The Family Firm

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, signed into law on December 17, 2010, extends for two years the income tax rates in effect since 2001.  In addition, several provisions in the previous tax law expired on schedule and were not extended, while others that were set to expire were extended.  While the extension of existing tax rates was the focal point of debate over the bill, several other parts of the law are important as well.  Nearly everything in the law is set to expire after 2012, making this a "temporary" or "stop-gap" tax law.  Playing political football with the tax law makes it very difficult to help clients implement effective tax strategies or even to apply a realistic tax burden to future financial conditions.

Our clients may see tax relief through 2012 in one or more of the following ways:

• all itemized deductions can be deducted against income for all tax payers through 2012;
• all personal exemptions are allowed for all tax payers through 2012;
• all workers, self-employed or otherwise, will pay 2% less payroll tax for remuneration up to the wage base of $106,800 in 2011 only.  This means a direct cash windfall.

Relief from the alternative minimum tax (AMT) is extended through 2011 and the "marriage penalty" is suspended through 2012.

The new law also made significant changes to the estate and gift tax.  Although, again, these are listed as temporary changes (for 2010-2012 only), the estates of those who died in 2010 or who will die in 2011 and 2012 are certainly affected.

Changes from the prior estate tax law are primarily in these areas:

1. Each individual can now pass $5MM (million) free of estate/gift tax.
2. The tax rate on amounts in excess of $5MM is now 35% (down from 55% previously).
3. The "step-up in basis" provision is reinstated.  This means that heirs, once again, will receive assets valued as of the decedent's date of death.
4. For deaths in 2010 executors may retroactively apply the above new rules.
5. The exemption equivalent is now "portable", meaning that the surviving spouse can "inherit" the unused portion of the deceased spouse's exemption equivalent.

The new $5MM exemption means that the vast majority of Americans will no longer pay estate taxes.  However, the buzz in the estate planning community is over a new (again, temporary) estate provision that allows a surviving spouse to "inherit" the unused portion of the deceased spouse's exemption equivalent credit.  Example: Husband dies with assets of $5MM, leaving $4MM to his spouse and $1MM to the children.  The wife now has her own $5MM exemption plus $4MM that he did not use (because he left the assets to her).  She now has a $9MM exemption equivalent available at her death.

Known as the "portability" provision, this new concept makes estate planning much easier and less costly, especially when a significant retirement account, such as an IRA, is involved.  The provision is likely to reduce the use of the "by-pass" trust to avoid estate taxes.  With the by-pass trust the assets of the deceased spouse are put in trust and, while available to the survivor, are not part of the survivor's estate, and thus avoid taxation.  The concern expressed by the estate planning community is that the provision does not eliminate other potential pitfalls (e.g. shifting future appreciation to heirs, controlling who ultimately inherits the assets, or providing asset protection) that are easily handled with the by-pass trust strategy.

Will this new "portability" provision become permanent after 2012?  This revolutionary concept certainly simplifies estate planning for the vast majority of Americans.  And while few estates are likely to benefit from it in the short term (both spouses must die before 2012), its arrival may signal a new movement towards less complexity in our tax code.

The relative cost (in lost revenue) of the key provisions discussed above are itemized below.