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  • Wealth planning under the 2010 Tax Relief Act: Temporary estate and gift tax planning opportunities

    The 2010 Tax Relief Act signed into law last month provides temporary estate and gift tax relief that will have an important impact on estate planning for the next two years. Susan Minahan and Brad Kalscheur discuss planning opportunities and challenges the Act provides estate planners.
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    Susan Minahan Brad Kalscheur

    By com scminahan michaelbest Susan Minahan and com bjkalscheur michaelbest Brad Kalscheur, Michael Best & Friedrich LLP, Milwaukee

    Jan. 5, 2011 – The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act (2010 Tax Relief Act), enacted Dec. 17, 2010, and signed into law on Dec. 18, 2010, provides temporary estate and gift tax relief that will have an important impact on estate planning for the next two years. The 2010 Tax Relief Act (the Act) extends the 2001 Bush era tax cuts; increases estate, gift, and generation skipping tax exemption amounts to $5 million; and reduces the estate tax rate to 35 percent, but only for 2011 and 2012. While the Act provides excellent planning opportunities for wealth transfers in the next two years, it also presents some challenges for estate planners.

    The new law came just days before the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) were scheduled to expire on Dec. 31, 2010. Starting in 2001, EGTRRA gradually increased the estate tax exemption to $3.5 million in 2009 and reduced the estate tax rate to 45 percent, culminating in a one-year repeal of the estate tax in 2010.1 Had the 2010 Tax Relief Act not been passed, the sunset would have occurred and the estate, gift and generation skipping tax exemption amounts would have returned to $1 million per person and a 55 percent tax rate.

    Exemptions and rates in 2011 and 2012

    Below are highlights of the Act, which are applicable in 2011 and 2012:

    • Unified estate and gift tax exemption of $5 million;
    • Generation skipping transfer tax (GST) exemption of $5 million (indexed for inflation in 2012);
    • 35 percent maximum federal estate tax rate on assets in excess of unified estate and gift tax exemption;
    • 35 percent maximum federal GST rate on assets in excess of exemption;
    • 35 percent maximum gift tax rate on assets in excess of unified gift and estate tax exemption;
    • Return of stepped up basis/repeal of carryover basis;
    • Portability of a deceased spouse’s unused estate tax exclusion amount.
    Wealth planning under the 2010 Tax Relief Act: Temporary estate and gift tax planning opportunities

    Exemptions, rates, and deaths in 2010

    For all deaths occurring in 2010, the estate tax exemption is $5 million and the top estate tax rate is 35 percent. However, estates may elect the regime in effect for most of 2010, which was the modified carryover basis system and no estate tax. For deaths occurring after Dec. 31, 2009, and before Dec. 17, 2010, if estates do not elect the “no estate tax” regime, estate tax returns will be due on Sept. 17, 2011, and heirs have nine months from Dec. 17, 2010, to disclaim an interest in property passing to them from a decedent who died during that period. For deaths occurring in 2010, the GST exemption is $5 million and the tax rate is 0 percent. Finally, the lifetime gift tax exemption in 2010 remained at $1 million and the top gift tax rate remained at 35 percent.

    Return of full basis adjustment

    A welcome relief for practitioners and taxpayers is the return of the full adjustment to income tax basis of assets received from a decedent in 2011 and 2012. Stepped up (or stepped down) basis allows for a cost basis adjustment of a decedent’s assets to date of death fair market value. Alternatively, under the modified carryover basis system, a decedent’s cost basis in an asset carries over to the beneficiary, potentially resulting in significant capital gains upon subsequent sale of the asset. Carryover basis also leads to cumbersome and time-consuming estate administration. As previously noted, however, the modified carryover basis/no estate tax regime may be elected in 2010 as an alternative to full basis adjustment and a $5 million estate tax exemption.

    Introduction of portability

    Under prior law, the estate tax exemption of the first to die was a “use it or lose it” proposition. The 2010 Tax Relief Act provides for portability of a deceased spouse’s unused estate tax exclusion amount (DSUEA). For deaths occurring in 2011 and 2012, a surviving spouse may add their DSUEA to the surviving spouse’s estate tax exemption without the use of the traditional credit shelter trust.

