www.willtrust.com
Seminars | Locations | Contact Us

FEDERAL ESTATE AND GIFT TAX LAW
________________

    • Repeal of Step-up in Basis
    • Determining the Taxable Estate
    • Present-Interest Gifts
    • Federal Gift Tax Annual Exclusion

    Federal Estate Tax

On June 7, 2001, past-President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001. One provision in this new law provided for a reduction in the maximum federal estate, generation-skipping and gift tax rates for the years 2002 through 2009. This law also increased the unified credit amount which exempts assets from the federal estate tax during those years. The new law further provided for an outright repeal of the federal estate and generation-skipping tax for persons dying after 2009. In 2009, the highest estate tax exemption was $3.5 million and the estate and gift tax rate was 45%. There was to be no estate tax in 2010. In December, 2009, the U.S. Senate was unable to extend the 2009 estate tax law for even a couple of months into 2010 until a more permanent solution could be passed. This means that there will be no tax on estates of those dying during 2010 unless Congress acts to reinstate the tax retroactively in 2010, which is not guaranteed. However, in 2011 the estate tax is restored at a rate of 55 percent on estates of $1 million or more, which is where things stood before the 2001 change.

Repeal of Step-Up in Basis

In 2009, the federal income tax laws assigned to inherited property a tax basis equal to the fair market value of that property on the date of the decedent’s death or six months later, if the alternate valuation date is selected. This step-up or step-down in the basis eliminated the recognition of income on the increase in the value of the property that occurred before the death of the deceased person devising the property, and eliminated the tax benefit from any unrealized loss. This exclusion of the gain from income taxation was due to a concern that a double tax existed when a beneficiary was subject to an estate tax and an income tax on inherited property.

Since beneficiaries receiving property due to inheritance will not be subject to a federal estate tax after 2009, the current law’s step-up in basis rule is replaced with a modified carryover basis rule. Beginning in 2010, inherited property will have a basis equal to the lesser of its fair market value on the date of death or the decedent’s adjusted cost basis in the property. However, a modified carryover basis rule will apply to these assets. The first modification to the adjusted cost basis rule is that the basis in each inherited asset will be increased proportionately so that the basis of all the estate’s property will be increased to an aggregate basis of $1,300,000. In addition, the basis in property left to a spouse outright or in a qualified terminal interest trust for a surviving spouse will increase to an aggregate of $3,000,000. This means that the basis of property transferred to a surviving spouse can be increased by as much as $4,300,000.

The new law states that the basis in property will not increase if the property is received by the decedent by gift or transfer for less than adequate and full consideration during the three-year period ending on the date of the decedents death. An exception will be when the property is acquired from the decedent’s spouse, provided the spouse did not within this three year period acquire the property by gift or for less than adequate and full consideration.
By example, assume your father died in 2010 and left you a home worth $1.5 million and a $500,000 portfolio of stocks purchased at various times over the past 40 years. If you decided to sell any of these assets, you'd normally pay in 2010 little or no capital gains tax on the sales. The new provisions mean that you have to calculate capital gains based on the value of the home and the stocks when your father bought them, not when you inherited them. That could be very expensive, not to mention time-consuming in trying to ascertain the original price your father paid for everything. 
This elimination of the federal estate tax exemption equivalent may be a basis for a person who has executed a credit shelter bypass to amend his or her present estate planning documents. The reason that an amendment to a present estate plan may be necessary relates to the fact that to say that you leave an amount in trust that is subject to the exemption equivalent amount is no longer relevant since there presently is no exemption equivalent in 2010.

