Under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act default rule for 2010 is that a federal estate tax exists for all of 2010 estates with a credit equivalent to a $5 million exemption and a maximum marginal rate of 35%. Thus, there was no estate tax repeal for 2010. However, for estates of decedents dying at any time during 2010, including after enactment, executors may elect to have the modified carryover basis rules apply rather than be subject to the estate tax. The timing and manner of making the election on the part of the executor is unclear. The Internal Revenue Service is expected to provide needed guidance concerning the election. The due date for the estate tax return and the payment of estate taxes has been extended by the Act to no earlier than nine months after the date of enactment. This extended due date applies to those decedents dying on or after January 1, 2010, and before the date of enactment. The date of enactment was December 17, 2010. Thus, the extended due date is September 17, 2011, which falls on a Saturday. Accordingly, the extended due date for the filing of the estate tax return and the payment of estate taxes for these estates will be no earlier than September 19, 2011.

Interestingly enough, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act did not extend the due date for the carryover basis report for those estates electing to be subject to carryover basis. The carryover basis report was due Monday, April 18, 2011. Informal remarks of government officials indicate that taxpayers will be granted an administrative extension of time to file Form 8939 until at least October 15,2011. This deadline was extended because of Hurricane Irene. The Service had released a draft Form 8939 on December 16, 2010, but there were no instructions to accompany that form. The IRS has now issued a Revenue Procedure 2011-41 and Notice 2011-66 with further instructions. The form, however, is still not available on the IRS Web site. Because this form was released prior to the date of enactment of the Act, it did not contain an election into the modified carryover basis regime but has been updated now. The IRS issues an IR-2011-83, Aug. 5, 2011 stating that 2010 Form 8939 is due Nov. 15, 2011; Reporting Option Applies to Many Large Estates.

For large estates far in excess of the $5 million, we expect that the executor would make the election to opt out of the estate tax and into the modified carryover basis regime. Likewise, for estates falling within the $5 million exemption amount the executors should do nothing and permit the regular "step-up in basis" rules of section 1014 to be applied to the decedent's estate. If there are uncertainties concerning hard-to-value assets, the executor may wish to file Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, to commence the running of the statute of limitations on any valuation issues. In the case of other estates falling outside these two ranges, however, the executor should analyze the tax issues and the nontax issues associated with the election. Some of the factors to consider include:

a. The amount of the estate tax payable currently as compared to future capital gains taxes that otherwise would have been avoided, but for the modified carryover basis;
b. Lost depreciation or amortization expenses from the modified carryover basis regime;
c. The timing of future sales and resulting capital gains;
d. The impact of possible increases in income tax rates;
e. The impact of the $1.3 million basis adjustment (if electing out of estate tax rules of the new legistlation) along with the other basis adjustments for assets passing to a spouse or as qualified terminable interest property, or Qualified Terminable Interest Property (QTIP) trust; and
f. Nontax impact of funding bequests if the executor opts out of the estate tax in 2010.

Many decedents who died during 2010 with estates of significant value had done estate planning based on the expectation that the estate tax would apply on their deaths. Accordingly, these estate planning activities resulted in the inclusion of provisions in the relevant legal documents to cause the funding of certain trusts based upon certain estate tax ramifications. The existence or nonexistence of an estate tax could significantly affect how those trusts are funded. Thus, the decision of the executor to opt out of the estate tax or to remain subject to the estate tax could significantly affect how the trusts are funded.

