Depending upon the state of residence of Husand and Wife, there may be state inheritance/estate taxes to pay. For example, my state of Oregon exempts the first $1M of assets with no portability so Wife would only be able to exempt $1M from Oregon inheritance tax and Husband lost the ability to exempt $1M. 

Portability is not automatic.  To take advantage of Husband's unused exemption, Husband's executor would have to file a federal estate tax return on which the unused portion is calculated and affirmatively allocated to Wife. Without such a filing, Wife's estate is unable to take advantage of portability.

What would happen if Wife remarried before her death and Husband 2 predeceases her?  Wife in this case could not take advantage of Husband 1's unused portion because Wife's last deceased husband is Husband 2.  If Husband 2 has unused his exemption and his executor files a federal estate tax return complying with TRA, Wife can take advantage of Husband 2's unused exemption.  If Husband 2 has used his exemption amount at the time of his death, Wife is left with her own unused exemption.

The new defninition in TRA to take account of portability is "Basic Exclusion Amount".  The Basic Exclusion Amount is the term now used for the term "applicable exclusion amount" which is currently $5M.  The definition of Applicable Exclusion Amount is the Basic Exclusion Amount plus the Unused Basic Exclusion Amount of the last deceased spouse (Applicable Exclusion Amount =Basic Exclusion Amount + Portable Amount).

Planners now need to be thinking about address portability in prenuptial/postnuptial agreements as well as considering portability in planning the wills and trusts of married couples.

For a summary of TRA 2010 click here.

Summary of New 2010 Estate and Gift Tax Relief

Before EGTRRA of 2001 was scheduled to sunset, Congress acted and President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ("TRA"). TRA extended some of the provisions of EGTRRA and JGTRRA of 2003 and added some new provisions such as portability and indexing (both of which will be discussed in future posts on this blog).

Because TRA is the Act that is applied to all estates of people dying in 2010. However, because the passage was so late in the year, the personal representatives and trustees of those estates are given the option to choose to have provisions of EGTRRA and JGTRRA apply to the estate or to have TRA apply.  Which option to choose will be decision based on whether in the long term, it is better to have the estate pass to the heirs and beneficiaries estate tax free or whether it is better to pay some tax but receiving the step up in basis.  This is because in 2010 the estate tax was repealed but there was only a limited step up in basis available under EGTRRA.  If TRA applies, the assets receive a step up in basis but the amount of the estate passing without estate tax is limited.

The limited of that tax is $5M per person ($10M per couple).  This limit applies to the assets being transferred at death and those transferred during the lifetime of the donor as a gift. From 2001 through 2010, lifetime gifting without incurring a gift tax was limited to $1M per donor.  But TRA unified gift, estate and generation-skipping transfer taxes to a lifetime limit of $5M.  This presents a golden opportunity of wealthier Americans to make large lifetime gifts of appreciating property to members of the family circle. This circle may include children and grandchildren (and more remote decedents) because of this unification.  Note, if in the future the estate tax is lower than $5M, any lifetime gifts made will come back into the estate of the decedent. Those gifts in excess of the estate tax imposed on the date of death will be subject to estate tax. If you make a $5M lifetime gift and the estate tax imposed is $3.5M, your estate will owe an estate tax on $1.5M.  However, you have managed to make a tax free gift for federal and state purposes and frozen the value of the asset at the value at the time of gifting. 

For a full summary of TRA 2010 click here.

Looking Into the Crystal Ball Darkly: Is Tax Repeal Good For You?

Because of the federal estate tax repeal for year 2010, people dying in 2010 may pass all of their estate to their loved ones without estate tax liability.  Repeal came with a shift of taxes from estate tax born by the decedent’s estate to the beneficiaries through income tax and capital gains tax because there is a limitation of the step-up basis at date of death and the spousal basis adjustment.  In some cases all of the estate will pass to the surviving spouse and in some cases all of the estate will go to the children. The difference will depend on whether there is a will or trust and its funding formula.

