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The New Estate Tax Law and Gift Tax Exemption

January 11, 2011 | Filed Under Finance, Investment, Retirement Savings, Tax Articles | Comments Off

As most people are aware, Congress passed a new estate tax law just prior to the end of calendar year 2010. Not only was the estate tax law changed, so was the lifetime gift tax exemption, as well as the generation skipping transfer tax exemption.

First, the estate tax exemption was increased to $5 million per person from the prior law, which was scheduled to sunset and be reduced to $1 million dollars. This is a $4 million dollar increase in the amount of wealth that an individual can die with, before the federal estate tax law applies to an estate. There is no way to describe this law change other than it is a windfall to taxpayers. Very few people have estates that are subject to estate tax and most of these people either reside on the east coast or west coast, due in large part to real estate values. Although this is a tremendous windfall to taxpayers, the counterargument is that the reduction in estate tax revenue to the federal government will hinder the government’s ability to decrease the federal deficit that is currently spiraling out of control.

The estate tax exemption is also now portable between spouses. This means that if spouse #1 dies and doesn’t need or use all of his or her $5 million exemption, the unused portion is portable or transferable to the surviving spouse. For example, husband dies and has an estate worth $3 million. His surviving widow can aggregate the unused $2 million exemption of her late husband and add it to her $5 million exemption, so she now effectively has a $7 million exemption. This provides for huge tax planning opportunities for wealthier people. Amounts passing to a US citizen spouse and to charity don’t count against the exemption amount.

Second, the lifetime gift tax exemption and the federal estate tax are once again unified; meaning both are set at a $5 million dollar exemption amount for 2011 and 2012 and are tied together. This concept is confusing for many people, so hopefully this will add clarity to the subject. Each year, you may gift up to $13,000 to any person (unlimited in number). This is referred to as the annual gift tax exclusion amount. If the amount of the gift is over $13,000, then it is subject to gift tax and reduces the amount of one’s lifetime gift exemption of now $5 million dollars. The reduction in the lifetime gift tax exemption also reduces the estate tax exemption because the system of gift and estate tax is designed to limit the amount of wealth that can be transferred either during lifetime or upon death. However, tremendous gift planning opportunities are available, without paying a gift tax, to reduce the size of an estate so that an estate tax will not apply upon death.

Lastly, the generation skipping transfer tax exemption, which is an additional tax imposed on transfers of assets to a “skip generation”; generally, one to grandchildren when the parents are still alive, is $5 million, up from $1 million in 2009. When this $5 million GST exemption is leveraged with advanced wealth transfer techniques, such as a grantor retained annuity trust or an installment sale to a trust, wealthy clients will be able to transfer vast sums, tax free, to trusts for their children, grandchildren and generations beyond.

With these new tax law changes, it is critically important to revisit your estate plan. Planning opportunities abound for people with substantial wealth.

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