By Thomas Pillari, Esq., Certified Specialist in Estate Planning, Trust and Probate Law
In December, 2010, the United States Congress passed legislation entitled the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010”. The terms of this legislation concerning income tax, gift tax, estate tax and generation-skipping tax matters, is intended to create “new law” in certain respects and to extend “current” (2010) law in other respects regarding taxes. By the terms of the legislation, the tax provisions will “sunset” (expire) as of December 31, 2012. There is much speculation about what the “new” Congress will do in this regard prior to January 1, 2013. The comments herein will concern what the law is and not what the law may be on January 1, 2013.
The purpose of this article is to provide information about the new “transfer” tax laws and to suggest that you consider the opportunities presented with the understanding that the new legislation will expire by its terms on December 31, 2012.
Ohio Estate Tax
Although it is obvious to say so, the recently-enacted federal legislation does not change the provisions of the Ohio estate tax. Currently, there is an “Ohio estate tax” which applies to the estates of all persons who are domiciled in Ohio (Ohio residents) at the time of death as well as certain persons who consider themselves to be residents of other states, but own certain assets “located” in Ohio such as real property or privately-owned business interests. Generally, the provisions of the Ohio estate tax can be summarized as follows:
1. As a general rule, all life insurance proceeds payable as the result of a decedent’s death to any person or entity except the executor of the decedent’s estate and the decedent’s creditors, is excluded from the application of the Ohio estate tax;
2. All decedent’s estates having a “gross” value of less than $338,333.00 (excluding life insurance as noted above) are excluded from the application of the Ohio estate tax or the need to file the Ohio Estate Tax Return; therefore, the “Ohio exemption” can be stated as $338,333.00;
3. All of the decedent’s assets payable to the surviving spouse or held exclusively in trust for the surviving spouse will be “estate tax deferred” until such person’s subsequent death; whereupon, the remaining inherited assets would be taxed as part of the surviving spouse’s estate (presuming the surviving spouse is then-domiciled in Ohio); and
4. The marginal rate of estate taxation is 6% for those “taxable” estates where the taxable estate exceeds $338,333.00, but is not more than $500,000.00 in value and the marginal rate is 7% for all taxable assets in excess of $500,000.00.
Any payment of Ohio estate tax is a “deduction” for determining federal estate taxes payable as the result of the decedent’s death.
Unless certain exceptions apply, Ohio estate taxes must be paid no later than 9 months from the date of death; however, there is an automatic 6-month extension for filing the return, if chosen by the personal representative of the decedent’s estate.
Although there is an Ohio estate tax, there is no Ohio “gift tax”.
Estates of Persons Dying In 2010 – Federal Estate Tax
For those estates concerning persons who died after December 31, 2009, but before January 1, 2011, the new federal legislation provides two choices regarding the “basis” of assets inherited and the federal estate tax to be paid. All persons acting as executors, trustees or other “personal representatives of a decedent’s estate”, will need to consider both alternatives before finalizing any estate/trust administration matters for persons dying in 2010.
The first choice provides that there will be no federal estate tax payable regardless of the value of the decedent’s taxable estate; however, the new “basis” for the assets inherited will be limited to the following:
1. “Carry-Over Basis/No Surviving Spouse”: Each “executor” must determine the decedent’s basis in all assets inherited and may then allocate an additional $1,300,000.00 of new basis to the “capital assets” selected by such personal representative;
2. “Carry-Over Basis/Surviving Spouse”: To the extent that assets pass to (or exclusively for) a surviving spouse an additional $3,000,000.00 can be added to increase the basis of those assets passing to the surviving spouse or in trust for the surviving spouse; and
3. If the “carry-over basis” option is selected by the executor for a person dying in 2010, a report must be filed with the Internal Revenue Service no later than September 17, 2011, reporting how the additional basis was allocated. There is a suggested “form” for this purpose which has not been finally issued by the Internal Revenue Service.
The second option for executors for decedents who have died in 2010 is to file a federal estate tax return reporting the “taxable estate”. As a general rule, if the net taxable estate does not exceed $5,000,000.00, there will be no federal estate tax payable. If the net federal taxable estate exceeds $5,000,000.00, the federal estate tax rate will be 35% of the net taxable estate in excess of $5,000,000.00. If the executor chooses to file the estate tax return, all assets will receive an unlimited “new” basis under the rules applying to estates prior to January 1, 2010. In other words, there is no $1,300,000.00 or $3,000,000.00 limitation as in the “carry-over basis” option.
The filing of any federal estate tax return under this second option must be filed no later than September 17, 2011.
