Bar News - March 18, 2011
Elder, Estate Planning and Probate Law: Lifetime and Testamentary Transfers in 2010
By: Ruth Tolf Ansell
At the beginning of 2010, applicable law provided for a $1,000,000 federal gift tax exemption, with a 35% tax rate for 2010 gifts in excess of the exemption, and no federal estate or generation skipping transfer (GST) tax on transfers completed before 2011. Retroactive changes were discussed early in the year, until the deaths of a Texas billionaire (Dan Duncan) and the owner of the New York Yankees (George Steinbrenner) resulted in the transfer of assets worth billions of dollars without federal estate taxation. Thereafter, it appeared likely that a challenge to the retroactive imposition of an estate tax would be met with significant and likely successful resistence. No changes to the tax law were then anticipated until after the November election. With a possible reversion to a $1,000,000 estate tax exemption in 2011 prompting bawdy speculation that wealthy Americans might die unnaturally before the end of the year, the pressure was on to pass a law, either reinstating the 2009 estate tax exemption of $3,500,000 or adopting a new law for 2011.
|Ruth Tolf Ansell
Although the 2010 law was seemingly simple, many questions arose during the course of the year, including the interpretation of formula clauses in documents which referenced the estate or GST tax exemption, and the interplay between 2010 transfers and subsequent exemptions and applicable tax rates. The Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the "2010 Act"), adopted on December 17, 2010, answers many of these questions and provides certain planning opportunities, in addition to changing the law for 2011 and 2012.
The following materials will focus on the application of the 2010 Act to lifetime and testamentary transfers completed in 2010. As applicable prior to 2010, all exemption amounts discussed below will be reduced by prior taxable gifts.
Gift Tax Provisions
The 2010 Act did not revise the gift tax laws applicable in 2010 under EGTRRA. The $1,000,000 lifetime exemption and $13,000 annual gift tax exclusion were unchanged. IRC sections 2505 and 2503(b). Taxable gifts in excess of the exemption were taxable at the rate of 35%. IRC section 2502.
The due date for filing gift tax returns is April 18, 2011 (since April 15 is a holiday in Washington, DC.) A 6 month extension should be considered, however, for any GST gift, discussed in greater detail below.
Estate Tax Provisions
The 2010 Act retroactively reinstated federal estate taxes for 2010. Unless an executor elects otherwise, an estate tax will be payable at the rate of 35% on taxable estates for 2010 decedents in excess of $5,000,000. The estate will receive a step-up in basis for all estate assets. IRC section 1014. This is the default provision under the new law, since it will apply to most 2010 decedent estates. In this respect, it is similar to the pre-2010 law, but with a significantly larger exemption. Marital and charitable deductions will be available, as in the past.
No forms are required to be filed with the IRS for 2010 decedents when the gross estate is less than $5,000,000. Since the estate will receive a step-up in basis for all estate assets, however, appraisals should still be secured for non-marketable assets and the fair market value of securities should be inventoried as of the date of death in order to adjust the tax basis of estate assets in the hands of the heirs, surviving joint tenants and/or legatees.
Consistent with pre-2010 law, an estate tax return will be required when the gross estate of a 2010 decedent is greater than the $5,000,000 exemption, unless the executor elects to pay no estate tax, with the modified carryover basis rules which had been included in EGTRRA. For simplicity, I will refer to the second option as the "elective 2010 law."
Of course, the deadline for filing an estate tax return has already passed for any decedent dying before April, 2010, and the IRS will need to publish a new estate tax return, IRS Form 706, for 2010 decedents. Accordingly, the 2010 Act extended the deadline for filing all estate tax returns for 9 months after the date of enactment. This means that all estate tax returns for 2010 decedents will be due on the later of September 19, 2011 (since September 17, 2011 is a Saturday) or 9 months after the date of death for decedents who died after December 17, 2010. The due date for payment of all estate taxes has also been extended.
In lieu of the estate tax with a $5,000,000 exemption, as indicated above, the executor of a 2010 decedent's estate may elect to pay no estate tax, with the modified carryover basis rules which had been included in EGTRRA. This election avoids the challenge which could otherwise have been made to the retroactive application of the estate tax for wealthy 2010 decedents. Under these rules, the basis of estate assets may be stepped-up or adjusted for pre-death appreciation, within limits. Appreciation of $3,000,000 may be allocated to assets passing to a surviving spouse and appreciation of $1,300,000 may be allocated to assets passing to the surviving spouse or to anyone else, including a credit shelter trust. IRC section 1022.
