2010 Tax Relief Act: Federal Estate Tax Provisions
On December 16, 2010 Congress passed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. Section III of the bill is titled “Temporary Estate Tax Relief”.
Section III gives instructions on how estate representatives should calculate and pay estate taxes for decedents who die in the years 2010, 2011 or 2012.
IF YOU DIE IN THE YEAR 2011 OR 2012
The 2010 tax relief act provides:
- The federal estate exemption allowance for a single person is $5 million.
- Married couples can pass $10 million of assets to their heirs free of estate taxes by the use of a new estate tax form referred to as the Deceased Spouse Unused Exclusion Amount (DSUEA)
- The maximum estate tax rate is 35%.
Q. Why should married couples care about the Deceased Spouse Unclaimed Exclusions Amount form?
A Before the 2010 Tax Relief Act created the DSUEA form, the only way a married couple could preserve the estate tax exemption allowance of the first spouse to die was to spend time and money in setting up an A/B trust.
The surviving spouse of someone who dies in the year 2011 or 2012 can now just file Form 706 with the Internal Revenue Service and claim the right to the deceased spouse unclaimed exclusion amount. When the surviving spouse dies, his or her estate representative can combine the last spouse to die $5 million personal estate tax exemption allowance with the first spouse to die deceased spouse unused exclusion amount.
The ability to transfer the estate tax exemption to the surviving spouse is sometimes referred to as portability. The net effect is it gives married couples the right to exclude $10 million of assets from federal estate taxes.
Q. Can domestic partners take advantage of DSUEA?
A. No. The existing Defense of Marriage Act limits federal benefits to a traditional husband and wife.
Q. Can the new DSUEA benefit help if a spouse died several years ago?
A. No. The ability to use the new DSUEA only applies to someone who dies after December 31, 2010.
Q. Is portability automatic?
A. No. The surviving spouse or someone responsible for settling the estate of the deceased spouse MUST file Form 706 estate tax return with the IRS and claim the deceased spouse unused exclusion amount, even if no tax is due. The 706 estate tax return must be filed nine months after death but you can apply for a 6 month extension. The IRS is expected to create a short Form 706 to make it easier to file and claim the DSUEA.
Q. What if the Form 706 is not filed?
A. If the estate of the deceased spouse does not file Form 706, the surviving spouse loses the right to portability.
Q. Should a surviving spouse file Form 706 if the estate is not subject to estate taxes?
A. Yes. If the executor doesn’t file the Form 706 estate tax return or misses the filing deadline, the surviving spouse loses the right to portability. Spouses should file Form 706 even if they’re not wealthy today. Who knows the future. The surviving spouse might win the lottery!
Q. Is the amount of the deceased spouse exclusion amount adjusted for inflation?
Q. Will the amount of the individual $5 million tax exemption allowance be adjusted for inflation?
Q. What happens if the surviving spouse remarries?
A. If a surviving spouse remarries, the surviving spouse must use the DSUEA of the new husband, even if the unused exemption of the new husband is less than the unused exemption of a prior husband.
Q. Does a married couple still need an A/B trust?
A. Married couples no longer need an A/B trust to preserve the federal estate tax exemption of the first spouse to die. Since the DSUEA is not adjusted for inflation, an A/B trust may still be useful in protecting the appreciation of the first spouse to die assets placed in Trust B.
An A/B trust may also be beneficial if someone wants to protect assets from creditors or protect an inheritance for children from a prior marriage.
2010 Portability Examples:
Example 1: DSUEA not available.
John and Mary owned assets with a taxable value of $8 million. John died unexpectedly in 2010 and had not created a will or an A/B trust. Mary, the surviving spouse, inherited John’s share of the marital assets. Mary could not file and claim a DSUEA because portability was not available in the year 2010.
Mary dies in 2012. Estate taxes will be due on $3 million, the value of the estate exceeding Mary’s $5 million estate tax exemption allowance.
Example 2: DSUEA is available.
John and Mary owned assets with a taxable value of $8 million. John died unexpectedly in 2010 and had not created a will or an A/B trust. Mary, the surviving spouse, inherited John’s share of the marital assets. Mary filed a timely Form 706 estate tax return and elected to claim John’s unused exemption amount.
Mary dies in 2012. No estate taxes are due, as Mary’s estate excluded $10 million of assets by combining Mary’s $5 million exemption allowance with John’s $5 million exemption allowance.
Example 3: Surviving spouse remarries.
John and Mary owned assets with a taxable value of $8 million. John died January 1, 2011. Mary, the surviving spouse filed a timely Form 706 estate tax return and elected to claim John’s unused $4 million exemption amount.
Mary marries Jim in December 2011.
Jim dies in June, 2012. Mary files a Form 706 claiming a $2 million DSUEA for Jim.
Mary dies in December, 2012. Mary’s estate can use and combine Mary’s $5 million estate tax exemption and Jim’s $2 million DSUEA.
If Mary remarries before she dies, the DSUEA of a prior spouse is replaced with the exemption allowance of the most recent spouse.
Example 4: A/B trust present
John and Mary owned assets with a taxable value of $10 million. John died in 2010 and left instructions to place his $5 million share of the marital assets in Trust “B”. One of the assets John owned was shares in a start up valued at $2 million when he died.
When Mary dies in 2012, the company John had invested in had been sold and the value of the shares in Trust “B” is now $8 million. Because the assets in Trust “B” are no longer considered assets owned by Mary, Mary’s estate does not need to include the value of the assets in Trust “B” as part of Mary’s taxable estate because the assets are owned by Trust “B”.
The use of an A/B trust rather than the use of a DSUEA form protects any appreciation in the assets of the first spouse to die.