The legislation’s “default” is the “second option” discussed above. In order to “opt-out” of the requirement to file the federal estate tax return, an election must be filed with the Internal Revenue Service on or before September 17, 2011, electing the carry-over basis option. Although every case will be different, it would seem that the larger the estate in excess of $5,000,000.00 (no surviving spouse), the more likely that the executor will choose the carry-over basis regime in order to avoid the payment of a 35% estate tax on the excess over $5,000,000.00 passing to non-spouses. Please keep in mind that every circumstance will be different and all executors should consult with their legal representatives before making any decisions in this regard.
On occasion, the beneficiaries of a decedent’s estate will choose to “disclaim” (refuse) some or all of the inheritance otherwise passing to such beneficiary. As a general matter, such a “disclaimer” results in the disclaimant being deemed to have died before the person who actually died and the persons who would have inherited if the disclaimant had actually died then inherit without any “gift” tax. In order to avoid any adverse gift tax consequences, any such disclaimer must be “completed” within 9 months of the decedent’s death. One of the provisions of the new legislation provides that the deadline for filing “qualified disclaimers” has been extended to September 17, 2011 for 2010 inheritances.
It is important to understand that the new legislation did not create any retroactive estate tax for persons dying in 2010. By electing the “carry-over basis” option described above, executors of a 2010 decedent can elect to pay no federal estate tax.
Federal Gift Tax Applicable for 2010 Gifts
For those persons making gifts in 2010, including persons who make gifts prior to such person’s death in 2010, the so-called “lifetime gift tax exclusion” remains at $1,000,000.00. If you are an “executor” for the estate of a person who made gifts during 2010, it is your responsibility to file the gift tax return for that person. All such executors and all persons who made gifts during 2010 should consult with each such person’s legal and tax representatives regarding any gift tax reporting and/or gift tax liability for gratuitous transfers made during 2010.
New Gift Tax Provisions for Gifts Made After December 31, 2010 but Before January 1, 2013
For transfers during 2010, the gift tax exemption amount and the federal estate tax exemption amount were not equal. For gifts made after December 31, 2010, but before January 1, 2013, the gift tax exemption and the estate tax exemption amounts have been re-unified at $5,000,000.00 per transferor/decedent. This means that taxable gifts must exceed $5,000,000.00 for the lifetime of the donor before gift tax is payable. If gift tax is payable, the rate of taxation is 35%, the same rate that will apply to taxable estates (see below). The new $5,000,000.00 exemption will be reduced for those taxable gifts made prior to January 1, 2011.
In the past, married persons could file a gift tax return electing what was commonly known as “gift-splitting”. Gift-splitting still applies. As a result, a married couple may make taxable gifts of $10,000,000.00 of assets before being required to pay any gift tax. Any gift tax exemption unused at the time of the first spouse’s death may be used by the surviving spouse provided that the appropriate elections are filed with the Internal Revenue Service (portability). This follows because the estate tax exemption and the gift tax exemption are “unified”.
No change in the annual exclusion ($13,000.00 per year, per donor, per donee) was made by the new legislation.
If you have any questions or wish to discuss gifting opportunities after December 31, 2010, we would be pleased to discuss options with you.
New Estate Tax Provisions for Persons Dying After December 31, 2010, but Before January 1, 2013
For those persons dying after December 31, 2009, but before January 1, 2013, the new estate tax exemption amount is $5,000,000.00 less any taxable gifts during the decedent’s lifetime. The new “flat” federal estate tax rate is 35% of the taxable estate. This so-called unlimited marital deduction (I prefer to call it the “unlimited marital deferral”) is still in effect without change.
For those persons dying after December 31, 2010, but before January 1, 2013, there will be a “new” basis for all “capital assets” comprising the decedent’s estate which will generally be equal to the fair market value of the asset on the date of the decedent’s death.
If the person who died was married at the time of death, any unused portion of the new $5,000,000.00 exemption can be “assigned to” and used by the decedent’s surviving spouse to shelter assets on that person’s subsequent death. For example, assets subject to federal estate tax are $2,000,000.00 upon the decedent’s death, the $3,000,000.00 “unused portion” of the decedent’s $5,000,000.00 exemption can be used by the decedent’s surviving spouse when that person dies. As a result, the surviving spouse will have an estate exemption of $8,000,000.00 less taxable gifts made during the surviving spouse’s lifetime. This will be particularly helpful for those clients who have substantial assets in retirement plans such as IRAs, annuities, profit-sharing plans, 401k plans, etc. This concept is known as “portability” and it did not exist prior to January 1, 2011.
Gift/Estate Tax Provisions for Gifts Or Death Occurring After December 31, 2012
Because the new legislation “sunsets” as of December 31, 2012, the very unfavorable tax provisions which would have been applicable on January 1, 2011, will apply unless legislative action is taken to change the result. The exemption amount for 2011 was to have been $1,000,000.00 per decedent and the highest marginal federal estate tax rate would have been 55%. At the same time, the gift tax exemption amount would return to $1,000,000.00 with an accompanying gift tax rate of taxation of 35%. Regardless of your political persuasion, it is important for you to be aware of what the Congress does regarding gift and estate tax legislation during the next two years.