A carry-over basis report, IRS Form 8939, will need to be filed by the executor of the estate to report the allocation of basis adjustment. IRC section 6018. This form was drafted by the IRS prior to the adoption of the 2010 Act, calling for the executor to list specific assets passing to each distributee, with carryover basis value, holding period and allocation of basis step-up for each asset. The due date for fling this report had been the due date for filing the decedent's final income tax return (April 18, 2011.) IRC section 6075(a).
As a result of the 2010 Act, the carry over basis report will be revised to include instructions on the executor's election. This report is not available for filing at this time. The time and manner for making the election will be prescribed by the IRS. A notice on the IRS website dated February 16, 2011 indicates that this report should not be filed with the decedentís final income tax return. This notice also indicates that the final Form 8939 will be posted to the IRS website at least 90 days before it is required to be filed. The executor should consider filing an application for an extension of time to file the estateís income tax return if any capital assets were sold in 2010. Similarly, each of the beneficiaries of the estate should file an application for an extension of time to file income tax returns which reflect the sale of estate assets in 2010. Once made, the election would be revocable only with the consent of the IRS.
Under the modified carryover basis rules, the tax basis of assets not receiving the limited step-up discussed above will have a basis equal to the lesser of the decedent's adjusted basis or the fair market value of the property on the date of the decedent's death. IRC section 1022.
Generally, the executors of estates of less than $5,000,000 will not make the election permitted under the 2010 Act, but the executors of estates greater than $5,000,000 will need to consider this option. For gross estates greater than $5,000,000, the 2010 law will probably be more attractive when deductions (such as a marital or charitable deduction) would reduce the taxable estate to less than $5,000,000. Even for taxable estates greater than $5,000,000, however, the 2010 law might be more attractive to secure a step-up in basis for all estate assets if the applicable estate tax would be significantly less than the anticipated capital gains tax upon a sale of estate assets.
By example, if a married 2010 decedent dies with a taxable estate of $6,000,000, and a marital deduction of $500,000, the applicable estate tax would be $175,000 ($6,000,000 less $5,000,000 exemption and $500,000 marital deduction X 35% estate tax.) If the basis of estate assets is $0, and a prompt sale of these assets is anticipated (such as an estate subject to a buy-sell required upon the death of a decedent business owner), the carryover basis rules would result in a higher ultimate tax, payable upon the sale of the estate assets. ($6,000,000 less $1,300,000 and $500,000 modified step-up in basis X 15% capital gains = $630,000.) In this case, all of the beneficiaries of the estate would benefit from the application of the 2010 law. (See example 1.)
Compare, however, if an unmarried 2010 decedent dies with a taxable estate of $9,000,000, the applicable estate tax would be $1,400,000 ($9,000,000 less $5,000,000 exemption X 35% estate tax.) Even if the basis of estate assets is $0, the carryover basis rules will result in a lower ultimate tax, payable upon a sale of the estate assets. ($9,000,000 less $1,300,000 modified step-up in basis X 15% capital gains = $1,155,000.) The elective 2010 law would be beneficial in this example for all of the beneficiaries of the estate. (See example 2.)
Most of the calculations will not be this easy, however. The executor must consider the impact of the tax payment on the beneficiaries of the estate. The estate tax burden could be disproportionately imposed on individuals who may not receive as much benefit from the basis step-up. When the tax burden is not shared by the same beneficiaries, even when an election will avoid the more immediate estate tax, caution should be exercised.
Consider the application of this law to a 2010 decedent's trust with a typical, pre-2010 formula allocation between a pecuniary marital bequest and a residuary credit shelter trust. The trust directs that the marital bequest will equal the maximum marital deduction, reduced by the amount which may otherwise pass without tax as a result of the unified credit. If the executor does not elect the elective 2010 law, $5,000,000 would be allocated to the credit shelter trust and the balance of the estate would be distributed to the surviving spouse. A step-up in basis would be applied for all estate assets, and there would be no tax payable by the 2010 decedent's estate as a result of the marital deduction for assets in excess of the $5,000,000 estate tax exemption. (See example 3.)
