2011 Tax Law Changes

Revisions required for Estate Tax calculation programs

Congress unfortunately has again failed to address a “permanent” fix of the federal estate tax. Section 101 of the newly enacted Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the Act) extends the Economic Growth and Tax Relief Reconciliation act of 2001 (EGTRRA) through 2011 and 2012 (with certain applications in 2010). In 2013, we’ll return to the same messy uncertainties we’ve been dealing with over the last few years.

This Tech Review addresses the effect of the Act on estate tax calculating programs and the need to revise those programs. It should be noted, also, that the Act will significantly affect estate planning and will require updates of the document assembly programs. The continued increase of the federal estate tax applicable exclusion will also affect practice building. Historically, the wide impact of the federal estate tax tended to generate estate-planning activity, which would then draw attention to the important issues of family solidarity and business succession. In the future, these issues may tend to be neglected in clearly nontaxable estates. Retirement planning, also, will tend to assume more practice significance as the event of death has less tax impact.

Timing

The provisions of Sections 301, 302 and 303 of the Act that address the federal rates and exemptions that apply to estates of decedents dying and gifts made after Dec. 31, 2009, will sunset at the end of 2012.

Provisions Applicable to 2010

Section 301(c) enacts a special election with respect to estates of decedents dying after Dec. 31, 2009 and before Jan. 1, 2011 that allows the executor of the estate to elect application of the carryover basis provisions of Section 1022 instead of having the estate tax provisions of the new law applicable to 2010 apply. If the revised estate tax provisions apply to such an estate for 2010, the eligible estate assets receive a full step-up in basis (subject to a federal estate tax on the value in excess of $5 million). If the estate elects out of application of the revised federal estate tax in 2010, then the basis provisions of Section1022 apply (but the estate is exempt from any federal estate tax). Evaluating this election requires a computer program that includes provisions for entering the decedent’s cost basis in individual asset items, allocating the Section 1022 basis increases to individual items and projecting the tax cost of future sale of estate items.

Projection of future tax cost of sale must, of course, account for depreciation recapture applicable to real estate, as well as various forms of personal property and the various tax rates that depend on the tax character of the asset sold. Other factors relating to the allocation of the basis increases include the marginal income tax brackets of each beneficiary, the allocation of the estate’s assets among the beneficiaries and the timing of any likely sale of the assets and whether the beneficiary intends to hold the asset until his death. The extension of the 2010 income tax rates into 2011 and 2012, instead of the increase of these rates provided for by prior law, will affect the computation of the projected future tax on gain as to estate assets, as well.

This election will pose great difficulty for executors in evaluating all the factors that weigh on the decision whether to elect carryover basis. Executors must, at least, have the basic tax costs of future sale of estate assets available to them.

The Act extends the due date of estate tax returns for estates of decedents dying in 2010 and for the filing of carryover basis Form 8939 to no earlier than nine months after the date of enactment of the Act. The due date for making any disclaimers for such estates under Section 2518(b) is similarly extended.

Section 301(d) extends the due date for the large transfers tax return (carryover basis allocations) to nine months after the Act’s enactment.

The federal gift tax exclusion remains at $1 million for 2010 and the maximum gift tax rate remains at 35 percent, so no change in gift tax calculation will be required in calculating programs for 2010.

The generation-skipping transfer (GST) tax rate, similarly, remains at zero for 2010 and requires no calculation program modifications.

Federal Estate and Gift Tax: 2011 and 2012

Section 303(a)(2) increases the applicable exclusion (basic exclusion amount) to $5 million and applies an inflation adjustment to it, determined in the same manner (applying the cost-of-living adjustment under Section 1(f)(3)) as is done in computing the annual gift tax exclusion. Programs calculating the federal estate tax will have to revise the basic exclusion amount for the years 2010, 2011 and 2012 and introduce calculation of the cost-of-living adjustment to the basic exclusion amount (for 2010). The maximum federal estate tax rate is reduced to 35 percent by eliminating all brackets above 35 percent in the current unified credit table.

The GST tax exemption also increases to $5 million for 2010 and 2012.The federal gift tax exclusion amount becomes $5 million for 2011 and 2012 and the maximum rate remains at 35 percent for those years.