For example, the proper interpretation of a will might be that all the assets of the decedent would pass into a credit-shelter trust if there is no estate tax, because that is the amount that can pass estate tax-free. A number of states passed laws during 2010 that affect the "tax-free" bequests under such formula provisions. Those states are Delaware, the District of Columbia, Georgia, Idaho, Indiana, Maryland, Minnesota, Michigan, Nebraska, New York, North Carolina, Pennsylvania, South Dakota, Tennessee, Utah, Virginia, Washington, and Wisconsin. In these states, the executor is required to fund the trusts assuming that 2009 estate tax rule applied with its $3.5 million exemption amount. Now that the exemption amount has been increased to $5 million for all of 2010, will these states "fix" the amount that will pass to the credit shelter to $5 million? How are wills and revocable trusts in states other than the listed states to be interpreted in light of the retroactive enactment of the estate tax during 2010? Florida and South Carolina passed statutes during 2010 allowing courts to consider evidence as to the intent of the testator or testatrix. In most cases, it would appear that the executor is well advised to obtain court approval or at least a beneficiary agreement as to the proper interpretation of the will or revocable trust given all the issues. On March 26, 2011, Governor McDonnell has signed into law emergency legislation that addresses uncertainty about the meaning of estate and generation-skipping transfer tax terms in the estate plans of persons who died in 2010. The legislation is effective immediately and is retroactive to January 1, 2010. The new law makes changes Virginia Code section §64.1-62.4 to provide, as a default rule, that a provision of a will, trust, or other instrument of a person dying in 2010 that is based on the federal estate and generation-skipping transfer (GST) tax laws will be deemed to refer to the law applicable in 2010 under the 2010 Tax Act, regardless of whether the decedent's personal representative or other fiduciary makes the election provided under the 2010 Act out of the federal estate tax and into an income tax regime. The law also provides for judicial or private relief in the event the default rule does not carry out the decedent's intent. Virginia is the first state to enact legislation in response to these issues created by the 2010 Tax Act. The 2010 Tax Act renewed the uncertainty about formula clauses in the estate plans of 2010 Virginia decedents, and in particular: (1) whether the $5 million estate and GST exemptions apply to formula clauses; and (2) whether the exemptions continue to apply where the executor opts out of the federal estate tax and into modified carryover basis. The changes to Virginia Code §64.1-62.4 attempt to resolve these concerns for 2010 decedents by the following provisions: If the document is otherwise silent, the statute provides a default rule of construction that applies the 2010 Tax Act $5 million estate and GST exemptions for the purpose of determining who receives assets. Va. Code §64.1-62.4(A). The statute clarifies that the 2010 Tax Act estate and GST exemptions continue to apply for the purpose of determining who receives assets even where the executor opts out of the federal estate tax. Va. Code §64.1-62.4(A). A personal representative, trustee, other fiduciary, or any beneficiary may seek judicial relief if the default rule does not carry out the testator's intent. So that the judicial relief provision operates properly, suits must be brought before January 1, 2012, extrinsic evidence is allowed, and the petitioner has the burden of proof by clear and convincing evidence. Va. Code §64.1-62.4(B). Consistent with the Virginia Uniform Trust Code, the statute also provides that all interested persons may enter into an agreement to depart from the default rule if the default rule does not carry out the testator's intent, and permits the parties to seek court approval of the agreement. Va. Code §64.1-62.4(C). These changes are intended to protect the intent of most testators, reduce litigation, and reduce risks for fiduciaries by replacing chaos with certainty and also allowing remedies if the default rule does not fit the situation.

Unlike, Maryland and DC, Virginia took a completely opposite response to the changes in the federal estate tax rules in 2006 when it abolished its estate tax for decedents dying on or after July 1, 2007.

In 2006, Maryland and the District of Columbia imposed a state Estate tax on estates valued at more than $1 million. Maryland and the District of Columbia were among a hand-full of jurisdictions that broke off from the Federal estate tax rules in 2006. Maryland also instituted a Maryland Only QTIP election in 2006.

In 2014, the Maryland legislature voted to increase the estate tax exemption gradually on an annual basis from the current $1,000,000 exemption until it matches the federal estate tax exemption in 2019 as follows:

Deaths between January 1, 2015 and December 31, 2015: $1,500,000 exemption
Deaths between January 1, 2016 and December 31, 2016: $2,000,000 exemption
Deaths between January 1, 2017 and December 31, 2017: $3,000,000 exemption
Deaths between January 1, 2018 and December 31, 2018: $4,000,000 exemption
Deaths on or after January 1, 2019: Maryland exemption will match federal exemption, estimated to be $5,900,000 in 2019 (more on that below)

With regard to state estate taxes, however, currently only Hawaii offers portability at the state level, but Maryland will begin offering portability of its state estate tax exemption beginning in 2019.

