Tax, Portability and Exemption Planning for 2010, 2011 and 2012
In 2010, the federal estate tax was repealed, meaning the estates of those dying in that year would not be subject to federal estate taxation. However, estate property that passed to heirs did not receive a date of death basis increase and were subject to modified carry-over basis rules.
The previous law stated that the exemption amount in 2011 was to be 1 million with a taxation rate of 55%. This law was changed in late 2010 by the 2010 Tax Relief Act, making the federal estate tax exemption 5 million with a taxation rate of 35% over that amount for 2011and 2012 .
Additionally, the 2010 Tax Act made the 2011 law retroactive to January 1, 2010 allowing the personal representative for estates of decedents who died in 2010 to either utilize the 5 million exemption or to elect the 2010 'no estate tax' system with the modified carry over basis rules.
The value of the estate will dictate the decision on which tax scheme to choose. Generally, for an estate below 5 million, which would not be subject to an estate tax, the decision would be to stay with the estate tax system. Estates larger than 5 million would opt out of the estate tax system and be subject to the carry-over rules.
For deaths before and after 2010, basis of property passing to someone at a decedent's death is the fair market value of the property at the time of death. If the decedent bought property for $100,000 and at the time of death the property was worth $400,000, the basis would be $400,000 and the recipient of the inherited property receives a $300,000 step-up in basis and no capital gains would be due.
For deaths during 2010, the basis is the lesser of the decedent's adjusted basis in that property or the fair market value of the property at the time of death. This is called carry-over basis and generally means that the basis that the recipient receives on the property will be that which it was for the decedent. If the fair market value of the property is greater at the time of death than when it was acquired by the decedent, a gain will be realized with taxation on the amount of the gain.
If the carry-over basis option is chosen, the estate will receive a 1.3 million basis step-up. Spouses will receive an additional 3 million basis step-up.
Portability and Exemption Planning for 2011 and 2012
For the next two years, portability may diminish the necessity to preserve a spouse's unified credit and thus eliminate the need for planning which involves exemption and credit shelter trusts. For 2011 and 2012, a spouse will inherit their deceased spouse's unused estate and gift tax exemptions.
This portability will not be available in 2013 and the exemption will be lost without planning to preserve the deceased spouse's unified credit.
Portability will make estate plans simpler in that an exemption trust would not be necessary, but portability is not scheduled to continue after 2012. Additionally, the representative for the estate must file a timely estate tax return, even if the estate is not above the current exemption amount, to preserve the deceased spouses unused exemption.