On January 1, 2011, as we welcomed the new year we also welcomed the largest exemption from federal estate taxes ever for married couples – a whopping $10 million exemption.
President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act on December 17, 2010. This new law provides changes to the rules governing federal estate taxes, gift taxes and generation-skipping transfer taxes for the 2010, 2011 and 2012 tax years.
SUMMARY OF THE TAX LAW CHANGES
For deaths occurring in 2010, the decedent’s heirs will have the choice of applying the 2011 federal estate tax (making use of the “unlimited step up basis”) or applying the 2010 unlimited exemption (making use of the “modified carryover basis”). The tax basis choice of rules determines how the heirs calculate their taxable gain when they sell property they have inherited. In general, for the vast majority of families, the better choice is the 2011 rules; the $5 million exemption is so large that more than 99.5% of estates will not owe any tax.
Here is a summary of what the new law provides for the estates of decedents who die in 2011 or 2012:
Sets new and unified estate tax, gift tax and generation-skipping transfer tax exemptions and rates. For 2011 and 2012, the federal estate tax exemption will be $5.0 million and the estate tax rate for estates valued over this amount will be 35%. The estate tax has also become unified with federal gift and generation-skipping transfer taxes such that the gift tax exemption and generation-skipping transfer tax exemption will be $5.0 million each and the tax rate for both of these taxes will also be 35%.
Offers “portability” of the federal estate tax exemption between married couples. In 2009 and prior years, married couples could pass on two times the federal estate tax exemption by including “Credit Trusts” (also called “AB Trusts”) in their estate plan. The new law eliminates the need for Credit Trust planning for federal estate taxes (however, see below for Washington state estate taxes) by allowing married couples to add any unused portion of the estate tax exemption of the first spouse to die to the surviving spouse’s estate tax exemption. This will effectively allow married couples to pass $10 million on to their heirs free from estate taxes with absolutely no planning at all. Note that portability was not applied retroactively to January 1, 2010, and is only available for deaths that occur during the 2011 and 2012 tax years.
Definition of Portability of the Estate Tax Exemption. In simple terms portability of the federal estate tax exemption between married couples means that if the first spouse dies and doesn’t use up all of his or her federal exemption from estate taxes, then the exemption that the deceased spouse didn’t use will be transferred to the surviving spouse’s exemption so that he or she can use the deceased spouse’s unused exemption plus his or her own exemption when the surviving spouse later dies.
Definition of Generation Skipping Tax. A generation skipping tax is a tax that is assessed on property that is passed from one generation to a generation that is two or more levels below the generation of the person who is making the transfer.
For example, a transfer of property from a grandparent to a grandchild while the child of the grandparent is alive would be subject to the generation skipping transfer tax. In addition, a transfer from one person to an unrelated person who is 37 1/2 years or more younger than the person making the transfer is subject to the generation skipping transfer tax.
Definition of Gift Tax: A gift tax is a tax assessed on the value of property that is gifted from one person to another. The person who makes the gift is the one responsible for paying the gift tax and reporting the gift to the IRS on Form 709 while the person who receives the gift will not need to report the gift as part of their income.
In 2011, federal law exempts the first $13,000 of gifted property to each individual from the federal gift tax. This dollar amount is referred to as the “annual exclusion from gift tax.”
Gifts to spouses who are U.S. citizen are exempt from gift taxes due to the unlimited marital deduction. In 2010, gifts made to spouses who are not U.S. citizens were exempt up to the first $134,000 and this amount has increased to $136,000 in 2011.
STATE OF WASHINGTON ESTATE TAX
The State of Washington has its own estate tax separate from the federal estate tax. The state estate tax has been in place since 2005. Currently, there is a $2 million exemption in the State of Washington, with a 10% tax that climbs up to 19% at $9 million and above. If a decedent has a gross estate or a taxable estate plus taxable gifts of $2.0 million or more, the estate is required to file a Washington State estate tax return. If the decedent has a gross estate or taxable estate plus taxable gifts of $5.0 million or more for 2011, the estate is required to file a Washington State estate tax return and include a copy of the filed federal estate tax return.
If a married couple’s combined estate is valued at $2.0 million or more, their Last Will and Testaments should include a Credit Trust and Marital Trust to 1) preserve some or all of the $2.0 million State of Washington exemption of the first spouse to die and 2) delay the payment of State of Washington estate taxes on any amounts in excess of the $2.0 million. Retirement accounts and life insurance death-benefit values are included when valuing a person’s estate for both federal and state estate tax purposes.
If you have questions regarding the above or need assistance with your estate plan, please call us at (206) 621-1600 or email Gary Gill at firstname.lastname@example.org.