Jeff Troll   |   September 20, 2011

As part of the sweeping changes that came at the end of 2010, somewhat lost in the federal income tax changes were some significant alterations to federal estate tax rules. As you may be aware, the unexpected happened during 2010 and the estate tax exemption was allowed to go to an unlimited amount. As several billionaires passed during 2010, estate tax rules had a much higher profile and with the federal exemption scheduled to revert back to $1 million with a 55% federal estate tax rate on January 1, 2011, something had to be done. Even though this was the same situation at the end of 2009, surprisingly, Congress did act and rules were changed for 2011 and 2012 with 2010 becoming a hybrid year. This article will discuss what the rules changed to, some planning opportunities and some things to think about beyond 2012.

For the next two years, we have been graced with a $5 million federal estate tax exemption and a 35% federal estate tax rate. In addition, the federal gift and generation skipping exemption have also been set at $5 million. Even during 2010, with unlimited estate and generation skipping exemptions, the gift exemption was not raised above $1 million. In addition, portability has been introduced which means that if you are married and you didn’t use your full exemption when you die, your spouse gets to keep the unused portion (as long as your spouse does not remarry) reducing, but not eliminating, the need for Family Trusts. This rule is especially beneficial for people who do not have estate planning documents or created simple ones years ago. The government also brought back the rules that allow for a step-up in cost basis, which had been largely eliminated during 2010. The new rules allow estates of people who died during 2010 to pick the rules they wanted to follow (2010 law as it existed, or the new rules as written for 2011 and 2012). This is all good news; however, the bad news is that this all expires at the end of 2012, which once again leaves us with a lack of clarity regarding future rules.

With each new tax law, opportunity abounds. With an increase in the level available for gifting, the next two years may represent a unique opportunity. Given this opportunity, those with the means should consider using as much of the limits as they can. If it is taking advantage of straight gifts, gifts to trusts, using more advanced planning in Family Limited partnerships or Grantor Retained Annuity Trusts (GRATs), the opportunity to transfer wealth today, and have all future appreciation occur outside of your estate, is very attractive. One of the best aspects of the current rules is the ability to make multi-generational gifts – that is skipping your children for grandchildren. A two year window has been established to implement estate planning strategies, don’t waste them if you are in a position to use them.

For the first time in history, we could have a gift and estate tax exemption that declines when rules change after the 2012 election. What happens will most likely be dictated by the results of the election and the state of the economy. Therefore, we now have a high level of uncertainty regarding gift and estate tax rules. If you gift $1.5 million now and use up part of your $5 million exemption, what happens if the rules change and go back to $3.5 million or $1 million? I posed this question to Michael Kitces, Pinnacle’s Director of Research, and unfortunately, there is no clear answer. His best guess is that you would end up recapturing some of this gift at death depending on the new level of the exemption. Hopefully this issue will be addressed at the end of 2012, but you never know. However, even if this were to occur, gifting now can still be very advantageous since all future appreciation occurs outside of your estate.

We have two more years to make smart estate planning decisions. After that, what will occur is open to plenty of speculation.