The New Tax Act - A Golden (limited) Opportunity for Generation Skipping Transfers in 2010

By:  James K. Leese, JD, MST, Certified Specialist, Estate Planning, Trust and Probate Law State Bar of California Board of Legal Specialization

In almost an incredible turn of events we now have something called the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“New Tax Act”), which was signed into law on December 17, 2010, by President Obama. We seriously didn't think it was possible, but here it is.

The New Tax Act made some significant changes to the Estate Tax, Gift Tax and Generation Skipping Transfer Taxes, as they apply to 2010, 2011, 2012, and perhaps, beyond.

First up, in 2010 the deceased taxpayer's estate has a choice of filing an estate tax return or electing out of the estate tax regime, by choosing a "modified carry over basis" regime. The executor's decision about which taxing scheme to choose will likely depend upon the value of the estate, with the applicable exclusion amount increasing to $5M for deaths in 2010. Therefore, it is likely that executors of estates greater than $5M will choose the "modified carry over basis" regime to defer payment of any tax until the sale of the property in question, thus paying later at capital gains tax rates, as opposed to electing to file an estate tax return and pay estate taxes now at the 35% estate tax rate for decedent's dying in 2010. For estates of less than $5M, it would appear a good move to file an estate tax return, receive an adjusted step-up in basis on all of the assets in the estate, and reduce the overall taxes accordingly. Although these are general rules, we will need to look at every estate, on a case by case basis, to determine what is the best regime under which to tax the estate or the assets passing from the estate. We will have until September 20, 2011 to do so.

The gift tax exclusion for 2010 remains at $1M and the highest marginal tax rate for gift tax will remain at 35%.

Beginning in 2011, the exclusion amount increases to $5M for estate tax, gift tax and generation skipping transfer tax, and the highest marginal rate will be set at 35%. That exclusion amount is indexed for inflation beginning in 2013, and may increase above the $5M threshold, depending upon the cost of living increases that are built into the New Tax Act.

For those taxpayers with high net worth, the New Tax Act is virtually guaranteed (if anything is certain in life) to continue for two years, and many taxpayers will want to seriously consider making gifts, and other advanced estate planning transfers within the two year period, because the chance to reduce gift, estate and generation skipping transfer taxes, may never be this good again.

One particular opportunity that almost seems to good to be true, it relates to a taxpayer's chance to make generation-skipping transfers (i.e., to grandchildren and/or great-grandchildren, skipping their children's and/or grandchildren's generation), this year (2010), Tax Free!

That's right, the New Tax Act provides a zero tax rate for generation-skipping transfers ("GST") that occur in 2010. There are some steps that must be taken by December 31, 2010 (ex. elect out of GST automatic allocation), but to make a long story short, the New Act has given high net worth taxpayers -

A Golden Opportunity:

This zero tax rate, coupled with other changes to the gift and GST tax provisions applicable this year, provides a unique opportunity to avoid GST tax for: (1) lifetime gifts to grandchildren and/or great-grandchildren, either outright, to custodial accounts, or irrevocable trusts; (2) transfers from trusts that are currently not exempt from GST tax; and, (3) in a few cases, even for transfers from trusts that are exempt from tax by reason of the prior allocation of GST exemption or by reason of grandfathering.

The real issue here is should a taxpayer or taxpayers (married couples) with a high net worth consider making gifts to Grandchildren this year?

The answer is, it depends. If a taxpayer has never made a taxable gift, a single taxpayer can give up to $1,000,000 ($2,000,000 for a married couple) to his or her grandchildren, and pay no gift tax, utilizing the lifetime gift tax exemption, and no GST tax, utilizing the zero tax rate, this year (2010).

Next year, 2011, in order to make the same gift a taxpayer will have to allocate his or her GST Tax exclusion to make the transfer exempt from GST Tax. This could result in the unnecessary payment of a 35% (or higher) GST Tax on any future generation skipping transfer to grandchildren or great-grandchildren that could have otherwise used the exemption.

Generally, this strategy will be most beneficial for estates of a single person who has a net worth of more than $3.5 Million Dollars, or to couples whose combined net worth are more than $7 Million Dollars, although there are exceptions, for example if the value of the given estate is less than these amounts but is likely to increase above these amounts in the future.

Those who elect to act, will have a very short window of opportunity to act. They will have to plan the gifts and carry them out before midnight, December 31, 2010.

If you are at all interested in this strategy, please email us to discuss this further.

Again, this is an opportunity that will not last long, and you will need to act well before December 31, 2010, to take advantage of it.

c copyright - Ferruzzo & Ferruzzo, LLP