Determining the Taxable Estate

To know whether a deceased person’s estate is presently liable for federal estate taxes, the person’s gross estate first needs to be determined. A gross estate (for federal estate tax purposes) includes all property that the deceased owned or had an interest in at his or her death. The gross estate of a deceased person also includes the fair market value of property owned jointly with another except to the extent the other owner contributed toward the purchase of the property. However, for a husband and wife, there is a special 50 percent ownership rule for their jointly owned property, generally causing it to be treated as being owned equally by each spouse, regardless of who originally paid the purchase price.
The gross estate for federal estate tax purposes is comprised of the fair market value of all stocks, bonds, tangible personal property, real property, cash, promissory notes, and the proceeds of life insurance policies owned by the deceased at death or under certain circumstances, within three years of his or her death.
The fair market value of the gross estate is determined as of the date of the individual’s death or as valued six months after death. This is known as the “alternate valuation date,”  that is allowed if the value of the gross estate is reduced and the election decreases the estate tax due the Internal Revenue Service.
Once the gross estate is determined, the amount is then reduced by funeral expenses, administration expenses, and debts and losses not reimbursed by insurance. Also, through the marital deduction, the taxable estate is reduced by whatever amount is left to the surviving spouse who is a United States citizen. The marital deduction can be taken for assets transferred to a marital deduction trust. The traditional marital deduction trust assures to the surviving spouse all the net income earned on the trust assets at least annually and as much of the assets of the trust as are necessary for the surviving spouses health, education, maintenance, and support.
For the deceased’s estate to be entitled to the marital deduction, the trust must also grant the surviving spouse a general power of appointment to state who will receive the remaining trust principal upon his or her death. The assets of the marital deduction trust will not be subject to federal estate taxes when the first spouse dies, but will be taxed at the death of the second spouse.
A qualified terminal interest trust (or Q-TIP trust) also qualifies for the estate tax marital deduction if the deceased’s personal representative makes the appropriate election on the deceased’s estate tax return. Under this type of trust, the surviving spouse will receive a qualifying income interest for life if the trust meets these conditions:
   1. The spouse must receive for life all the net income from the entire or specified portion of the trust assets, payable annually or more frequently. Income interests granted for a term of years or interests that expire on a person’s death or which terminate upon remarriage will not qualify for the marital deduction.
   2. No person (including the surviving spouse) has the power to appoint any part of the property subject to the qualifying income interest to any person other than the surviving spouse during his or her lifetime.
Property not consumed or disposed of prior to the death of the surviving spouse will be included in the spouse’s gross estate at fair market value as of the spouse’s date of death. The trust of the first spouse to die must instruct the trustee to pay these estate taxes upon the death of the surviving spouse.

Present-Interest Gifts

The Internal Revenue Service requires that a gift tax be assessed when a person gives real or personal property (including money) to another person exceeding the annual gift tax exclusion. There will be no repeal of the federal gift tax. While the maximum gift tax rate will be reduced pursuant to the same percentages as for estate taxes, there is only a lifetime gift exemption amount of $1,000,000.
The gift tax is assessed against the person who gave the property during his or lifetime. If a gift is made that has a value in excess of the annual exclusion amount of $13,000, the applicable lifetime exclusion amount of $1,000,000, is first applied. Any gifts made in excess of the annual exclusion and the applicable lifetime exclusion amount will be taxed at the same rate as the estate tax rate.  A federal estate tax return must be filed by April 15th of the year following the year in which the taxable gift is made.
It is important to remember that a gift tax also may be required when property is transferred at much less than the fair market value. Forgiveness of a loan when the debt can still be collected is also considered a gift, and that loan amount including any forgiven interest is subject to the gift tax.

Federal Gift Tax Annual Exclusion

The annual gift exclusion is $13,000 per person in 2009. Gift-splitting spouses can transfer a total of $26,000 per person per year without a gift tax in 2009. The annual gift tax exclusion will be increased by a cost-of-living adjustment. The amount of the adjustment is the percentage by which the consumer price index for the preceding calendar year exceeds the consumer price index for 1997. If the amount of the annual exclusion, as adjusted, is not a multiple of $1,000, the amount of the adjustment will be rounded to the next lowest multiple of $1,000. Thus, the amount of the annual exclusion will not increase from $13,000 to $14,000 until the cost-of-living adjustment is at least another 10%. At current levels of inflation, it may be several years before the annual gift tax exclusion rises to $14,000.
The annual gift tax exclusion is the maximum amount a person can give each year to an unlimited number of people without reducing his or her applicable exclusion amount.
Gifts given to individuals (1) as educational tuition or (2) as payment for the individual’s medical care are not limited to the annual gift tax exclusion. This exclusion is permitted regardless of whether or not the person making the gift and the recipient are related.
A spouse can give an unlimited amount of real or personal property to his or her spouse without any liability for a gift tax. However, this deduction is not permitted if the spouse receiving the property is not a citizen of the United States.
Any money given to a qualified religious or charitable organization is not subject to a gift tax. In addition, there are significant federal income tax deductions for contributions to a qualified charitable organization. It is important to remember that a check for a charitable gift must be postmarked by December 31 for it to be considered a deduction for that year.