Estate planning in transition
Many farm families are breathing a sigh of relief — at least for two years — on the issues of income tax and the Federal Estate Tax. Late in 2010, Congress passed and the president signed into law major tax legislation by way of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (signed into law Dec. 17). The bill reinstated the Bush-era income tax breaks and included several provisions pertinent to farm families (bonus depreciation and expense method depreciation were renewed).
The act significantly changed the federal estate tax by reinstating the tax for those people that passed away during 2010 at an exclusion level of $5 million per decedent and a 35% top rate. The same exclusion level and top rate apply for all deaths in 2011-12. Thus, the modifications pertain to deaths through 2012.
We published an article this fall pointing out the issues caused by congressional inaction on the estate tax. In 2001, Congress enacted legislation that gradually reduced the federal estate tax over several years and then eliminated the tax for those dying in 2010. The legislation was referred to as the Economic Growth Tax Relief Reconciliation Act of 2001, or EGTRRA. Had Congress not acted this year, the estate tax would have been reinstated for deaths in 2011 at an exclusion level of $1 million per decedent and a top tax rate of 55%.
Unfortunately, there is still some uncertainty for farm families and other small and large business owners. If Congress doesn’t enact additional legislation before 2013, the estate tax rate will revert to a $1 million exclusion amount per decedent at a 55% rate. Thus, less than two years from now, we will once again be faced with the same issue.
What about ‘modified carryover’?
The act also replaced the “modified carryover basis” rule for 2010 with the “fair-market value basis” rule. This rule had been used for deaths through 2009 under EGTRRA. It means the tax basis heirs get in property they inherit is the fair market value in the hands of the decedent at the time of his or her death. Many refer to this as “stepped-up” basis, because it allows heirs to sell or transfer the land without incurring a hefty capital gains liability.
The modified carryover basis rules that applied during 2010 (pre-legislation) allowed executors of an estate to increase the basis of estate property by $3 million for assets passing to a surviving spouse and an additional $1.3 million for assets passing to others (total basis increase potential was $4.3 million). All remaining estate property would pass at a carryover basis equal to the lesser of the decedent’s basis (amount when they purchased or inherited the property) or the fair market value as of the person’s death. Most often, the decedent’s basis in the property was lower than the fair market value.
However, “modified carryover basis” hasn’t completely disappeared. The act specifies that executors of an estate where the decedent passed in 2010 have the “option” of electing use of the old scheme — consisting of modified carryover basis and no federal estate tax. This election allows those estates with significant wealth to pass the entire estate tax free.
Had Congress not allowed this election, it would most likely have a constitutional challenge on its hands. Estates worth more than $5 million would most likely have protested, claiming the law was retroactive and unfair. The election gives high net worth estates the option to choose their estate tax scenario. Remember, the election is valid only for 2010 deaths.
Some other specifics
In an interesting twist, the act also provides for “portability” between spouses of the unused exclusion amount for estates of those decedents dying in 2011 and 2012. The portability provision allows the surviving spouse to apply any unused amount of the $5 million exclusion of the predeceased spouse to their estate. However, this portability provision only applies if both spouses die before 2013. To make an effective election, the surviving spouse must make an election to use the unused portion on the estate tax return.
Also pertinent to the discussion is the gift tax rate. For gifts made in 2010, the maximum gift tax rate was 35% and the exclusion amount was $1 million. In 2010 and 2011, the gift tax and federal estate tax are re-coupled, meaning that the gift tax rate is now equal to the federal estate tax at 35% with a $5 million exclusion. The Generation-Skipping Transfer Tax, or GSTT, also applies the same rates.
Planning for the future
What does this new legislation mean for farm families attempting to create an effective estate plan? Perhaps, it means there will be less emphasis on concerns regarding the federal estate tax for most decedents and more emphasis on other areas within the realm of estate and business succession planning.
It is always a good idea to consult your attorney and other professionals regarding your estate plan. Though you may not have a net worth high enough to trigger the federal estate tax, remember this law is only effective until the end of 2012. It is still important to update your will and financial and medical power of attorneys.
Herbold is staff attorney for the Center for Agricultural Law and Taxation at ISU.
This article published in the February, 2011 edition of WALLACES FARMER.