Most “non-taxable” estates (so characterized based on years up to and including 2009), will pass in 2010 to the surviving spouse or to the children, if there is no surviving spouse. In taxable estates (based on previous years), estate planners minimized the estate tax due by a formula which allocated to the family trust (also known as by-pass trust or credit shelter trust) the amount which could pass without federal estate tax (in 2009 that amount was $3,500,000). The excess amount was allocated by formula either outright to the surviving spouse (usually in first marriages) or to the marital trust (in a QTIP usually in second marriages).

If these tax sensitive wills and trusts were not amended to limit the allocation to the family trust, if death occurs in 2010 that will result in overfunding the family trust which could have the result of disinheriting the surviving spouse.  Even if there are sufficient assets and income for the use and benefit of the surviving spouse, overfunding the family trust will result in the loss of the $3.0 million spousal basis adjustment. 

Repeal of federal estate tax does not affect the estate/inheritance tax imposed by many states including Oregon ($1,000,000) and Washington ($2,000,000).  Those estates which exceed these amounts if death occurs in 2010 will pay estate tax on the excess to those states where there is an overfunded family trust.

What to do?  The first thing to do is to review your estate plan. Once you have done that, here is a list of other things to consider with your counsel:

1. Call your estate planning attorney to discuss the specifics of your situation. You may find everything is fine. Or you may be told that you have an overfunded family trust.
2. In the overfunded family trust situation, your attorney may advise you to amend your will or trust to limit the amount that is allocated to that trust for the year 2010.
3. To avoid the potential of losing the spousal basis adjustment, consider transferring assets from the wealthier spouse to the poorer spouse to “save” that adjustment.
4. To prepare for the possibility of paying state estate/inheritance tax, consider a 1 year term insurance for the expected tax liability. 

To emphasize, any action taken should be taken with the advice and assistance of competent estate planning counsel.  This is a very technical area of the law which requires the services of an expert.

Join us for an employee benefits seminar on 9/17 at Bridgeport Brewing

Our Labor & Employment Group is hosting a seminar entitled "20/20 Benefits Planning for 2010" on 9/17 at Bridgeport in the Pearl.  For more info on the event, go here. 

Oregon Department of Revenue Reverses Position on Transfers Within 3 Years of Death

Following is a quote from the website of the Oregon Department of Revenue.

In the 2006 Oregon Inheritance Tax Return instructions (Rev. 8-06) for gross estate (page 1, left column), we stated the gross estate includes “...all transfers of property made by the decedent within the three-year period ending on the date of death.”
 
We based our position on Oregon Revised Statute (ORS) 118.160(2) and Oregon Administrative Rule (OAR) 150-118.005(2)(f). In summary, OAR 150-118.005(2)(f) provides that the gross taxable estate includes... gifts made within the three-year period ending on the date of death.
 
We revisited our position on the three-year gifts issue and determined that the rule does not reflect the provisions of ORS 118.007, which connects the Oregon determination of the gross estate to the Internal Revenue Code as it existed on December 31, 2000. Instead, the rule reflects a connection to prior federal law, which did require inclusion of gifts within three years of death in an estate for federal tax purposes. We are removing this requirement from our instructions, eliminating inclusion of the three-year gifts in the gross estate. We will revise OAR 150-118.005 and update you on our progress.
 

Oregon Inheritance Tax: 2009 Amnesty Progam

The Governor signed into a law a bill that directs the Oregon Department of Revenue to conduct a tax amnesty program. Amnesty will be available for any inheritance tax return which had an original due date prior to January 1, 2008.

Oregon disconnected from the current federal law and calculates its inheritance tax under the prior federal law which exempts $1,000,000 from inheritance tax. Oregon does recognize the marital deduction and allows the transfer of an estate to the surviving spouse (or registered domesic partner) without tax liability.

Oregon inheritance tax is 100% of the state death tax credit allowed by 2000 federal law. Oregon does not allow the calculation of taxable estate after the state death tax deduction.