The December 2010 tax compromise between President Obama and Republican lawmakers provided for a $5 million gift and estate tax exemption ($10 million for a married couple). Assets exceeding that amount are taxed at a 35% rate. The $5 million exemption is indexed for inflation beginning in 2012 ($5.12 million). The Act also unifies the gift and estate tax exemption so that the $5 million exemption can be used to make lifetime gifts and/or testamentary bequests. The Act also provides for "portability," a feature that eliminates the need for a married couple to establish a Credit Shelter Trust to ensure that their heirs receive the benefit of both spouse's estate tax exemptions. The Tax Relief Act of 2010 that established the current estate tax rules is set to expire on January 1, 2013.

Pursuant to the Budget Control Act of 2011, the so-called "Super Committee" had until November 23, 2011, to issue a formal proposal containing at least $1.2 trillion in deficit reduction for the full Congress to consider. Among the rumors circulating, as the Committee neared decision time, was that the gift tax exemption amount would be decreased to $1 million effective January 1, 2012, instead of January 1, 2013. Some even predicted that the decrease would take effect on November 23, 2011. In the end, the Super Committee made no decision.

President Obama's 2012 budget proposes to bring the estate tax exemption back to 2009 levels - $3.5 million with a maximum 45% tax rate. The President also wants to eliminate unification by making the gift and generation-skipping tax exemption $1 million, with a top rate of 45%. The President also proposes to make the portability provision permanent so that married couples may continue to carry over unused exemptions, but the exemption amount that would be preserved would be limited to the estate and gift exemption in effect in 2013 and beyond.

In contrast to the President's proposal, every Republican candidate for President wants the federal estate tax repealed. The most often cited reasons for repealing the estate tax are that many small businesses and family farms have to be sold to pay estate taxes, and that the estate tax (along with the income tax) stifles saving and investing, thereby undermining job creation and productivity. Most Democrats counter by pointing out that reducing or eliminating estate taxes for the richest 1% of Americans is bad policy, given the large deficits facing the US.

So, the fate of the federal estate tax likely lies in the results of the next election. Here are the most likely scenarios:

1. Scenario No. 1: Because of continued gridlock and Congress's reluctance to address entitlements and tax reform in an election year, Congress could allow the new law to sunset (as it is scheduled to do on December 31, 2012). Since this scenario is already in place, it requires no further Congressional action. If this happens, then a $1,000,000 estate tax exemption and 55% estate tax rate will begin on January 1, 2013. It's also possible under this scenario that if the new Congress strikes a deal on the estate tax, the new law will be made retroactive back to January 1, 2013. Support for this scenario recently came from Congressman Jim McDermott of Washington, a senior member of the House Ways and Means Committee. On November 17, 2011, Congressman McDermott introduced the "Sensible Estate Tax Act of 2011." The bill would, among other things, roll back the top estate tax rate to 55%, with a $1 million exemption ($2 million for married couples) indexed for inflation. The bill would also retain both unification and portability.



2. Scenario No. 2: If neither Party has complete control over tax legislation, Congress could extend the 2010 law in 2013 and beyond. This would mean that the estate tax exemption would be indexed for inflation above the $5,120,000 exemption that will go into effect in 2012 and the top rate would remain at 35%. Under this scenario, unification and portability remain intact. If this scenario occurs, then the estate tax will be de facto repealed for more than 99% of Americans. According to estimates from the Tax Policy Center there are only an estimated 3,300 estates in the US that would owe federal estate taxes in 2011 under the current exemption of $5 million.



3. Scenario No. 3: If the Democrats control tax legislation, Congress could pass some form of an estate tax compromise which will lower the estate tax exemption and increase the estate tax rate to something more in line with the 2009 numbers, as the President has proposed for his 2013 budget.



4. Scenario No. 4: If the Republicans control tax legislation, Congress could permanently repeal the federal estate tax (and bring back carry-over basis). If a Republican wins the White House, this is a distinct possibility given that Republicans are in control of the House and have gained significant ground in the Senate (where 60 votes are needed to repeal the estate tax). Support for repealing the estate tax comes from a recent study commissioned by the American Family Business Foundation and conducted at the Institute for Research on the Economics of Taxation. The study found that repealing the estate tax would increase GDP by 2.26% by 2021, and would generate enough revenue over a ten year period to cover almost a third of the current $1.2 trillion in deficit reduction. Additional support for repealing the estate tax is that it represents a negligible amount of the Government's revenue. According to the Congressional Research Service, with a $5 million exemption and a top rate of 35%, only $11 billion in estate taxes will be raised. That amount only contributes 0.321% of the $3.5 trillion needed for the government's estimated annual budget. Some observers predict that the Republicans might even be willing to trade higher income tax rates for the repeal of the estate tax.

