Introduction
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312 (TRA 2010) was signed into law by President Obama on December 17, 2010. The law gave a much-needed (though temporary) reprieve from the uncertainty that has plagued estate and gift tax planning for the past decade. It also introduced a few unexpected changes that will alter how estate planning is done in the future.
This paper will look at how TRA 2010 will affect estate planning in 2011 and beyond. This article discusses legislative history that led to the passing of TRA 2010. It’s impossible to understand the new law without a grasp of these details, particularly the tax situation created by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). We will then look at the estate and gift tax provisions of the Act, including retroactivity and portability, give a few planning pointers along the way.
The Historical Framework
The Internal Revenue Code gives each person an exemption from the so-called transfer taxes—the Federal estate, gift, and GST taxes. This exemption is known as the applicable exclusion amount and represents the value that a person can leave to others free of transfer taxes. The applicable exclusion amount has fluctuated over time and been set at different amounts for the different types transfer taxes.
Historically, the Internal Revenue Code had a simple rule about basis of property inherited from a decedent: As long as a person held an asset until death, the basis of the asset was “stepped up” to the asset’s fair market value at the date of death. This allowed the recipient to sell the asset without paying tax on appreciation that accrued during the decedent’s lifetime.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) changed these rules. It gradually raised the applicable exclusion amount from 2001 to 2009 and, in 2010, repealed the estate tax altogether. But it also repealed the unlimited basis step-up that existed under prior law. Under EGTRRA, those who inherit assets from a decedent who died in 2010 take a basis equal to the lesser of the decedent’s adjusted basis or the fair market value on decedent’s date of death. Because those who inherit property from the decedent usually take the decedent’s basis in the asset (carryover basis), the appreciation that is built in to the asset when it is transferred will eventually be taxed when the asset is sold.
For political reasons, Congress provided that EGTRRA would sunset on December 31, 2010. At that time, the applicable exclusion amount would return to $1 million and the estate tax rates would go up to 55 percent, a prospect that neither the Republicans nor the Democrats were happy with. This sunset provision put Congress under pressure to either extend EGTRRA or come up with a new law before the end of 2010. (Note: for a more comprehensive discussion, see our prior article on Estate Planning in 2010).
As we neared the end of 2010, it looked like Congress would not reach a solution by the end of the year. But early December saw a flurry of legislative activity. On December 2, 2010, Senator Max Baucus (D-MT) introduced a bill that reinstated the estate tax with a $3.5 million exemption and a 45 percent tax rate, a proposal that was unacceptable to Republican leaders. On December 6, President Obama announced a compromise with Republican leaders to extend the Bush tax cuts for two years and reinstate the estate tax with a $5 million exemption and a 35 percent tax rate. The text of TRA 2010 was released on December 9. It was eventually passed by both the House and the Senate and signed into law by President Obama on December 17, 2010.
About Jeramie Fortenberry