Effective for decedents dying after December 31, 2009, but before January 1, 2013, the generation-skipping tax exemption amount has been increased to $5,000,000.00. For “taxable” generation-skipping transfers during 2010 occurring because of death, the tax rate is zero. The nuances of the generation-skipping tax statute and regulations are beyond the scope of this general “information” letter; however, if you wish to meet with one of our attorneys to discuss these matters, please contact us and we will be pleased to review your current situation and your plans regarding generation-skipping or dynasty trusts.
Income Tax Matters
The income tax rates that apply to taxpayers for 2010 have been extended for two more years. The details of the income tax rules are best discussed with your income tax preparer.
As I have indicated above, the purpose for this letter was to provide you with general information and not planning advice; nonetheless, it is appropriate to highlight certain “planning opportunities” which you may wish to take advantage of during the next two years. Please consider if the following “opportunities” apply to you:
1. Separate “Marital Deduction” “Living Trusts” versus “Joint Trusts”: For reasons beyond the scope of this letter, we have been suggesting to our clients that they consider modifying their estate plans consisting of two separate revocable/living trusts and implementing one “Joint” or “Family” Trust, in order to take advantage of certain Ohio estate tax exemptions which are enhanced through the use of joint/family trusts when compared to individual revocable trusts. For those clients whose combined net-worth (including life insurance) is less than $5,000,000.00, it may be appropriate to “simplify” your estate plan by revoking your current “two-trust” estate plan and implementing a Joint/Family Trust Plan. In most cases, the cost-benefit analysis of modifying your planning is compelling; however, each case must be evaluated on its specific facts and circumstances. If you wish to consider this option, our attorneys will request a new “net-worth” statement from you to ensure that our planning review and recommendations are specific as to you and your current tax and family objectives.
2. Irrevocable Trusts: Many of our clients have implemented Irrevocable Trusts in order to shelter insurance proceeds (and other assets) from both federal and state estate tax. For some time now, we have been advising our clients to postpone implementing any irrevocable trusts until we knew about the estate tax regime for years after 2010. For those clients who already have implemented Irrevocable Trusts, the maintenance costs and need for such trusts should be reviewed. For those clients who have not implemented such trusts, a review of your current net-worth (particularly if that net-worth exceeds $5,000,000.00) would be appropriate to determine if the use of an Irrevocable Trust would be appropriate at this time. When considering this option, please keep in mind that the current legislation does “sunset” on January 1, 2013.
3. Review of Gift-Giving: Particularly for those clients who own “family-owned businesses”, the new gift tax exemption amount of $5,000,000.00 provides an opportunity to engage in significant “corporate succession planning” without the payment of any gift tax or estate tax. Those of us in the PEP Department of our Firm work closely with the attorneys in the Business, Organizations and Tax Department and can assist you in coordinating and evaluating the corporate succession planning opportunities which involve gifts. Even though the exemption amount is substantial, the filing of gift tax returns (annually) is still important in order to document the portion of the gift/estate tax exemption which remains unused at death. Remember, the “unused portion” of a decedent’s exemption amount can now be preserved for use by that person’s surviving spouse (“portability”).
4. Life Insurance: Many of our clients have purchased single-life or “survivorship life” insurance policies in order to provide liquidity to pay estate taxes when the insured dies. Depending upon the anticipated net-worth at the time of death, it is appropriate to reconsider any life insurance policies or the acquisition of life insurance policies for the sole and express purpose of paying estate taxes. Again, however, caution is advised because the current $5,000,000.00 exemption is not “permanent”. By reviewing your net-worth, we (along with your insurance advisor) can assist you to ensure that your life insurance policies are appropriate for your current and future needs. It also must be noted that many life insurance policies are purchased in order to replace lost income, provide liquidity to pay debts and to provide generation-wealth transfer. None of these latter reasons have been affected by the new legislation.
The “Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010” has many nuances which are not yet fully examined. On balance, the legislation in the estate tax/gift tax area appears to be very good and provides the opportunity for very significant planning. It should also be kept in mind that the Congress will likely “amend” provisions of the new legislation to clarify matters. Further, the Internal Revenue Service will be issuing regulations, forms and procedures which will “clarify” the legislation. As a result, my comments herein are intended to provide you with the most current information available to us, but they are not intended to provide a thorough explanation of all of the provisions of this very comprehensive legislation.
The attorneys and staff of Wickens, Herzer, Panza, Cook & Batista strive to always provide advice which is “cutting-edge” advice to you, our valued clients and friends. We hope you find the information contained in this article to be helpful. We look forward to the opportunity to assist you as the need arises.