Federal Estate and Gift Tax Update: 2009 – 2011

No doubt you have heard about changes to the estate and gift tax law this year as well as proposed legislation. This advisory helps answer some key questions you may have:

1. Have I inadvertently disadvantaged my spouse in my current plan?
   
   
2. Could my existing plan result in tax liability when I die?
   
   
3. How do depressed asset values, low interest rates, and valuation discounts create opportunities to transfer wealth in this economy?

Federal estate tax

On Jan. 1, 2009, the federal estate tax exempt amount increased from $2 million per person to $3.5 million per person. Current law calls for the repeal of federal estate tax for people dying in 2010. However, that repeal is temporary and applies only in 2010. The effective federal estate tax rate and federal estate tax exempt amounts currently on the books are as follows:

Congress and President Obama's administration will most likely address the federal estate tax issue to avoid these results for 2010 and 2011. President Obama has suggested that he is in favor of freezing the exemption at $3.5 million and retaining the current 45 percent top rate for 2010 and beyond. A bill already has been introduced in the House of Representatives along these lines.

Federal gift tax

On Jan. 1, 2009, the federal gift tax annual exclusion increased from $12,000 to $13,000 per gift recipient. The federal lifetime gift tax exemption (for gifts in excess of the annual exclusion) has not changed; it remains at $1 million.

Oregon inheritance tax

Beginning in 2003, when Oregon separated its inheritance tax (Oregon's estate tax) from the federal estate tax by freezing the inheritance tax exempt amount at $1,000,000, some estates began to owe Oregon inheritance tax even though they owed no federal estate tax. This year's increase in the federal exempt amount to $3.5 million further widens the gap between the federal and Oregon exempt amounts, surprising even more surviving spouses with Oregon inheritance tax bills.

Planning pitfalls and opportunities

It is important to recognize that estate planning opportunities and pitfalls result from the increase in the federal estate tax exempt amount and the difference in the federal and state estate tax exemptions.

1. Have you inadvertently disadvantaged your spouse?
   
   A common estate plan for a married couple includes an exemption trust, also referred to as a bypass or credit shelter trust, and a marital trust. The exemption trust takes full advantage of the federal estate tax exemption, while allocating any amount in excess of the exempt amount to the marital trust to take advantage of the unlimited marital deduction. This structure provides for zero estate tax at the first spouse's death and excludes the amount in the exemption trust from being taxed in the surviving spouse's estate.
   
   Many times the surviving spouse has access to funds in both the exemption and the marital trusts. However, your plan might need immediate revision if you leave assets equal to your federal exempt amount to someone other than your spouse (such as to children), because the substantial increase in the federal estate tax exemption to $3.5 million might consume the assets available to your spouse on your death.
   
   
2. Could your current plan result in tax liability when you die?
   
   If your estate plan leaves assets equal to the full federal exemption in an exemption trust for your spouse, your plan may need revision to avoid payment of the Oregon inheritance tax when you die. For example, if your estate is $3.5 million and would pass into an exemption trust for your spouse, $229,200 in Oregon inheritance tax would be payable within nine months following your death, even though no federal estate tax will be due. With a trust to take advantage of newer tax provisions, this tax can be deferred.
   
   
3. Valuation discounts
   
   Estate planning for many clients has included gifts of interests in family LLCs and partnerships to take advantage of valuation discounts.
   
   A bill already introduced in the House of Representatives could substantially curtail the use of this planning technique (and could also limit the ability to claim valuation discounts for estate tax purposes). Because this bill, if passed, would affect gifts made after the enactment of the bill, there is a current incentive to complete any such gift planning as soon as possible.
   
   
4. Gift opportunities
   
   Making gifts now may be especially advantageous in light of the significantly depressed value of many classes of assets.
   
   
5. Advance planning techniques
   
   Not all of the economic news is bad. Based upon a “perfect storm” of low interest rates and low asset values, a sale or gift of an asset to a specialized trust can significantly reduce estate and inheritance taxes. If the asset's appreciation exceeds a measuring rate (currently around 2 percent) over the next 8 to 10 years, the increased value can be transferred without the payment of gift tax. The benefits include the following:
   
   
   • Income tax: The transfer to the trust creates no capital gain or interest income.
     
     
   • Gift tax: The seller may leverage his or her gift tax exemption and pays income tax on behalf of the trust beneficiaries.
     
     
   • Estate tax: The seller removes the appreciation in the value of the asset from his or her taxable estate at death.
     
     
   • Trust term: The trust may last for a few years or several generations. Long-term trusts have additional tax benefits.

Some of the benefits of this estate planning technique may be affected by proposed legislative changes, so now is the time to act.

If you wish to discuss the application of these changes (and anticipated changes) as they apply to your estate plan, please notify your estate planner.