This article was originally published in Washington Jewish Week
Under an obscure provision of a 2001 tax law, there is to be a one-year repeal of the federal estate tax for the year 2010. Contrary to all predictions, Congress failed to act before the end of 2009 and the year of no estate tax has begun.
Whether the one-year repeal will continue depends on the action Congress takes in 2010. There is some precedent for a retroactive reinstatement of the tax, if the House and Senate can agree on the terms. Even in the absence of congressional action, however, the estate tax will spring back into existence on Jan. 1, 2011 . The reinstatement of the tax in 2011 comes with a lower exemption level and a higher rate than was in effect at the end of 2009.
In 2009, the estate tax applied only to estates with assets in excess of $3.5 million, and it was imposed at a flat tax rate of 45 percent. If Congress doesn't act during 2010, the estate tax will not be in effect at all for those dying in 2010, but the gift tax will continue, with a 35 percent flat rate. The law as in effect during 2010 also would significantly limit the availability of a stepped-up basis at death. In 2011, however, the exempt amount would fall to $1 million, and the stated maximum tax rate would return to 55 percent.
At this time, there is uncertainty as to whether there are adequate votes in Congress either to eliminate the repeal in 2010 or to increase the exemption level and lower the rates for 2011 and beyond. If Congress does not act, 2010 will be a very good year for wealthy taxpayers to make gifts, as the 35 percent gift tax rate would be historically low.
No matter what the outcome is for 2010 in Congress, there are estate planning opportunities to consider in 2010, assuming that you are planning to live into 2011 and beyond. The easiest way for wealthy individuals to reduce the estate tax bill at death is to give away assets while alive. Every person has a $1 million lifetime exemption from gift tax. However, there are a few other exclusions available that allow gifts to be made without eating into that lifetime exemption.
First, each person has a $13,000 annual exclusion that can be used to avoid tax on gifts. The limit applies on a per donee basis, so a donor can give up to $13,000 per year to as many different donees as she likes without tax consequences. In other words, if a donor has two children and three grandchildren, she can make annual exclusion gifts to her. family of $65,000 (5 ? $13,000) without any gift tax consequences. And if the donor is married, each spouse can give each' donee a $13,000 gift, effectively doubling the amount of the exclusion.
Second, a separate exemption from the gift tax allows a donor to pay unlimited amounts in tuition and medical expenses for others without dipping into the $1 million exemption amount. This is a narrow exception, however, and it applies only to direct payment of tuition to the educational institution and direct payment of medical expenses to the provider. The tuition payment need not be for college, it can be tuition at any educational level, including preschool. The medical expense exception, for example, can be used to pay for a relative's orthodontia, or a new graduate's health insurance premiums.
Gifts to charity have even more tax benefits. Not only do charitable gifts reduce the size of the estate, they also qualify for an income tax deduction. A special provision in effect for 2009, and likely to be extended to 2010, allowed a direct gift to charity from an IRA for those over the age of 70. If the IRA money is not needed for retirement, giving it to charity is advantageous because that avoids the income tax otherwise due when the funds are withdrawn from the IRA.
With the arrival of the new year, now is a good time to reexamine your estate planning to make sure it will minimize your tax bill. And whether Congress acts to revive the estate tax or not, 2010 looks like a good year to make gifts to your family and favorite charities.
This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.