IF YOU DIED IN THE YEAR 2010
There are two different estate tax laws governing the estates of someone who died in the year 2010.
2001 Economic Growth and Tax Reconciliation Act (EGTRRA)
In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). The EGTRRA contains estate tax laws governing the estates of someone who died in the years 2002 through 2010.
In 2010, EGTRAA eliminated the estate tax. The estate did not need to calculate or pay any estate tax. As such, there was no 2010 estate tax rate or 2010 estate tax exemption allowance. No estate tax was paid before distributing assets to the beneficiaries.
Since the estate was no longer responsible for paying taxes before distributing assets to the beneficiaries, EGTRRA changed how beneficiaries calculate the tax basis of inherited assets.
Prior to 2010, the tax basis for beneficiaries was a “stepped up basis”. The step up in basis establishes the tax basis for beneficiaries as the fair market value of the asset on the date of death of the decedent.
In the year 2010, EGTRAA changed the tax basis for beneficiaries to a carryover basis. The carryover basis establishes the tax basis for beneficiaries as the original cost basis of the decedent plus qualified improvements. Each estate can exempt $1.3 million of gains from the carryover basis rule. Another $3 million exemption applies to assets inherited from a spouse. In order to comply with the new carryover basis rules, executors and beneficiaries need to document and report the sale of inherited assets to the Internal Revenue Service, using special forms.
2010 Tax Relief Act:
The 2010 Tax Relief Act created a $5 million federal estate tax exemption allowance and set the maximum estate tax rate at 35%, retroactive to January 1, 2010. The beneficiary tax basis is a step up in basis value.
Which law governs the estate of someone who dies in 2010: EGTRRA? Or the 2010 Tax Relief Act?
The 2010 Tax Relief Act gives the estate of someone who died in 2010 the right to choose which law to use.
The language in the 2010 Tax Relief law assumes the estate of someone who dies in the year 2010 will be subject to an estate tax and the tax basis for beneficiaries will be a step up in basis. Since the 2010 tax exemption allowance is $5 million, very few estates will actually need to file and pay estate taxes. If estate taxes are due, the maximum tax rate is 35%. No action is required by the estate to make this election.
If the estate elects to not pay any estate taxes and use the carryover tax basis for beneficiaries, the estate representative must file special forms with the Internal Revenue Service stating such intent. Once this election is made by the estate representative, any change must be approved by the Secretary of Treasury or the Commissioner of the Internal Revenue Service. The form for making this election is not available today.
Example: Beneficiary Carryover Tax Basis.
When her father died, Mary inherited the family residence. On the day her father died, the fair market value of the house was $500,000. Mary’s father purchased the house 20 years ago for $200,000.
Mary sold the house for $500,000. Mary’s tax basis was $200,000, the original cost to her father. Mary had to report and pay capital gains tax on $300,000.
The estate was not subject to any estate tax calculations. There was no need for the estate representative to calculate or pay estate taxes before transferring the title of the real estate to Mary.
Mary’s tax basis remained the same as the decedent. The estate representative elected to give other assets of the decedents the right to exempt $1.3 million of gains from the carryover basis rule.
Example 2: Beneficiary Step Up In Value Tax Basis.
When her father died, Mary inherited the family residence. On the day her father died, the fair market value of the house was $500,000. Mary’s father purchased the house 20 years for $200,000.
Mary sold the house for $500,000. Mary’s tax basis was $500,000, as the tax value was stepped up to the fair market value on the date of death of Mary’s father. Mary reported a capital gain of zero dollars and owed no taxes.
The estate representative calculated and paid any estate taxes due if estate taxes were due; the estate paid the taxes before distributing inherited assets to Mary and other beneficiaries.
WHAT IF YOU DIE AFTER JANUARY 1, 2013
The recent 2010 Tax Relief Act temporarily extended the temporary reduction in estate taxes prescribed by EGTRRA. The current estate tax laws expire on December 31, 2012 and revert back to the tax laws in existence in the year 2001.
Don’t let the new $5 million estate tax exemption allowance and the Deceased Spouse Unclaimed Exclusion amount fool you about the importance of planning for estate taxes. State estate taxes and inheritance taxes did not go away…and they don’t provide generous exemptions or portability. It is also unclear what will happen with any unused deceased spouse exclusion amounts after 2012.
SUMMARY OF ESTATE TAX LAWS: 2001 through 2013.
|Year||Personal Estate Tax Exemption Allowance||Top Estate Tax Rate||Deceased Spouse Unused Exclusion amount||Tax Basis||Applicable Tax Law|
|2001||$675,000||55%||No||Step Up In Basis||Taxpayer Relief Act of 1997|
|2002||$1,000,000||50%||No||Step Up In Basis||EGTRRA|
|2003||$1,000,000||49%||No||Step Up In Basis||EGTRRA|
|2004||$1,500,000||48%||No||Step Up In Basis||EGTRRA|
|2005||$1,500,000||47%||No||Step Up In Basis||EGTRRA|
|2006||$2,000,000||46%||No||Step Up In Basis||EGTRRA|
|2007||$2,000,000||45%||No||Step Up In Basis||EGTRRA|
|2008||$2,000,000||45%||No||Step Up in basis||EGTRRA|
|2009||$3,500,000||45%||No||Step Up In basis||EGTRRA|
|2010||$0||0%||No||No Step up in Basis||EGTRRA|
|$5,000,000||35%||No||Step Up In Basis||TTRA2010|
|2011||$5,000,000||35%||Yes||Step Up In Basis||TTRA2010|
|2012||$5,000,000||35%||Yes||Step Up In Basis||TTRA2010|
|2013||$1,000,000||55%||No||Step Up In Basis||Taxpayer Relief Act of 1997|