If the executor elects the elective 2010 law, however, there would be no estate tax on the estate, and all of the trust could pass under the applicable trust formula to the credit shelter trust with a limited basis increase of $1,300,000. Alternatively, under the applicable trust formula, all of the trust could pass to the surviving spouse with a basis increase of up to $4,300,000. This election may or may not cause the surviving spouse's estate to be subject to estate tax at his or her death, and may or may not subject estate assets to a capital gains tax on pre-death appreciation, but it could also permit the surviving spouse to divert the trust assets to individuals who are not beneficiaries of the 2010 decedent's trust. Caution should be exercised in this event, especially when the surviving spouse is not the parent of the decedent's children. (See example 3.)
A number of other factors should also be considered when an executor is deciding whether to elect the elective 2010 law. Given the significantly increased estate tax exemption and elective option, historically fewer taxable estate tax returns will be filed for 2010 decedents, potentially increasing the risk of audit if deductions are questionable, if the decedent may have made significant, unreported lifetime transfers, or when valuation of assets includes substantial discounts. Alternatively, the executor of an estate may have difficulty in substantiating the carryover basis of assets in order to file a carryover basis report and elect out of the 2010 estate tax. State estate taxes may also be applicable when a 2010 decedent owns property in another state.
The executor of an estate should also consider the impact that a delay in making the election may have on the distribution of an estate or trust. If a wealthy individual died in January of 2010, and the election changes the amount which would be allocated under a formula bequest to the surviving spouse or others, distribution should be delayed until the election has been filed. In this case, the election could delay distribution of the estate by more than 17 months after the 2010 decedent's death. What if estate assets had been distributed or allocated before December 17, 2010 on the basis of the pre-2010 Act law? Will the executor be required to make an election in that event? Will Court action be required to re-allocate estate assets in a more tax advantageous manner? Answers to these questions may not be available within the next few months.
Although not relevant for most New Hampshire estates, a state death tax deduction is available for 2010 decedent estates who own property subject to tax in another state.
Under the 2010 Act, the deadline for filing a disclaimer with respect to 2010 estates has also been extended until the later of September 19, 2011 or 9 months after the date of death for decedents who died after December 17, 2010. Similar to the estate tax filing deadline, the 9 month deadline had already passed for pre-April 2010 decedents. Beneficiaries may have already accepted some of the property which could have otherwise been disclaimed under the 2010 Act. Also of concern, RSA 563-B:2 expressly provides for qualified disclaimers to be made within 9 months after the death of the deceased owner. However, RSA 563-B:6 expressly provides that this chapter does not "abridge the right of a person to ... disclaim or renounce property or an interest therein under any other statute." Accordingly, a qualified disclaimer executed in accordance with the 2010 Act before September 19, 2011 should be recognized under federal law, and will probably be recognized under state law.
The portability provisions of the 2010 Act are not effective in 2010, whether or not the executor of an estate elects the application of estate tax for a 2010 decedent.
GST Tax Provisions
The 2010 Act also retroactively reinstated federal GST tax for 2010, but unlike the estate tax, no election is permitted to take advantage of the 2010 law prior to amendment. The retroactive reinstatement of GST tax laws to 2010 clarifies most of the uncertainty which had resulted from the temporary repeal of this tax. A 2010 decedent will be treated as the transferor under IRC section 2652(a)(1), whether or not the executor elects for the estate tax to not apply to the estate.
A $5,000,000 exemption is retroactively imposed for 2010. IRC section 2631. This exemption may be used to shelter transfers to trusts which include a spouse, child, or any other individual who is in a generation higher than grandchildren, including a credit shelter trust, which may ultimately generation skip.
The restoration of a GST exemption for 2010 decedents clarified the application of formula clauses in pre-2010 trusts which referenced this exemption. Since this exemption is not elective, the amount which will pass to the GST exempt trust will be capped at $5,000,000. Formula clauses in trusts which reference the amount which may pass without GST tax (without reference to the GST exemption) should be carefully reviewed to determine the appropriate apportionment of the trust estate.
With respect to any direct skip (a transfer to a grandchild or more remote descendant (skip-persons), or to a trust for the benefit of skip-persons, however, the applicable rate of tax for 2010 was 0%. Although time was short after the enactment of the law before the end of the year, otherwise taxable terminations and taxable distributions from previously created GST non-exempt trusts were essentially exempt from tax as a result of the 0% tax rate.
