Highlights of the Newly-Enacted 2010 Tax Relief Act
The 2010 Tax Relief Act – more formally known as the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010″ – was signed into law on December 17, 2010, after months of political wrangling. The Act is a sweeping tax package that includes, among many other items, Estate Tax relief, an extension of the Bush-era tax cuts for two years, a two-year “patch” of the alternative minimum tax (AMT), and a host of retroactively resuscitated and extended tax breaks for individuals and businesses. It is important to keep in mind, however, that many of these provisions are temporary and will expire after 2012, unless Congress intervenes.
Here is a brief look at the key elements of the 2010 Tax Relief Act, with a special emphasis on Estate and business planning:
Estate Tax. After a one-year hiatus in 2010 when there was no Federal Estate Tax, the Estate Tax has been reinstated for 2011 and 2012, with a top rate of 35%. While prior to 2010 the Federal Estate Tax exemption was $3.5 million, it will now be $5 million per individual in 2011 and will be indexed for inflation starting in 2012. As discussed in more detail below, both the Gift Tax and the Generation Skipping Transfer (GST) Tax exemption have also been increased to $5 million.
From an Estate planning perspective, an important feature of the new Act is a concept called “portability.” This means that any or all of a deceased spouse’s unused $5 million exemption may now be transferred to the surviving spouse by making an election on a timely-filed Estate Tax return. Under these rules and with proper planning, a married couple can now shield up to $10 million of their assets from Federal Estate Tax; however, it will be necessary to file an Estate Tax return after the first spouse’s death, no matter the size of his or her Estate. However, as discussed below, there are many situations where it will not be advisable to rely on this portability provision.
Careful planning will be necessary because there are still many reasons why couples with combined Estates under $10 million would not want to leave their entire Estate outright to the surviving spouse. Establishing a Credit Shelter, or “By-Pass,” Trust for the survivor remains a significant tool to remove appreciation from the Estate of the surviving spouse and to provide asset, creditor and divorce protection. It is also important in the event the survivor remarries, in order to ensure that assets pass to the decedent’s heirs, rather than the survivor’s new spouse. Additionally, since the GST exemption is not portable, the Executor of the first spouse to die may choose to establish trusts to utilize that spouse’s unused GST Tax exemption.
Despite the advantages of the new portability provisions, they may have unintended consequences where a surviving spouse remarries, because the first-to-die’s exclusion amount is lost if the survivor remarries and his or her new spouse predeceases him or her. In light of this, and the fact that the GST exemption is not portable, careful planning is essential to determine whether and how to use these new provisions. Additionally, since the new Act is scheduled to “sunset” after 2012, planning is also important to ensure flexibility for the surviving spouse in the event the $1 million Estate Tax exemption is in fact reinstated in 2013, as now provided under the new law.
It is also important to note that the new Act gives Executors of individuals who died in 2010 a choice of which Estate Tax rules to apply – those of 2010 or 2011. This is significant because, although there was no Federal Estate Tax in 2010, some inherited assets will be subject to higher capital gains tax under the 2010 rules, a situation that actually raises the tax burden for some heirs. The general rule under the 2010 law is that inherited assets have a basis equal to their purchase price – commonly referred to as “carryover basis” – rather than the value at death. The carryover basis rules could lead to a significant tax bite for heirs who sell assets, such as stocks or real property, that had been held by a decedent for many years and have greatly appreciated in value.
By contrast, under the 2011 rules heirs will inherit assets with a basis “stepped-up” to the date of death value. While individuals with Estates under $5 million would most likely prefer the 2011 regime – $5 million exemption from both Estate and GST Tax – and an unlimited step-up in basis of assets to their current fair market value – the decision is more complicated for Estates over $5 million.
For Estates of the very wealthy, Executors may find it more advantageous to elect the 2010 eliminated Federal Estate Tax despite the limited step-up in asset basis. For Estates between $5 million and $30 million, however, it may be better to allow the 2011 rules to apply in order to take advantage of unlimited basis step up, even though some Federal Estate Tax may be due.
If the Executor makes the election to follow the 2010 rules, the Estate Tax return must be filed by September 20, 2011, the date that is nine months after the new law’s enactment. This filing extension gives Executors additional time to meet with their tax advisors to evaluate which rules are more advantageous for the heirs’ particular situations.
Gift Tax. The new Act impacts significantly on the ability to make additional lifetime gifts, such as interests in business assets. For gifts made after December 31, 2010, the Gift Tax is reunified with the Estate Tax, which means that the $5 million Estate Tax exemption will also be available for gifts. The law in effect prior to 2010 provided a $3.5 million lifetime exemption for Estates, but only $1 million for gifts. The Gift Tax rate, starting in 2011, will be 35%. Given the new gifting rules, individuals with substantial wealth may wish to consider making significant gifts between January 1, 2011 and the end of 2012.
