Legal Bulletins

The Year 2010. The year 2010 was a bizarre year for estate planning. Except as noted below, there was no federal estate tax. Nevertheless, the lack of an estate tax was offset by less favorable income tax basis rules. If the 2010 Tax Relief Act (the “Act”) had not been passed, 2011 would have ushered in significantly higher estate, gift and generation-skipping transfer (“GST”) taxes. (See Note A below concerning an election that can be made by estates of persons dying in 2010.)

More Favorable Exemptions and Rates. With the passage of the Act, a wealth transfer tax structure is now in place that is very similar to the one in place prior to 2010, but with exemptions and a top rate that are much more favorable to taxpayers than the exemptions and tax rate that were in effect in 2009. Unfortunately, the Act lasts for only two years – it “sunsets,” or expires, at the end of 2012. If Congress does nothing, in 2013 we will return to the much harsher wealth transfer tax system that we faced for 2011 had the Act not been enacted.

The following chart summarizes the estate, gift, and GST tax rates and exemptions for 2009 through 2013:

Notes:

A – The Act allows the estates of persons dying in 2010 to choose between no estate tax (and modified carryover basis rules), or an estate tax imposed with an exemption and rate as shown above for the year 2010 (with the step-up in basis rules). If you are dealing with the estate of someone who died in 2010, please contact us to discuss the related issues. Note: If the estate does not want the estate tax to apply in 2010, it must do so by filing an election with the IRS.

B – Indexed for inflation.

C - The 2010 law "sunsets" at the end of 2012; old law returns in 2013, if Congress takes no action.

D – Indexed for inflation, but different reference point from (B).

Income Tax Basis of Decedent’s Assets. Prior to 2010, the assets of a decedent received a basis adjustment that caused those assets to have an income tax basis equal to the value of the assets for federal estate tax purposes (typically, the date of death value, but subject to certain exceptions for assets such as traditional IRA accounts). In many cases, this meant erasing years of taxable gain for income tax purposes. In 2010, the step-up in basis was replaced by a modified carryover basis system. With two large, but limited, exceptions, the decedent’s assets received a basis equal to the lesser of the decedent’s basis or the fair market value of the property at death. The Act has reinstituted the step-up in basis rules. (This Bulletin assumes that assets have appreciated in value from the time of acquisition to the date of death. If they have declined in value, there would be a step-down in basis under the reinstituted rules.)

Gift Tax. Beginning in 2011, the gift tax and the estate tax are once again unified, using the same exemption and rate. For 2010, however, the gift tax exemption remained at $1 million, while the estate and GST tax exemptions increased to $5 million under the Act.

GST Tax. The Act resolves a significant uncertainty concerning the ability to apply one’s GST exemption to gifts made in trust in 2010, including insurance trusts. Until the Act, there was a question as to whether the GST exemption could be allocated to such gifts because, technically, the GST tax did not exist in 2010. The Act restores the GST exemption for 2010, thereby allowing it to be allocated to gifts in trust. However, the Act effectively prevents the imposition of any GST tax on transfers made in 2010 by providing that the 2010 GST tax rate is 0%. The Act has the ripple effect of retaining the GST exemption automatic allocation rules. You may opt out of the automatic allocation rules, but you should do so only after reviewing this with us or your gift tax return preparer.

Portability. The Act introduces the concept of “portability” for 2011 and 2012. Prior to the Act, if the first spouse died without fully using his or her estate tax exemption, the unused portion was wasted. Under the Act, that unused portion will now be available to the survivor, in addition to the survivor’s own exemption for gift and estate tax purposes. The amount that can be transferred to the survivor is limited to the unused exemption of the survivor’s most recently deceased spouse. Thus, remarriage can dramatically affect this amount. Portability requires an election on a timely filed estate tax return of the deceased spouse, even if an estate tax return is not otherwise required to be filed. Portability does not apply to the GST tax exemption.

