2010 Tax Relief Act Creates New, Temporary, Rules
January 7, 2011
On December 17, 2010, the President signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Tax Relief Act”). The Tax Relief Act was passed by Congress on December 16. The Tax Relief Act is an extensive tax package that includes, among many other items, an extension of the Bush-era tax cuts for two years, estate tax relief, a two-year “patch” of the alternative minimum tax (AMT), a two-percentage-point cut in employee-paid payroll taxes and in self-employment tax for 2011, new incentives to invest in machinery and equipment, and a host of retroactively resuscitated and extended tax breaks for individuals and businesses. The key elements of the package include: · The current, favorable income tax rates will be retained for two years (2011 and 2012), with a top tax rate of 35% on ordinary income and 15% on qualified dividends and long-term capital gains. · Employees and self-employed workers get a reduction of two percentage points in Social Security tax in 2011, bringing the rate down from 6.2% to 4.2% for employees, and from 12.4% to 10.4% for the self-employed. · A two-year AMT “patch” for 2010 and 2011 provides a modest increase in AMT exemption amounts and allows personal nonrefundable credits to offset AMT as well as regular tax. · Key tax credits for working families that were enacted or expanded in the American Recovery and Reinvestment Act of 2009 are retained. For example, the new law extends for two years (a) the $1,000 child tax credit (and maintains its expanded refundability), and (b) the American Opportunity tax credit for higher education, and its partial refundability. · Two crackdowns on deductions for higher-income people have been deferred. For 2011 and 2012, higher-income individuals will not face a reduction in their itemized deductions or a phaseout of personal exemptions. · Businesses can write off 100% of their new equipment and machinery purchases in the placed-in-service year, effective for property placed in service after September 8, 2010 and through December 31, 2011. For property placed in service in 2012, the new law provides for 50% additional first-year depreciation. · Many of the popular tax breaks that went off the books at the end of 2009 have been retroactively reinstated for 2010 and extended through the end of 2011. Among many others, the retroactively reinstated and extended individual and business provisions include the election to take an itemized deduction for state and local general sales taxes instead of the itemized deduction for state and local income taxes; the $250 above-the-line deduction for certain expenses of elementary and secondary school teachers; and the research credit. The credit for making energy-saving improvements for a home also has been extended for one year, through 2011, but more rigorous rules apply to the credit after 2010. · After a one-year hiatus, the estate tax will be reinstated for 2011 and 2012, with a top rate of 35% and a step-up in basis. The exemption amount will be $5 million per individual in 2011 and will be indexed to inflation in following years. Estates of people who died in 2010 can choose to follow either 2010's or 2011's rules. As the Trusts and Estate Practice Group focuses its attention on matters relating to estate, gift and generation-skipping transfer (GST) taxes, what follows is a more detailed look at the Tax Relief Act’s provisions involving such taxes. Please note that the Tax Relief Act involves federal law, not state law. As such, the New Jersey estate and inheritance tax laws remain unchanged. PRIOR LAW - EGTRRA The provisions of the 2010 Tax Relief Act can best be understood against the backdrop of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). EGTRRA increased the estate and GST exclusion in stages, and decreased the tax rate, so that, for those who died in 2009, the exclusions were $3,500,000.00 and the tax rate was 45%. EGTRRA further repealed the federal estate tax and the GST tax for estates of individuals dying in 2010. Gift taxes, however, were not repealed. Under EGTRRA, the previously unified system for estate and gift taxes was changed and the gift tax exclusion was maintained at $1,000,000.00, while the estate tax exclusion increased. Further, although prior to EGTRRA property acquired from a decedent generally got a basis equal to its fair market value at the decedent’s death (which meant that, on a later sale by the heir, no income tax would be imposed on the appreciation in the property that occurred while it was held by the decedent), EGTRRA changed this rule for those who died in 2010. Thus, property acquired from a decedent who died in 2010 got a basis generally equal to the decedent’s basis (which meant that, on a later sale by the heir, income tax would be imposed on the appreciation in the property that occurred while it was held by the decedent), subject to modified carryover basis rules that only permitted limited increases in the basis of assets acquired from a decedent. Due to budgetary and legislative considerations, the provisions of EGTRRA were scheduled to expire (or “sunset”) on December 31, 2010 and the pre-EGTRRA rules were to return after 2010. As such, absent Congressional action and Presidential approval, the unified gift tax and estate tax exclusions for those dying in 2011 and later would be reduced to $1,000,000.00 and the top tax rate would be increased to 55%. Further, the carryover basis provisions of EGTRRA would end and the date of death fair market value for basis would return after 2010. Note, carryover basis still generally applies for property transferred by gift. EGTRRA also made other changes to the transfer tax rules that also were scheduled to sunset after 2010. For example, it repealed the state death tax credit and replaced it with a deduction. Under the sunset rules, the deduction was to end and the credit was to return in 