Take Advantage of Estate Tax Benefits

No one is surprised that the federal estate tax has returned after a one-year absence. Many of us are surprised, however, that the new estate tax law is significantly improved over the law that existed prior to 2010. Some of these improvements offer closely owned business owners and familyowned businesses some interesting planning opportunities during the next two years.

First, the estate tax exemption amount has been increased to $5 million per individual ($10 million for married couples). The maximum estate tax rate has been set at 35%. This means that many families and family-owned businesses will no longer be subject to federal estate tax.

Additionally, the estate tax and gift tax have been “reunified.” Prior to 2010, the estate tax exemption was $3.5 million, but the gift tax exemption was only $1 million. That meant that an individual could make $1 million of gifts during his or her lifetime tax-free and an additional $2.5 million of gifts at the time of death tax-free. However, lifetime gifts greater than $1 million were subject to a 35% gift tax.

Under the new law, a “unified” estate and gift tax means that up to $5 million can be given during a lifetime or at death estate tax-free. Individuals who have already used their $1 million gift exemption under the old law can now make an additional $4 million of gifts during their lifetimes. Wealthy individuals may want to make lifetime gifts, particularly of property that is likely to appreciate. This will remove not only the present value of the property but also future appreciation from their taxable estates.

The generation-skipping transfer (GST) tax is a tax that is imposed upon gifts made to persons who are 37.5 years younger than the donor. It is designed to prevent individuals from “skipping” an estate tax by making gifts to grandchildren rather than to children. The GST tax exemption has been increased to $5 million. This is a good time, therefore, for wealthy individuals to make generation-skipping transfers.

The new law replaces the modified “carry-over basis” rule with a “step up in basis” rule. This change is best explained with an example. Assume that in 2010, a relative died leaving you publicly traded stock that had a value of $100,000 on your relative’s date of death. Your relative purchased the stock many years ago for $20,000. Under the carry-over basis rule, you inherited your relative’s cost basis for tax purposes. This means that if you sell the stock for $100,000, you would have a taxable gain of $80,000. Under the step up in basis rule, your basis in the stock for tax purposes is the value of the stock on your relative’s date of death — $100,000. Thus, if you sell the stock for $100,000, you will have no taxable gain.

Individuals who own property that has greatly appreciated in value may want to hold onto that property and transfer it at the time of their death in order to save their heirs income taxes.

Unfortunately, the new estate tax law is only in effect from January 1, 2011 through December 31, 2012. In the absence of congressional action, the estate, gift, and GST exemption will drop to $1 million, and the maximum tax rate will increase to 55%. While Congress will likely take some action, but given the uncertainty after 2012, it makes good sense to consider these planning opportunities now.

Michael P. Coyne is a founding partner of the law firm, Waldheger Coyne, located in Cleveland, Ohio. For more information on the firm, visit: www.healthlaw.com or call 440-835-0600.