On December 17, 2010, Congress passed, and President Obama signed, the “Reid–McConnell Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010.” Primarily, that Act extends until the end of 2012 most of the provisions of two separate tax relief laws that were scheduled to expire at the end of 2010, viz., the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). The provisions of the Act expire on January 1, 2013, and the affected provisions of the IRC revert back to pre-EGTRRA status.

Reunification and Applicable Exclusion Amount. Under the Act, gift and estate taxes are reunified as of January 1, 2011 (as they were before EGTRRA), minimizing the effect of the choice to make a gift during life or at death. The “applicable exclusion amount” under IRC §2010 is set at $5,000,000 and this amount is indexed by IRC §2505, with the result that beginning January 1, 2011, the so-called “unified credit” for gift and estate taxes is $5,000,000. Although this reunification and increase in exclusion amount is effective under the act for only two years (2011 and 2012), the $5,000,000 amount is indexed for inflation in multiples of $10,000 beginning in 2012. On January 1, 2013, the applicable exclusion amount will revert back to $1,000,000, as it was scheduled under prior law.

Estate tax rates. Estate tax rates are simply truncated by the Act at the top marginal rate of 35%. The brackets between 18% and 34% remain exactly the same, and the 35% bracket is imposed as the maximum rate.

Marital Deduction and the Applicable Exclusion. One of the most important and significant features of the federal estate tax, since before the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, is that a decedent is entitled to a deduction from his or her gross estate for any amount left to a surviving spouse. This deduction is known as the “unlimited marital deduction.” In order to be deductible under this provision, the gift to a surviving spouse must be of a non-terminable interest (except as set forth below) and must “qualify” for the marital deduction. The purpose of the requirement of qualification for the marital deduction is to insure that the amount left to a spouse be left in such a fashion that it will eventually be included in the surviving spouse’s taxable estate. A direct gift, with no strings attached, automatically qualifies. In order for a trust to qualify for the marital deduction it must provide that the spouse (1) have at least a right to all of the income from the trust payable at least as frequently as annually; and (2) have a general power of appointment over the corpus of the trust that can be exercised in his or her will. A general power of appointment means that the spouse is free to decide who gets the corpus of the trust at his or her death and in what proportions. The federal estate tax provides for a statutory exception to the requirement that a gift to a surviving spouse be non-terminable; this exception is for “Qualified Terminable Interest Property” (QTIP). The decedent can create a QTIP Marital Trust which restricts the surviving spouse’s access to and control over the Marital Trust corpus during his or her life and at death, so that the decedent can control the ultimate disposition of the QTIP Marital Trust corpus at the surviving spouse’s death (to assure that the property in the trust passes to the decedent’s children, for example). The executor must elect to accept this requirement at the decedent’s death. Ordinarily this is not an issue, since making the QTIP election means that the trust is larger during the surviving spouse’s lifetime by the amount of federal estate tax that is saved by making the election than it would be if the executor refused it. Thus, the surviving spouse will enjoy a significantly higher amount of income from the QTIP trust than if the executor had not made the election. The requirement that all income be paid to the surviving spouse during his or her life is also a requirement of QTIP Marital Trusts.

Since the marital deduction is “unlimited,” it would seem to make sense for a married individual to rely completely upon the marital deduction to shelter his estate from estate tax upon death. This leads, however, simply to a postponement of estate tax, rather than to complete avoidance. Upon the death of the first spouse to die, if all property passes to the surviving spouse, no tax will be payable when the first spouse dies; the tax will simply be deferred until the death of the surviving spouse, when all property previously transferred to that spouse will be included in the surviving spouse’s estate, subject only to available credits in that estate or “portability” of the unused exclusion in the predeceased spouse’s estate (see below). In an ultimate sense, therefore, no tax savings have been accomplished since the unified credit available to the first spouse to die was not used, and potentially up to $1,455,800 was unnecessarily paid to the IRS. That is the case in most situations where a married couple holds the majority of its assets in joint tenancy and each names the other as beneficiary of all life insurance, IRAs and qualified retirement benefits: all such property qualifies for the marital deduction and none of it for the applicable exclusion amount. An estate plan utilizing a “credit shelter trust” can maximize each person’s available exclusion amount and shelter up to $10,000,000 ($5,000,000 in the estate of each spouse) from federal estate tax. Additional tax savings can be accomplished through the use of a gifting program to reduce overall estate size (see below), or by incorporating more sophisticated planning vehicles into the estate plan. Each individual should discuss these, and other, options with his or her estate planning professional.

Portability. Section 303 of the Act introduces “portability” to the applicable exclusion amount (unified credit), the ability for a surviving spouse to use any applicable exclusion amount left unused by his or her predeceased spouse. Thus, for example, under the Act, if Spouse A dies using only $2,000,000 of his $5,000,000 applicable exclusion amount, then upon the subsequent death of Spouse B, she may use her $5,000,000 plus his unused $3,000,000, for a total of $8,000,000. To prevent serial credit collection, the act allows the portability of the unused applicable exclusion amount of only the last spouse to die. It is important to note, however, that a portability election must be made in the estate tax return of the first spouse to die in order to preserve it in the estate of the last spouse to die. Thus, if the surviving spouse wishes to preserve her predeceased spouse’s exemption amount, an estate tax return will need to be filed in the estate of the predeceased spouse whether or not that estate is a taxable estate or not. In the absence of such a filing, portability of the unused estate tax exclusion amount from the predeceased spouse’s estate to the surviving spouse’s estate cannot be accomplished.

Generation–skipping transfer tax. As under current law, under the Act the so-called GST exemption is equal to the applicable exclusion amount, now $5 million, as imported by reference by IRC §2631(c).

It is important to understand that the Act is essentially a two-year patch to prevent economic damage from tax provisions that are expiring at an inconvenient time. This will all have to be revisited before the end of 2012, when the party balance in Washington may be very different than it is today. It is probably not a coincidence that the provisions of the act expire in the year of the presidential election and elections in both the Senate and House.

– Heinz J. Brisske