    Portability was designed to simplify estate planning, but it may pose challenges. Clients may be inclined to rely on portability rules for estate tax avoidance, using outright bequests to spouses instead of traditional trust planning. However, portability should not be relied upon solely for utilization of the first to die’s estate tax exemption, and credit shelter trusts created at the first spouse’s death may still be advantageous for several reasons:

    • Portability may be lost if the surviving spouse remarries and is later widowed again, because the DSUEA may only be used for the “last” deceased spouse;
    • Portability is available only if an election is made on the first to die’s timely filed estate tax return;
    • Credit shelter trusts protect appreciating assets from estate tax at the second spouse’s death;
    • Credit shelter trusts provide asset protection, keeping trust assets from the reach of the surviving spouse’s creditors;
    • Portability does not apply to the GST tax. Therefore, in order to fully leverage the GST exemptions of both spouses for dynasty trust planning (to mitigate estate taxes in subsequent generations), it will still be necessary to create a trust at the first spouse’s death.

    Planning opportunities for 2011 and 2012

    Wealthy clients have an opportunity in 2011 and 2012 to reduce the size of their estates by making gifts up to $5 million (less any used gift exemption) to heirs free of gift and GST tax. When combined with the use of valuation discounts, which were not restricted by the Act as some anticipated, the potential for gifting is even greater.

    Those who want to make lifetime transfers in excess of $5 million will pay 35 percent gift tax, a relatively low rate that will likely increase in 2013.

    The 2010 Tax Relief Act does not contain restrictions on the Grantor Retained Annuity Trust. This highly effective wealth transfer planning technique takes advantage of the current historically low interest rates to make gifts of appreciating assets.

    Those who have utilized a sale to an intentionally defective grantor trust (IDGT) may wish to make additional discounted gifts to the IDGT. Seed gifts for sales to IDGTs may also be larger in the next two years.

    Advising clients of the timing of gifts will be important. Unless further legislation is forthcoming, we will return to $1 million estate tax exemption and a 55 percent tax rate after Dec. 31, 2012.

    With the top income tax rates holding steady for 2011 and 2012, clients making Roth IRA conversions in 2010 who considered electing to accelerate all the income recognized on conversion into 2010 will most likely defer the income recognition into 2011 and 2012 (which is the default rule for 2010 conversions).

    The Act also extended for 2010 and 2011 the ability to make a charitable distribution from an IRA directly to a qualifying charity. Special rules apply to distributions made in January 2011 to treat those distributions as being made in 2010.

    Review of formula clauses

    Due to the increased estate tax exemption amounts, practitioners should review formula clauses in trusts to ensure that either the marital trust or the credit shelter trust is not receiving proportionately more of the client’s assets than anticipated and desired. This will be especially important in a second marriage situation where the spouse is not a beneficiary of the credit shelter trust.


    The Act provides a window of opportunity for lifetime gifting and other estate planning. However, clients may feel that with the larger exemption amounts and the introduction of portability, there is no need for traditional estate planning. As previously noted, portability should not be blindly relied upon, and while tax planning is one reason for estate planning, practitioners may need to place emphasis on non-tax goals such as: probate avoidance, asset protection, business succession planning, asset management, and various personal reasons.

    About the authors

    Susan Minahan is a partner in the Wealth Planning Services Practice Group at Michael Best & Friedrich LLP. Minahan focuses her practice in the areas of estate planning, probate and trust administration, will contests and trust litigation, charitable giving, prenuptial agreements, and business succession planning. Her experience includes the preparation and implementation of estate planning documents for the purpose of achieving clients’ personal goals while minimizing wealth transfer taxes. She can be reached at (414) 225-4962 or by email at com scminahan michaelbest michaelbest scminahan com.

    Brad Kalscheur is a partner in the Wealth Planning Services Practice Group at Michael Best & Friedrich LLP. Kalscheur’s practice includes all areas of estate and business succession planning, as well as the structuring and taxation of partnerships and limited liability companies. In his practice, he has assisted with the transfer of many closely-held family businesses between generations, monitoring the viability of the companies while minimizing taxes of the older generation. Kalscheur can be reached at (414) 225-2763 or by email at com bjkalscheur michaelbest michaelbest bjkalscheur com.


    1Estate tax “exemption amount” as used in this article means the applicable exclusion amount, which is newly defined in the Act as the “basic exclusion amount” plus the deceased spouse’s unusued exclusion amount.


    • PINNACLE seminars: Restoration of the Estate and Gift Tax in 2011: Planning and Drafting Issues, Part 1, Jan. 11; Part 2, Jan. 12 (telephone)