The future of federal estate tax law was a mystery until Congress recently passed the "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010." This legislation included, among many tax law items, changes to the estate tax law for years 2010, 2011, and 2012. The following is a summary of the new changes in the federal estate tax law.
Under previous tax laws, the estate tax was fully repealed for 2010, but the new legislation retroactively reinstated an estate tax for 2010. For 2010, the estate tax exemption amount is $5 million. The amount of an estate that exceeds the exemption amount is taxed at 35%. Retroactively applying an estate tax law may seem unfair to many estates of individuals who died during 2010; however, the estates of individuals who died during 2010 have a choice in which rules they want to follow. They can be subject to the new estate tax law for 2010 or elect to follow the previous rules assuming a full repeal of the estate tax in 2010. The basis of inherited assets is treated differently under each scenario and may influence which rules a decedent's estate elects to follow.
Under the new estate tax law for 2010, the basis of inherited assets is the full market value at the decedent's death. Under the 2010 repeal of the estate tax, the basis of inherited assets is limited to the lesser of the decedent's basis or the full market value at the decedent's death. Estates of less than $5 million will probably want to assume an estate tax during 2010. They can still avoid paying estate tax with the $5 million exemption, and their heirs can receive a full fair market basis in the inherited assets. Estates of more than $5 million may want to elect the repeal of estate tax for 2010. Their heirs will not receive a step-up of basis, but future capital gains they may have can be taxed at the long-term capital gains rate of 15% rather than the current estate tax rate of 35%.
For 2011 and 2012, the estate tax exemption is $5 million (adjusted for inflation in 2012), and the amount of an estate that exceeds the exemption is taxed at 35%. One main difference in the estate tax law for years 2011 and 2012 compared to previous years is the portability of the estate tax exemption between spouses. In previous years, any unused portion of a deceased spouse's exemption amount could not be used by the surviving spouse, but for 2011 and 2012, any unused portion of a deceased spouse's exemption is added to the exemption amount available to the surviving spouse. For example, if a husband dies and leaves everything to his wife, then he uses none of his $5 million available estate tax exemption. His wife would then have an available estate tax exemption of $10 million, which is the $5 million unused by her husband plus the $5 million of her own exemption.
The "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010" did not address changes in the federal estate tax law for years beyond 2012. Starting in 2013, absent further legislation, the estate tax exemption amount will revert to $1 million, and the maximum estate tax rate will be 55%. The portability of the estate tax exemption between spouses will also disappear starting in 2013. Congress could pass additional legislation before 2013 that extends the recent changes in the estate tax law, but to assume that now would be pure speculation. Until we have legislation that makes the federal estate tax law permanent, the future of estate tax law will always be a mystery.
Supporting Documents: Text of Legislation; Technical Explanation; Summary