For 2011, the annual Gift Tax exclusion remains at $13,000 for each donee, and married couples may continue to “split” their gifts, thereby permitting combined gifts of $26,000 to each donee without reducing either spouse’s $5 million exemption.
Generation Skipping Transfer (GST) Tax. Under the new Act, the exemption from GST Tax – the additional tax on gifts and transfers to grandchildren and later generations – will also rise to $5 million. The GST tax rate for transfers made in 2011 and 2012 will be 35%. As noted above, however, the GST exemption is not “portable” between spouses; consequently, there remains a need to balance assets between couples if the goal is to maximize each spouse’s GST exemption.
The new Act also extends certain technical provisions of the GST laws, such as automatic allocation of GST exemption for GST trusts, and the ability to make qualified severances for GST planning.
Individual Income Tax Rates. Among the most valuable tax breaks for individuals under the new Act is a two-year extension of individual income tax rate reductions. The new law keeps in place the current 10 through 35 percent individual tax rates for two years, through December 31, 2012. If Congress had not passed this extension, the individual tax rates would have jumped significantly for all income levels.
Capital Gains/Dividends. The new law also extends reduced capital gains and dividend tax rates. Like the individual rate cuts, the extended capital gains and dividend tax rates are temporary and will expire after 2012 unless extended again by Congress. In the meantime, however, for the next two years individuals in the 10 and 15 percent rate brackets can take advantage of a zero percent capital gains and dividend tax rate. Individuals in higher rate brackets will enjoy a maximum tax rate of 15 percent on capital gains and dividends. Only net capital gains and qualified dividends are eligible for this special tax treatment.
The Bottom Line: Despite many favorable aspects of the 2010 Tax Relief Act, there is still a need for careful planning to take advantage of the new provisions and to avoid the pitfalls of their potential unintended consequences.
Previously In the News
Attorney News
Plotnick & Ellis is pleased to announce that Sean Norton has joined the firm as an associate attorney. Sean is licensed to practice law in Pennsylvania, Maine and Massachusetts. He attended Villanova School of Law and graduated in 2009. Sean recently received his LLM in Taxation from Villanova School of Law, where he focused his studies on estate planning.
While an LLM student, Sean also worked for the Villanova School of Law Federal Income Tax Clinic, where he represented low-income taxpayers before the IRS. Prior to attending law school, he worked as a field representative for United State Representative Tom Allen in Portland, Maine. Sean graduated from Cornell University with a degree in economics and government. In his free time, Sean enjoys traveling, fly-fishing and camping.
Plotnick and Ellis is also proud to announce that Charles Plotnick has — for the second year in a row — been named a FIVE STAR Wealth Manager by Philadelphia Magazine. In selecting this year’s Wealth Managers, the magazine surveyed consumers, financial service professionals and subscribers to find wealth managers in the Philadelphia area who score highest in overall client satisfaction.
The 2010 list of FIVE STAR Wealth Managers will be published in the November 2010 issue of Philadelphia Magazine.
Lyn Eisner will be speaking at the 17th Annual Estate Planning Institute in Philadelphia in November on the subject of Qualified Domestic Trusts (QDOTs), an important estate planning technique for non-citizen spouses. Prior to 1988, a decedent could transfer unlimited amounts to his or her spouse through the application of the unlimited marital deduction against Federal Estate Tax which was afforded to all married couples regardless of the spouses’ citizenship. Likewise, he or she could make lifetime gifts to his or her spouse, or title assets in joint names with his or her spouse, and such “transfers” would qualify for the unlimited marital deduction. After 1988, however, the marital deduction was repealed for non-citizen surviving spouses. That means that commonplace transfers during life between spouses (such as the titling of an asset in joint names) as well as those transfers occurring at death, could result in taxation at a rate of 45-55%, after application of an exemption.
With careful planning, a couple can take advantage of the marital deduction if property passes into a QDOT, either because the decedent had executed a QDOT-type of trust prior to his or her death; because the decedent’s will is reformed after death; or because a non-citizen surviving spouse executes a lifetime QDOT in his or her name to receive all of the assets he or she receives by right of survivorship (e.g. as joint property) or by beneficiary designation.
Lyn will speak on the importance of evaluating lifetime transfers (or joint titling) between such clients before death and what a non-citizen surviving spouse can do to ensure that transfers at death qualify for the unlimited marital deduction. Her talk is timely, since such considerations may become even more important if the exemption from Federal Estate Tax is lowered to $1,000,000 so that more estates –perhaps those with a residence, a modest retirement account and life insurance — will become subject to the Federal Estate Tax.