With all the recent tax law changes at the federal and state levels, it is advisable to review their documents for regarding the credit shelter trust funding.

The District of Columbia is working on similar legislation to increase its jurisdictions exemption amount annually.

The time for making any disclaimer for property that passed by reason of the death of the decedent during 2010 prior to the date of enactment (December 17, 2010) has been extended to nine months after the date of enactment of the Act. Thus, the extended due date for disclaimers of this nature would be September 17, 2011. The two major issues that will be associated with such disclaimers will be first, whether the beneficiary has accepted the benefits of the property, and second, whether the period for such disclaimer has expired under state-law requirements. The federal law appears to allow an assignment of the interest in lieu of the state-law disclaimer, but in that case the disclaimer must be of the entire interest in the property that is disclaimed by the beneficiary. Note that this particular extension of the disclaimer period only applies with respect to decedents' estates, it does not apply to gifts.

The generation-skipping transfer tax was retroactively enacted to January 1, 2010, and is effective for all of 2010, but with a zero GST tax rate. The generation-skipping transfer tax exemption-equivalent amount was likewise increased, similar to the estate tax exemption-equivalent amount, to $5 million. The decision to opt into the modified carryover basis regime will not affect the GST tax exemption amount for generation-skipping transfers during 2010. By reenacting the GST tax retroactive to January 1, 2010, Congress "fixed" many of the issues planners had encountered concerning the ability to allocate the GST exemption to an irrevocable trust that had been funded during 2010. Not only can taxpayers allocate the GST exemption as they would have in prior years, but the exemption amount has increased to $5 million.

Furthermore, direct skips, taxable distributions, and taxable terminations are technically generation-skipping transfers during 2010, but the tax is imposed on such transfers at a 0% rate. Because such transfers are technically taxable events, those transfers should be reported on an appropriate timely-filed return. For direct skips, the required return would be a gift tax return or an estate tax return. For taxable terminations, the required return would be Form 706-GS(T), Generation-Skipping Transfer Tax Return for Terminations. For taxable distributions, the required return would be Form 706-GS(D), Generation Skipping Transfer Tax Return for Distributions. Some might argue that, because the penalty for failure to file these returns is based on the amount of tax due, no return is required to be filed. Generally, filing the return would commence the running of the statute limitations on the transactions reported and thus would appear to be the preferred approach. Because a direct skip during lifetime has always attracted an automatic allocation of the GST exemption, it will be necessary to opt out of this automatic allocation for 2010 direct skips assuming such election satisfies the client's objectives. However, the client may not want to opt out where the client made a contribution to an irrevocable trust solely for the benefit of skip persons and the trust is designed as a dynasty trust so that subsequent generations will also benefit from the trust. In that case, even though there would be no tax imposed upon funding, GST taxes will be due in the future because of the subsequent taxable distributions or possible termination of interests. In addition to the issue concerning the ability to allocate the GST exemption during 2010, there had also been concerns about whether making direct skips to irrevocable trusts or even transfers to grandchildren's accounts established under the Uniform Transfers to Minors Act might result in future GST-taxable transactions when distributions were made to skip persons in subsequent years. Again, because the GST tax was retroactively enacted, the so- called "move-down rule" should apply to such transfers so that subsequent distributions to the skip persons will not result in GST tax. The effect of the move- down rule was that the transferor was assigned to one generation above the highest generation of any person who had an interest in the trust immediately after the transfer.

The exemption-equivalent amount for taxable gifts during 2010 remained at $1 million. Commencing in 2011, however, the gift tax and estate tax became unified again with the same $5 million exemption-equivalent amount for both the gift tax and the estate tax. The maximum gift tax rate for 2010 through 2012 is 35%. Some taxpayers may have made taxable gifts in 2010 in anticipation of the tax rate returning to a maximum 55% rate. With the exemption-equivalent amount increasing to $5 million for 2011 and 2012, these clients may be very disappointed that they made the gifts during 2010. Affected clients may wish to discuss with their attorney the possibility of using disclaimers and/or rescissions to reverse otherwise taxable gifts made during 2010.