Similarly, otherwise taxable year-end gifts to skip-persons were advantageous, especially for individuals who could transfer assets to these individuals or to trusts for their benefit within the 2010 gift tax exemption ($1,000,000.) Note that the GST automatic allocation rules will apply to 2010 transfers, so that a gift tax return will need to be filed if the taxpayer wants to elect the 0% tax rate on a taxable transfer, in lieu of the automatic allocation of GST exemption to these transfers.
Also note that although no GST tax will be payable on the 2010 transfer to a trust for the benefit of grandchildren, GST tax would be payable upon the death of a grandchild unless GST exemption is allocated to the trust. The "move-down" rule in IRC section 2653 will continue to apply.
Qualified disclaimers by non-skip persons (such as the surviving spouse and/or children of the decedent) within the extended 9 month period after enactment of the 2010 Act (until September 19, 2011, as discussed in greater detail above) may be used to increase the amount of a direct skip which will be deemed to have passed in 2010, subject to the 0% GST tax.
Under the default rules for 2010 decedents, a $5,000,000 estate tax exemption will be applicable, coinciding nicely with the automatic $5,000,000 GST exemption. Although the interplay between the $5,000,000 GST exemption and the elective 2010 law is not as clear under the law, the apparent intention and general interpretation of the new law includes a $5,000,000 GST exemption and the decedent to be treated as the transferor even when no estate tax is payable.
Schedule R of the estate tax return, IRS Form 706, will need to be filed for 2010 decedents in order to allocate GST exemption. The due date for filing all GST tax returns was extended under the 2010 Act for 9 months after the date of the enactment of the law. This means that all GST tax returns will be due on the later of September 19, 2011 (since September 17, 2011 is a Saturday) or 9 months after the date of death for decedents who died after December 17, 2010. The time for filing a return to make a timely allocation of GST exemption or to elect out of the automatic allocation rules for a direct skip has also been deferred until September 19, 2011.
Nevertheless, the due date for filing gift tax returns was not automatically extended by the 2010 Act. An application for extension of the time to file a gift tax return should be filed in order to make a timely allocation of GST exemption or to elect out of the automatic allocation for lifetime indirect skips.
IRA Charitable Rollover
IRA charitable rollovers under IRC section 408(d)(8) are retroactively permitted for 2010. Given the short period of time for these rollovers to have been completed between the enactment of the 2010 Act and the end of the year, these rollovers may be made at any time before February, 2011.
Under this law, an IRA owner aged 702 or older may direct a distribution of up to $100,000 from his or her IRA to a qualified public charity without recognition of income, but also without a charitable deduction. This transfer will qualify as a required minimum distribution to the IRA owner, although most IRA owners had already taken their 2010 required distribution before the law was changed. Direct roll-overs to donor advised funds or supporting organizations are not permitted.
 These materials have been written very shortly after the adoption of the 2010 Act. Some of the issues raised in these materials may be clarified within the next few months. I encourage you to investigate these issues further.
 The Economic Growth and Tax Relief Reconciliation Act of 2001. P.L. 107-16.
 An estate tax return, IRS Form 706, may also need to be filed in order to report GST transfers or to allocate GST exemption.
 The actual formula in each trust must be reviewed carefully to be certain that this is the result.
 A skip person is a person who is assigned to a generation more than one generation below the generation of the transferor, or a trust where all interests are held by skip persons. IRC '2613(a).
 A distribution of income or principal from a non-exempt trust to a skip person upon termination of the trust by death, lapse of time, release of power or otherwise. IRC '2612(a)(1). An exception is made if immediately afterwards a non-skip person has an interest in the property or at no time thereafter may a distribution be made to a skip-person.
 A distribution of income or principal from a non-exempt trust to a skip-person during the term of a trust. IRC '2612(b).
 The transferor is treated as being one generation older than the oldest beneficiary of the trust.
 Footnote 53 to the Technical Explanation prepared by the Staff of the Joint Committee on Taxation dated December 10, 2010 indicates that this exemption will be available even when the executor elects the 2010 elective law.
Comparison of 2010 Act and Elective 2010 Law Examples
All examples assume a $0 basis for all estate assets prior to death.
Marital ded./Basis adj.
Estate tax 35%
Capital gains tax 15%
Estate tax 35%
Capital gains tax 15%
Marital ded./Basis adj.
Estate tax 35%
Capital gains tax 15%