Tax law changes have made it a moving target.
When President Barack Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 last December, it changed the federal estate tax.
The estate tax dates back 1916, when it was imposed at a rate of 10 percent on the portion of estates above $50,000. Unfortunately, it has been a moving target for at least 10 years, and it appears it may continue that way for at least the next several years. This makes planning difficult.
In 2001, Congress passed the first of two legislative packages that contain most of what are now commonly referred to as the Bush tax cuts. That gradually lowered the maximum estate tax rate and substantially raised the applicable exclusion amount from 2002 to 2009, from $1 million to $3.5 million; there was no estate tax in 2010. The maximum tax rate fell from 60 percent to 45 percent.
The 2001 law repealed the estate tax completely for those dying in 2010. This led to several well-publicized instances in which famous people (including George Steinbrenner) who died in 2010, leaving multi-billion-dollar estates to their heirs without paying a penny in federal estate tax.
Those provisions were scheduled to sunset on Dec. 31, 2010, meaning that if Congress had not acted before then, the estate tax would have reverted to 2001 levels, with a $1 million exclusion. Under the new law, the exemption rose to $5 million for 2011, with a further increase for inflation in 2012. It also reduced the top tax rate to 35 percent.
However, the changes are only temporary because on Jan. 1, 2013, the top tax rate will increase to 55 percent and the exemption will be reduced to $1 million unless Congress takes action.
Based upon the $5 million exemption, it's estimated the majority of estates (all but an estimated 3,500 nationwide in 2011) will not be subject to any federal estate tax. The revenue raised from the estate tax in 2011 will be about $11.4 billion.
If the exemption had been reduced to $1 million in 2011 with a top tax rate of 55 percent, it is estimated that there would have been 43,540 taxable estates which would have raised $34.4 billion.
The new law also gave heirs in 2010 a choice of which estate tax rules to apply – the 2010 rules (that provide for no estate tax and carryover basis) or the 2011 rules (which provide a $5 million exemption).
Since there was no estate tax in 2010, some inherited assets are subject to higher capital gains taxes under the 2010 rules, a situation that could increase the total tax burden for some heirs. Inherited assets under 2010 rules have a tax basis equal to the price when they were purchased (often referred to as carryover basis) rather than the price at death (often referred to as stepped-up basis).
Under the 2011 rules, heirs can inherit assets with a stepped-up basis. While most would choose the 2011 tax rules, the heirs of very wealthy decedents could find it more advantageous to elect the 2010 law.
For many years, the gift tax and the estate tax were unified, shared a single exemption and were subject to the same rates. This wasn't the case in recent years. In 2010, the top gift tax rate was 35 percent and the exemption was $1 million. However, for gifts made after Dec. 31, 2010, the gift tax will be re-unified with the estate tax, which means the $5 million estate tax exemption will also be available for gifts.
Although the new law significantly changes federal estate and gift tax laws, Indiana inheritance tax laws remain the same. Because of the constantly changing federal estate tax law, you should review your estate plan with your estate-planning attorney on a regular basis.
Tory Prasco is an attorney with Burke Costanza & Carberry LLP and a CPA. His practice is concentrated in estate and business planning, trust and probate administration and real estate.