Absence makes the heart grow fonder. There is also good news in what is not included in the Act. Although rumored and feared, the Act does nothing to change the use of short-term GRATs or the use of sales to intentionally defective trusts. A good use of the expanded $5 million gift exemption may be to use a part of it in connection with those estate planning vehicles. These opportunities should be pursued sooner rather than later, given the current historically low interest rates and the chance of renewed legislative efforts to do away with them.

Maryland Estate Tax. The above discussion concerns the federal estate tax. The threshold amount for the Maryland estate tax remains at $1 million. For married couples, Maryland continues to allow one to defer (not avoid) the Maryland estate tax on the excess of the federal exemption over the Maryland threshold amount until the second death, as long as this excess is held in a trust exclusively for the surviving spouse’s benefit.

What should I do? The biggest mistake would be to assume that the increased exemptions and portability do away with the need for estate planning and/or tax planning. First, the Act lasts for only two years, and then we face the same uncertainty as before. Second, while the new law creates significant opportunities, it also raises many complex estate planning issues. For example:

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  One may think that a bypass (estate tax exemption) trust no longer serves a purpose on the death of the first spouse. However, these trusts will prevent appreciation that accrues between the deaths of the spouses from being subject to estate tax on the survivor’s death. The $5 million gift tax exemption should be used with care. If the exemptions are reduced to $1 million in 2013, it is possible that upon death, gifts using the excess of the $5 million exemption over that amount may be subject to a recapture tax.
  
  
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  If you leave your estate tax exemption amount to your children and the balance of your estate to your spouse, you may be unintentionally disinheriting your spouse now that the exemption has increased to $5 million. If you leave your GST exemption to your grandchildren and the balance of your estate to your children, you also may be unintentionally disinheriting your children.
  
  
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  Perhaps the most important reason that you should not ignore planning issues is that the non-tax issues in your planning may be the most critical ones. The use of trusts – bypass, marital, or otherwise – can offer a significant layer of asset protection and valuable management for assets. Trusts can provide a safety net for your descendants and protect assets from the grasp of a subsequent spouse of the survivor of you. Simply leaving everything to each other or to your children outright may be inappropriate for your family’s needs and long-term benefit.

We suggest that you contact us to review these matters, and to investigate the opportunities that are available to you. Most importantly, you should determine whether your estate planning wishes are carried out by your current planning documents.

The New Maryland Power of Attorney Law

As of October, 2010, a new law became effective in Maryland governing those powers of attorney documents which concern the management of your assets and financial matters. The law provides two statutorily prescribed forms – a Limited Power of Attorney and a Personal Financial Power of Attorney. Essentially, these forms replace the “General Power of Attorney,” which individuals had executed previously.

Prior to this new law, there was little guidance regarding power of attorney documents under Maryland law. Although the new law provides some clarity on certain points, such as the execution and validity of the document, the new law has resulted in various questions relating to the language of the statute and the forms.

A significant benefit of the new law is that if your document is in substantially the same form as the statutorily prescribed document, it must be accepted by any party who is presented with the document. If the party does not accept the document, such party is liable for reasonable attorneys’ fees and costs incurred as a result of any court action to have the power of attorney accepted.

Ironically, the new “Limited Power of Attorney” form is anything but limited. It is far more extensive than the new “Personal Financial Power of Attorney” and even more detailed than most “General Powers of Attorney” used previously. The new law has turned the Power of Attorney into a booklet of more than 15 pages. Of the two new forms, in most cases we recommend the use of the purportedly “Limited” format because it (i) includes everything in the Personal Financial format, (ii) covers a much broader array of asset management issues, and (iii) allows you to more precisely include or exclude particular provisions. The downsides are (i) that you need to initial the Limited Power of Attorney form in a number of places, and (ii) it is lengthy.

If you have any questions about these matters, please contact your regular Gordon Feinblatt attorney, or our Trusts & Estates Group:

This bulletin is designed to inform you of current legal developments and

should not be construed as legal advice or opinion concerning specific factual situations.