Overview of 2011 and 2012 Estate Tax and Gift Tax Laws
Overview of Estate and Gift Tax Exemption, Rate and Portability in 2011 and 2012
After much debate and last minute shenanigans, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act ("TRUIRJCA" or "TRA 2010" for short) was signed into law by President Obama on December 17, 2010. This new law provides sweeping changes to the rules governing federal estate taxes, gift taxes and generation-skipping transfer taxes, but only for the 2010, 2011 and 2012 tax years.
2011 and 2012 Changes to Estate Tax, Gift Tax, and Generation-Skipping Transfer Tax Laws
Here is a summary of what TRA 2010 provides for gifts made in 2011 and 2012 and the estates of decedents who die in 2011 or 2012, as well as some problems created with regard to state estate taxes and generation-skipping trusts:
Sets new and unified estate tax, gift tax and generation-skipping transfer tax exemptions and rates. For 2011, the federal estate tax exemption will be $5 million and the estate tax rate for estates valued over this amount will be 35%. The estate tax has also become unified with federal gift and generation-skipping transfer taxes such that in 2011 the lifetime gift tax exemption and generation-skipping transfer tax exemption will be $5 million each and the tax rate for both of these taxes will also be 35%.
Indexes estate tax, gift tax and generation-skipping transfer tax exemptions for inflation in 2012. The estate tax, gift tax and generation-skipping transfer tax exemptions have been indexed for inflation for the 2012 tax year such that each will be increased from $5 million to $5.12 million beginning on January 1, 2012.
Offers "portability" of the federal estate tax exemption between married couples. In 2009 and prior years, married couples could pass on up to two times the federal estate tax exemption by including "AB Trusts" or "ABC Trusts" in their estate plan. TRA 2010 eliminates the need for AB Trust planning or ABC Trust planning for federal estate taxes by allowing married couples to add any unused portion of the estate tax exemption of the first spouse to die to the surviving spouse's estate tax exemption. This will effectively allow married couples to pass $10 million on to their heirs free from federal estate taxes with absolutely no planning at all; however, note that the surviving spouse must file IRS Form 706, United States United States Estate (and Generation-Skipping Transfer) Tax Return, in order to take advantage of the deceased spouse's unused estate tax exemption. Also note that portability was not applied retroactively to January 1, 2010. Aside from this, as it now stands portability is only available for deaths that occur during the 2011 and 2012 tax years. In addition, without AB Trust or ABC Trust planning, state estate taxes may be due in states that collect them. See more on state estate tax issues below.
State estate tax issues. To date, none of the states that collect a separate state estate tax have adopted portability of the state estate tax exemption between spouses, nor have I heard any discussion about portability becoming available in any state. So while portability may be relied on in states that do not collect a separate state estate tax, AB Trust or ABC Trust planning may still be required in states that collect state estate taxes, particularly in states where the couple has a large estate, the state estate tax exemption is less than the federal estate tax exemption, and state law allows for a separate state QTIP election. This will include couples who live in states like Maine, Maryland, Massachusetts, Minnesota, New York, Oregon and Tennessee where the state estate tax exemption is only $1 million, leaving a gap of $4 million in 2011 and $4.12 million in 2012.
Generation-skipping trust issues. Unlike the estate tax exemption, the generation-skipping transfer tax exemption has not been made portable between spouses for the 2011 and 2012 tax years, nor have I heard any discussion about this becoming a possibility. Therefore, couples who want to take advantage of passing on up to two times the generation-skipping transfer tax exemption to their heirs in generation-skipping trusts will still need to include AB Trust planning or ABC Trust planning in their estate plans.
Estate Planning with a Non-Citizen Spouse
Estate planning for married couples where one spouse is a noncitizen of the United States is different than when both spouses are citizens. Generally speaking, assets that pass between spouses at the first death are free from estate taxes regardless of the amount transferred. However, where the surviving spouse is a non-citizen resident, the unlimited marital deduction is not automatically available.
During life, where married U.S citizens can make unlimited gifts to each other, if either spouse is a non-citizen, a citizen spouse in 2009 may only gift a maximum of $133,000 per year to the non-citizen spouse.
For estate tax purposes, it is necessary to determine whether someone is a non-resident alien or a resident alien. Non-citizen resident aliens whose intent is to be a resident are subject to estate and gift taxes on all worldwide assets. If a resident alien, the non-citizen spouse will have the use of $5,000,000 exclusion amount for estate taxes.
Let’s look at an example where the surviving spouse is a noncitizen resident. Let’s assume husband dies leaving a noncitizen spouse. Husband has $6,000,000 of assets. Normally, husband’s estate would owe no estate tax in that the husband will make use of the unlimited marital deduction to avoid estate tax at first death. However, with a non-citizen spouse, no marital deduction is allowed unless the property passes to the wife through a Qualified Domestic Trust (QDOT) and the personal representative of the estate makes a timely QDOT election. With a $5,000,000 estate tax exclusion amount, husband can pass the first $5,000,000 to the non-citizen spouse but the other $1,000,000 will be currently estate taxed unless a QDOT trust is credited and elected.
A QDOT allows a citizen spouse to transfer assets at death to a non-citizen spouse without having o pay federal estate taxes on the transfer. At least one of the Trustees of the QDOT must be an individual who is a citizen of the United States or a domestic corporation which is typically a bank or trust company. The Trustee has the right and duty to withhold federal estate taxes from any distribution of principal. Income can be received as in other trusts but it’s not possible to remove principal without paying federal estate taxes on the amount removed at the estate tax rate of the deceased spouse. QDOTS over $2,000,000 must have a corporate Trustee that is a U.S bank, furnish a bond in favor of the IRS equal to 65% of the Trust assets, or furnish a letter of credit for such amount. Small QDOTs where more than 35% of the Trust assets are real property located outside the U.S must also comply with the large QDOT rules. At the death of the non-citizen spouse, any remaining assets held in the QDOT will be subject to estate tax at the deceased spouse’s estate tax rate.
There is a hardship exemption to avoid estate tax, but it is only available if the non-citizen spouse has insufficient income or assets to meet basic needs. If the non-citizen spouse becomes a U.S citizen during the term of the QDOT, the principal of the QDOT can be distributed free of estate tax.
Lastly, where both spouses are U.S citizens, jointly titled property is assumed to be owned 50% by each spouse. However, where the surviving spouse is a non-citizen, this rule is completely eliminated and the party actually expending the funds to purchase such property is deemed the owner for estate tax purposes.
To avoid QDOT restrictions, consideration should be given to having a life insurance policy in an irrevocable life insurance trust. The non-citizen spouse or the trust can apply for and own the policy. This can ease concerns that the non-citizen spouse may not have enough money to live on due to payment of estate taxes.