Jonathan H. Ellis will again be teaching the Family Wealth Planning course at Villanova University School of Law for the Spring 2011 semester. This is Jon’s fourth year as an adjunct professor teaching Family Wealth Planning at Villanova.
Along with Lyn Eisner, Jon will also be speaking at the 17th Annual Estate Law Institute in Philadelphia. Jon’s program will be an Advanced-Level Workshop on QTIP Trusts on November 11, 2010. Jon will also be speaking at the Greater Philadelphia Chapter Annual Tax Forum of the Pennsylvania Institute of Certified Public Accountants on Tuesday, November 16, 2010 at the Springfield Country Club, Springfield, Pa. His topic will be Estate Planning & Estate Tax Returns.
Lisa Shearman continues her outstanding work with the Pennsylvania Bar Association Wills For Heroes Program. She has been named Co-Coordinator of the program with Daniel McKenna, Esq., a founder of the Pennsylvania Wills for Heroes Program. Lisa participated in the June 12, 2010 Ellis Island/Liberty Island Wills for Heroes event for New Jersey and New York first responders. Another program event was held August 28, 2010 at the Trevose Fire Co., Trevose, PA.
A special Wills for Heroes event will be held Saturday, September 11, 2010 at the Public Safety Training Center in Doylestown, PA. Other upcoming events will take place September 25, 2010 at the Montgomery Township Fire Department, Montgomeryville, PA; October 23, 2010 at the Midway Fire Company in Lahaska, Pa; November 6, 2010 at the Plumsteadville Fire Company, Plumsteadville, PA; and November 13, 2010 at the Tullytown Fire Department and Police Department, Tullytown, PA.
Previous Attorney News
Jonathan H. Ellis will be the Course Planner for an upcoming Pennsylvania Bar Institute Program entitled “Wills v. Trusts: A Primer on the Right Tool for Your Clients.” The course will be given at four locations: Philadelphia on Tuesday, July 13, 2010, Pittsburgh on Wednesday, July 28, 2010, Mechanicsburg, PA on Thursday, August 19, 2010, and Media, PA on Tuesday, July 20, 2010.
Jon will also be participating on the faculty for another Pennsylvania Bar Institute Program, “Common Estate Planning Blunders – How to Correct and Avoid Them.” This course will be held in Philadelphia on Wednesday, August 11, 2010, and Jon will be speaking on the topic of “Errors in Federal Estate Tax Planning.”
Lisa Shearman has been asked to co-chair the Pennsylvania Bar Association’s “Wills for Heroes” Program with Daniel McKenna, Esq., the founder of the Pennsylvania Program and a Wills for Heroes Foundation National Board Member. On April 17, 2010, Lisa coordinated the first Wills for Heroes event at a Pennsylvania Law School at Widener Law School’s Harrisburg campus. At that event she trained five new county coordinators for the program.
On behalf of Wills for Heroes, Lisa recently accepted a $1,000 grant from the Montgomery County Bar Association, a portion of which was the 2010 Birdsall Impact Grant award. She participated in a special Wills for Heroes Program on Ellis Island on June 12, 2010, and has upcoming Bucks County events scheduled for July 31, August 7, and August 28, 2010. Another event will be held in Montgomery County on September 25, 2010, and she will also participate in Lackawanna County’s kick off of their Wills for Heroes Program on Sept. 11, 2010 in commemoration of the 9/11 Terror Attacks.
Previous Attorney News
Plotnick & Ellis is pleased to announce that Sean Norton is joining the firm as an associate attorney. Sean is a graduate of Villanova University School of Law, and is currently completing his Master of Laws in Taxation at Villanova.
We are also happy to announce that Susan L. Fox has recently been admitted to the Florida Bar, and now joins Jonathan H. Ellis as a Plotnick & Ellis attorney offering advice to our Florida clients. Susan sat for the Bar Examination in February 2010. She is also admitted to practice law in Pennsylvania, New Jersey, and New York.
Lisa Shearman is continuing her volunteer work with the “Wills for Heroes” Program, for which she has recently been named Coordinator for the Montgomery County and Bucks County programs. “Wills for Heroes” is an innovative nationwide program that provides legal services to police, firefighters, and emergency medical personnel and their spouses for the preparation of essential legal documents, such as Wills, Powers of Attorney, and Health Care Directives.
Attorneys working with the “Wills for Heroes” Program donate their expertise and time to meet with our dedicated first responders and prepare documents so that their families will be protected in the event of disability or death. Lisa’s recent “Wills for Heroes” events were February 20 and 27, 2010; March 6, 2010; and April 17 and 24, 2010. Upcoming dates are June 12, 2010, and July 10 and 31, 2010.
