By Michael D. Koppel, CPA
Tax Partner
Gray, Gray & Gray, LLP
March 2011
The recently enacted tax law (formally known as the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010) has far reaching implications for taxpayers beyond the retention of the Bush-era tax cuts. The new law has also completely changed the gift and estate situation for many people.
First let’s discuss the old estate rules. The gift tax is a federal tax on large financial gifts. It has two exclusions – annual and lifetime – that protect some gifts from being taxed.
The annual exclusion is the amount (currently $13,000 per recipient) that a person may give to another during a single year without invoking the lifetime exclusion. There is no limit to the number of annual exclusions a person can use each year.
The lifetime exclusion is the amount a person can gift during their life in excess of their annual exclusion gifts. The lifetime gift tax exclusion was set at $1 million dollars in 2001.
The latest tax law has drastically changed the gift and estate tax landscape. The estate tax exclusion has been pushed up to $5 million dollars for 2011 and 2012. The legislation also made the exclusion “portable,” which means that a surviving spouse inherits any unused exclusion of their deceased spouse. For example:
If Mr. Smith dies in 2011 and has made no taxable gifts during his lifetime, Mrs. Smith with inherit his unused exclusion of $5 million. Assuming she also dies in 2011, Mrs. Smith will have no estate tax as long as her estate does not exceed $10 million.
The new tax law relinks the gift tax exclusion with the estate tax. This means that the gift tax lifetime exclusion is $5 million for 2011 and 2012. For a married couple that is $10 million that can be gifted during their lifetime. For a couple who had previously maxed out their lifetime gift exclusion this provides an additional $8 million dollars that can be gifted in 2011 and 2012.
It is important to remember that the basis of assets gifted and left through estate are not treated equally. Generally, gifted assets retain their basis while assets passed through an estate will have fair market value basis. The carryover basis versus step-up in basis is an important consideration in deciding which assets to gift and which to leave through an estate.
During 2010, when there was no estate tax, the amount assets which could have a step-up in basis was limited to $1.3 million ($4.3 million for a surviving spouse). For 2011 and 2012 there is no limit to the amount of assets which can have their value increased to fair market value.
The new tax law also reinstated the generation skipping tax (GST). The GST is generally in place to stop people from avoiding gift and estate taxes by purposely skipping a generation. For
Let’s say that Mr. Jones wants to give a gift with a fair market value of $1,013,000 to his granddaughter. The $13,000 would qualify for the annual exclusion. The $1 million would be charged against both the lifetime gift and GST exemptions.
One rule that did not change is the availability of lack of control and lack of marketability discounts. These discounts can significantly reduce the value of gifts and assets passed though an estate. The discounts can be especially important in succession planning for family owned businesses. For example:
Mr. & Mrs. Green own 100% of their business, Green Enterprises. An appraisal indicates that the business has a fair market value of $10 million. They want to gift their daughter Joan, who works in the business, 30% of the company. But they have already used their annual exclusion in previous gifts to Joan. Assume that the combined discounts aggregate 40%. Without the discounts the gift would be $3 million. Taking the discounts reduces the amount of the lifetime exclusion used to $1.8 million, saving $1.2 million dollars of lifetime exclusion to be used later.
Without further changes the lifetime gift, estate and GST exemptions will return to $1 million in 2013.
This article provides a brief overview of the estate and gift changes made by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. It is strongly recommended that you review your will and estate plans in light of these changes.
Michael D. Koppel, CPA is the senior tax partner with Gray, Gray & Gray, LLP, Certified Public Accountants, Westwood, MA. Mr. Koppel can be reached at (781) 407-0300, or via e-mail at mkoppel@gggcpas.com.