The bottom line is that it's impossible to know how and when lawmakers will act (and whether any new law will be permanent or just another extender bill). And that makes it exceedingly difficult for clients (and their advisors) to do any intelligent estate planning.

For more information regarding this topic, please e-mail your requests to Julius Giarmarco, or call Julius at (248) 457-7200.

Form 8939 must be filed by January 17, 2012 by executors/trustees who wish to report carryover and step-ups in basis for estates/trusts of decedents who died in 2010, and wish to elect out of the default Federal estate tax regime.

The following are some keys to keep in mind when finalizing this return:

1. The fair market value of an asset at the moment of distribution or sale by the executor/trustee may be less than the date of death fair market value, but still result in a gain. In the case of a distribution to a beneficiary, this would be case if the asset were promptly sold by that beneficiary following his/her receipt. In this circumstance, the executor/trustee may wish to consider allocating less than all possible basis to the gain of this asset.



2. Schedule A, Line 4, Box in column (e)(ii). If a executor/trustee sold assets - instead of distributing them outright to the surviving spouse or funding them into a QTIP Trust - such assets will not be eligible for the $3M spousal basis increase. However, there is an exception which would allow the basis increase. If the executor/trustee, checks the box on 8939 (referenced above) and, in fact, ensures that the net proceeds from the sale of such assets will be distributed to or for the benefit of the surviving spouse, then the spousal basis increase may be applied to those assets.
   
   NOTE: There is no comparable box to check for sold assets where the executor/trustee seeks to apply the $1.3M general basis increase.



3. If an executor/trustee is unable to fully allocate the spousal basis increase by January 17, 2012, he/she is permitted the automatic ability to file an amended 8939. However, in order to receive this privilege, the executor/trustee must (a) have already filed an 8939 by January 17th that is complete except for the allocation of full amount and (b) file the amended 8939 within 90 of the distribution of the assets which will have spousal basis increase allocated to them.
   
   NOTE: Because of this automatic amendment privilege, it may make sense to allocate the $1.3M general basis increase to assets passing to the surviving spouse or QTIP Trust before allocating the $3M spousal basis increase. There is no automatic amendment privilege for late allocation of the general basis increase.



4. Should personal property be listed? Yes. However, keep in mind that household and personal property in the same room may be grouped together provided that no single item exceeds $100 in value.



5. Capital gain exclusion for sale of primary residence. The sale of a personal residence by (a) the estate, (b) an individual who acquires the residence from the estate, or (c) a qualified revocable trust may qualify for up to an $250,000 exclusion of the gain, pursuant to IRC ?121(d)(11). The estate and the transferee, together, must meet the two-out-of-five-year ownership and use tests in order qualify; see Section 121(a). If these tests are met, the executor/trustee should consider using this $250,000 exclusion first before allocating any of the $1.3M general basis or $3M spousal basis increases.

For more information regarding this topic, please e-mail your requests to Thomas P. Cavanaugh, or call Tom at (248) 457-7218.

The many events narrated in PLR 2011-39011 (released on September 30, 2011) - the misappropriation of qualified plan funds left to a minor, the immediate state and federal income taxation of the same, the initiation of probate court proceedings to recover the stolen funds, and the filing of amended returns to claim state and federal income tax refunds upon the IRS's granting permission in this PLR to restore the recovered funds to an inherited IRA for the child (not to mention the PLR request itself) - could all have been avoided (and all associated costs) had a trust for the child (age 13) been named the beneficiary of the plan, instead of the child outright.

What kind of trust should have been used? For certain, one that qualifies as a "see-through" trust, otherwise the (direct) rollover to an inherited IRA for the child would not be allowed. That narrows the options to either a conduit trust or an accumulation trust. Of the two, the accumulation trust (e.g., discretionary distributions as needed for support with a right of withdrawal at age 35) would probably be the better choice. Depending on the remainder beneficiary, this format might not allow for the maximum stretch-out available (69 years in this case), but that might not be needed, especially if the inherited IRA is the primary source of support. For example, if the child's 50-year-old uncle were the outright remainder beneficiary of the trust, the "stretch" would be for "only" 35 years. This would still allow an additional 12 years of "stretch" on whatever may be left in the account after its distribution (in-kind) to the child at age 35.

It should be noted that this PLR is also instructive for those who have done trust planning, but before 2010. The reason is that a pre-2010 trust might legitimately have been designed to be a non-"see-through" trust since rollovers such as these were not mandatory then. But now that they are, unless updated, such a trust would negate the rollover opportunity, whether to a traditional inherited IRA or to an inherited Roth IRA, which is also now allowed where qualified plans are concerned.

For more information regarding this topic, please e-mail your requests to Salvatore J. LaMendola, or call Sal at (248) 457-7204.