Status of Estate Tax Law
At the end of 2009, we fully expected Congress to extend the $3.5 million exemption from Federal Estate Tax into the current year. However, Congress adjourned in December without extending the 2009 Federal Estate Tax rules and created a great deal of confusion as to the estate planning approaches which need to be taken.
At present, the Federal Estate Tax and Generation Skipping Tax have been repealed. However, unless Congress takes action, the Estate Tax will be reinstated in 2011 with a $1 million exemption. At first blush, the current absence of the Federal Estate Tax appears to be a positive development, but as part of the repeal, Congress also repealed the “step-up in basis rules.” The step-up in basis rules can be somewhat complicated, but essentially these rules provided that when an individual died, any capital gains associated with their non-retirement assets would largely be eliminated.
With the repeal of the step-up in basis rules, Congress enacted some modified relief in the form of providing a $1.3 million step-up in basis, together with a $3 million step-up in basis if the assets passed to a spouse in a qualifying manner. This means that, while step-up in basis used to be automatic, it will now require a great deal of planning.
Therefore, anyone with non-retirement assets in excess of $1.3 million should meet with an estate planning attorney to review their existing documents. They may need to have certain language added to their documents in order to maximize the planning opportunities available. Also, people with existing plans designed to minimize the estate tax with the creation of marital trusts and credit shelter trusts, may need changes to their documents.
If anyone were to die this year without the proper changes in their documents, their existing estate plan may not work properly, since most estate planning documents were designed to operate where there was a Federal Estate Tax. In the current environment, the objective now is to maximize the step-up in basis opportunities.
We realize that this uncertainty creates a great deal of confusion, but unfortunately these are issues that need to be addressed. It is also important to keep in mind that Congress can modify these rules. Therefore, we recommend that you contact an estate planning attorney to make certain that your documents are properly updated.
Retirement Accounts and Roth Rollovers: New Savings Opportunities
2010 has brought with it some great opportunities, among them the chance to convert your Individual Retirement Account (IRA) into a Roth IRA regardless of your income. The tax impact can be spread over two years. You may then enjoy tax-free growth in your account, and you will never be subject to the mandatory minimum distribution rules. That means, if you do not end up needing the money, you can pass the account out to your beneficiaries.
While the market appears to be rebounding, it is still off its historic highs. Therefore, the tax impact will be minimized since you will be paying income tax on the depreciated value of your account. Such a conversion can have even more impact if, as many believe, income and estate tax rates will increase in the future. Income taxes paid at today’s low rates have the added benefit of reducing your taxable estate. Moreover if you make a mistake or change your mind, you are afforded the ability to “recharacterize” your Roth rollover back to a traditional IRA, so long as you follow the rules and timing requirements.
Whether you meet with one of our attorneys or your accountant to crunch the numbers to determine whether you would benefit from a Roth rollover, there are several important considerations which your estate planning attorney should evaluate with regard to any retirement account. For example, what happens if your beneficiary designation on your account provides that the account will be payable to your children, John and Joanne? What if Joanne dies, and you do not change your beneficiary designation? Would you want Joanne’s share to pass to John, or would you prefer it pass to Joanne’s children?
In order to assure that your account passes in the way you prefer while retaining the ability to have the proceeds paid out over your beneficiary’s lifetime, it is advisable to have a special “beneficiary designation” drafted by your attorney. If Joanne’s children are minors, this document can provide that her share pass into trust for them. This trust must be drafted in a particular way so that the favorable payout over a child’s life expectancy is preserved. Especially with regard to a Roth conversion, the tax planning in your documents should be reviewed to divert taxes away from the Roth and also to determine which Trust should ultimately be the recipient of your Roth.
As is true for many persons, if your retirement assets comprise a substantial part of your estate, your retirement account beneficiary designations may ultimately be more valuable than your Will in determining how and to whom these assets pass. Your Will and the trusts under your Will should be drafted to carry out the plans you have for your retirement assets.
Previous Attorney News
Charles K. Plotnick has been named a 2009 “5-Star Best In Client Satisfaction Wealth Manager” in a survey of 100,000 high net worth consumers in the Philadelphia area. The announcement will appear in the November issue of Philadelphia Magazine.
Jonathan H. Ellis will again be teaching the Family Wealth Planning course at Villanova University School of Law for the Spring 2010 semester. His next scheduled speaking engagement for lawyers, accountants and financial planners is the “Pennsylvania Complete Trust Course,” sponsored by Professional Education Systems, Inc. in February 2010.
Lisa A. Shearman again participated in the “Wills for Heroes Program” on September 19, 2009. The “Wills for Heroes Program” provides essential legal documents to police, firefighters and emergency medical personnel and their spouses. Attorneys donate their services free of charge to make certain that the families of our dedicated public servants will be protected in the event of their death or disability.