Deceased Spousal Unused Exclusion Amount

Section 303(a)(4) provides for the portability of the spousal unused exclusion amount and enacts the deceased spouse unused exclusion amount (DSUEA). The DSUEA applies only to the estates of decedents dying in 2011 or 2012. Under Section 303(a)(5) the executor of the estate of the first deceased spouse must file an estate tax return on which the DSUEA is computed. The executor must also make an election on that return that the DSUEA may be taken into account in the estate tax return of the surviving spouse. Under Section 303(a)(2), the applicable exclusion amount for the surviving spouse is the basic exclusion amount plus the DSUEA of the deceased spouse. Programs addressing the DSUEA need to provide for the steps the executor of the deceased spouse’s estate must take under Section 303(a)(5).

DSUEA (as to the surviving spouse) applies only to the unused exclusion amount flowing from the estate of the deceased current spouse and must be elected in that estate.. If the surviving spouse remarries after the death of a spouse, the DSUEA of the prior deceased spouse is lost upon the death of the prior new spouse. However, if the surviving spouse dies prior to the death of the new spouse, the estate of the surviving spouse may still use the DSUEA. Further, the estate of the surviving spouse may also make the DSUEA election that will result in making its DSUEA available to the estate of the new spouse. The limitations, however, prevent any DSUEA from the first estate from being transferred through the estate of the former surviving spouse to the subsequent estate of the new spouse. It should be noted that the statute of limitations remains open on any estate tax return on which the election is made so that the amount of the DSUEA can be adjusted in the estate of the surviving spouse.

Return of Pre-EGTRRA 2001 Provisions in 2013

EGTRRA repealed Internal Revenue Code Section 2057 and the family-owned business interest (FOBI) deduction beginning after the year 2003. The Act extends this repeal through the year 2010. In the year 2013 the pre-EGTRRA law will return, including the FOBI deduction. Addressing this deduction programmatically requires identification of the eligible and elected assets and replication of the former Form 706, Schedule T to compute the deduction.

The Act extends IRC Section 2058 providing a deduction for state estate and inheritance taxes rather than the credit provided by the pre-EGTRRA law under Section 2011 for 2010, 2011 and 2012. In these years, the state death tax deduction is still available on Form 706, Line 3b as it was in 2005 through 2009. In 2013, the Section 2011 credit returns and the Section 2058 deduction will no longer apply, and federal estate tax calculations will have to be adjusted accordingly.

State Estate Taxes

The Act extends the Section 2018 deduction of state death taxes through 2010, but the old state death tax credit returns in 2013. Given the increased federal exemption in 2011 and 2012, states may be inspired to enact or reenact decoupled state estate taxes applying, at least, to those two years. In Illinois, for example, the decoupled state estate tax ended for deaths after Dec. 31, 2009, and, thereafter, the state estate tax equals the credit for state tax allowable under IRC Section 2011 (pick-up tax only). Because it’s tied to the federal estate tax, there will be no Illinois state estate tax for 2010, if an estate elects carryover basis. Programs that compute the state estate tax will require revisions for 2010 and later years with the postponement of the state death tax credit calculation to 2013.

Bottom Line

You will need to pay careful attention to the programs that you use or are considering purchasing in the light of the new Act. Those programs that cover the areas discussed herein and that affect your practice should be updated in supplementation or enhancement of the program. Of course, in 2013 this whole mess returns and we will no doubt have to revisit calculation of each of these issues again.


Trusts & Estates magazine is pleased to present the monthly Technology Review by Donald H. Kelley—a respected connoisseur of the software and Internet resources wealth management advisors use to further their practices.

Kelley is a lawyer living in Highlands Ranch, Colo. and is of counsel to the law firm of Kelley, Scritsmier & Byrne, P.C. of North Platte, Neb. He is the co-author of the Intuitive Estate Planner Software, (Thomson – West 2004). He has served on the governing boards of the American Bar Association Real Property Probate and Trust Section and the American College of Tax Counsel. He is a past regent and past chair of the Committee on Technology in the Practice of the American College of Trust and Estate Counsel.

Trusts & Estates has asked Kelley to provide his unvarnished opinions on the tech resources available in the practice today. His columns are edited for readability only. Send feedback and suggestions for articles directly to him at [email protected].

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