2011. EGTRRA also repealed the qualified family-owned business deduction, which was to return in 2011. It also made modifications to the rules regarding qualified conservation easements, installment payment of estate taxes, and various technical aspects of the GST tax. These modifications were to terminate at the end of 2010 under the sunset rule. NEW LAW – THE TAX RELIEF ACT Estate Tax Implications: The Tax Relief Act provides temporary relief – for 2011 and 2012 only. Thereunder, estate and GST taxes are reduced for 2011 and 2012 by increasing the applicable exclusion amount from $1,000,000.00 to $5,000,000.00 (indexed for inflation in $10,000.00 increments after 2011) and by reducing the top tax rate from 55% to 35%. The $5,000,000.00 exclusion is per person. Also, there is a new portability feature for married couples. Under the Tax Relief Act, any applicable basic exclusion ($5,000,000.00 for 2011, and indexed thereafter for inflation) that remains unused as of the death of a spouse who dies after 2010 can be added to the exclusion amount for the surviving spouse; but only if an affirmative election is made on a timely filed estate tax return (including extensions) of the predeceased spouse (even if the estate of the predeceased spouse was otherwise not required to file an estate tax return). However, if a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by the surviving spouse is limited to the lesser of the applicable basic exclusion or the unused exclusion of the last deceased spouse. The Tax Relief Act generally repeals EGTRRA’s modified carryover basis rules that applied for those who died in 2010. As such, under the Act, a recipient of property acquired from a decedent who dies after 2010 generally will receive a basis in assets equal to the date of death fair market value under the rules applicable to assets acquired from decedents who died prior to 2010. Further, these rules may also apply with regard to those who died during 2010 if the decedent’s estate makes the affirmative election further described below. The Tax Relief Act allows estates of decedents dying in 2010 to elect between (1) the imposition of estate taxation based on a $5,000,000.00 exclusion and 35% top tax rate, and basis adjustment based on the date of death value, or (2) no estate tax and modified carryover basis as described above. One would expect the executor to analyze the combined estate and income taxes for the estate and its beneficiaries that would result from either choice and to choose the one that is likely to have the lesser tax cost; keeping in mind, however, that any estate tax imposed would be currently owed, but the income tax imposed by reason of modified carryover basis would not be due until such time when, and if, the inherited property is sold. GST Tax Implications: Under the Tax Relief Act, the GST exemption for decedents dying or gifts made during 2010 is equal to the $5,000,000.00 applicable exclusion amount for estate tax purposes. Therefore, up to $5,000,000.00 in GST tax exemption may be allocated to a trust created or funded during 2010. However, for transfers made during 2010 the GST tax rate is 0%. The GST tax exemption for decedents dying, or for gifts made, after 2010 is equal to the basic exclusion amount for estate tax purposes; that is, $5,000,000.00 as indexed for inflation; but, not to be increased by a predeceased spouse’s unused GST exemption or estate tax exclusion amount. The GST tax rate for transfers made in 2011 and 2012 is 35%. The Act extends the EGTRRA modifications to the rules regarding various technical aspects of the GST tax. Gift Tax Implications: For gifts that were made in 2010, the gift tax exclusion and the gift tax rate continues to be $1,000,000.00 and 35%, respectively. For gifts made after 2010, the gift tax is reunified with the estate tax, and the applicable exclusion amount is $5,000,000.00 with a top estate and gift tax rate of 35%. The Tax Relief Act also clarifies that gift taxes on prior gifts are taken into account by using current tax rates in the calculation of gift taxes on later taxable gifts and in the calculation of the estate tax upon the donor’s death. Under the Tax Relief Act, for a decedent dying after 2009 and before December 17, 2010 (the date of enactment), the due date for certain tax actions is not to be earlier than September 17, 2011 (nine months after the enactment date of the Tax Relief Act). This extension applies for the filing an estate tax return, for paying the federal estate tax, and for the date by which a qualified disclaimer of an interest in property must be made. Further, for generation skipping transfers made after 2009 and before December 17, 2010, the due date for filing any required return (including the making of any election required to be made on the return) is not to be earlier than September 17, 2011 (nine months after the enactment date of the Tax Relief Act). Other Implications: The Tax Relief Act temporarily continues other changes made by EGTRRA for decedents dying during 2010, 2011 or 2012. These changes include allowing the deduction for certain death taxes paid to any State or the District of Columbia and modifications to the rules regarding qualified conservation easements and installment payment of estate taxes. It is essential to remember that the provisions of the 2010 Tax Relief Act expire on December 31, 2012. Consequently, neither the EGTRRA provisions nor the provisions of the 2010 Tax Relief Act will apply for those who die, or for gifts made, after 2012. Accordingly, in less than two short years we can again expect to witness uncertainty and chaos – and this time in the context of a pending national election…. Should you need assistance or have questions, please contact Judson M. Stein, Esq. or Jodi C. Lipka, Esq. of our Trusts and Estates Practice Group at (973) 533-077 or you can e-mail them at email@example.com or firstname.lastname@example.org.