With the new exclusions set at the federal level at $5 Million for tax-free gifts, the states may want to impose a state gift tax. Generally, the gift taxes set by the federal government are the only gift taxes that apply to monetary gifts and estate gifts. However, there are certain states that have imposed regulations regarding their own set of gift taxes for the same situations in which gifts are taxed federally. Seven states impose their own gift tax requirements, namely: Wisconsin, Delaware, New York, Louisiana, North Carolina, South Carolina, and Tennessee. Each of these states has their own rates at which they tax valuable gifts from one person to another. With these states, there are certain situations in which there are exemptions to the gift taxes. These exemptions must be researched for each state individually.

Gift taxes, at either the federal or state level, are not assessed for every single financial gift. The rates for gift taxes usually only triggered after a set amount of money has been given, and these rates are set at an amount high enough so that most people don’t have to worry about them for routine financial gifts. For example, in most states, other than the seven states enumerated above, adopt the law that any gift under the maximum value of $13,000 (so-called "annual gift tax exemption amount") is considered exempt from any sort of gift tax, both federal and state. These values are subject to change, however, so it might be wise to look into the current tax year's rates. Neither the District of Columiba, Maryland or Virginia has a state gift tax.

Further, there may also be exemptions to the gift tax if qualified medical or educational expenses are paid directly to a medical care provider or to a educational institution. It is wise to consult with an experienced tax attorney to help determine whether or not a financial gift is subject to tax.

The Act is designed so that, absent further congressional action, the relevant tax laws in place prior to 2001 will again become effective beginning January 1, 2013. For estate and gift tax purposes, this would result in a $1 million exemption-equivalent amount with a 55% maximum marginal tax rate. If a client takes advantage of the $5 million exemption-equivalent amount and makes a $5 million gift during 2011 or 2012, it is unclear what will happen if the client dies after 2012 and the estate-tax exemption- equivalent amount has returned to $1 million. The exemption-equivalent amount has never decreased in this fashion and the Internal Revenue Code is unclear as to what results should be obtained under a unified transfer-tax system in these circumstances. Based on the existing Form 706 instructions, a recapture of the tax would occur, i.e., the tax payable with the Form 706 could effectively include additional gift tax based on a reduced exemption-equivalent amount. Given that the current instructions were drafted without this issue in mind, it is difficult to know with certainty how the Service would apply the rules in this context. Generally, absent a decline in value of the assets transferred before death, the client will be no worse off should there be a subsequent recapture of the transfer tax. Using a depreciating asset to make a taxable gift has always been a bad planning idea. Thus, as a practical matter, planners should warn clients of the possible recapture, or so-called "clawback," but generally clients should proceed with taxable gifts to take advantage of the increased exemption-equivalent amount. The future income on such property as well as the future appreciation in value of such property will not be included in the donor's gross estate. Furthermore, often such taxable gifts carry valuation discounts, thus further leveraging the taxable gift. If the client does proceed with making taxable gifts that use the increased exemption-equivalent amount, the client may wish to consider the following:

a. Marital and Charitable Deductions. If the decedent's estate is subject to the recapture tax and the entire estate is passing to charity and/or the surviving spouse or trusts for the surviving spouse eligible for the marital deduction, the additional recapture tax will be paid from the assets used to fund the charity and/or spousal bequest, causing a reduction in the deduction. This results in an interrelated calculation because the reduced deduction results in an increase in estate taxes which likewise must also decrease the size of the deduction, and so on.

b. Inequitable Distributions Among Beneficiaries. If the taxable gifts are made to one set of beneficiaries who are different from the beneficiaries under the will and/or revocable living trust, the recapture tax paid by the estate in effect causes the testamentary beneficiaries to bear the burden of the wealth transfer tax for the gifts made during lifetime. If the recipients of the taxable gifts are also beneficiaries of the estate, it should be possible for the will and/or revocable trust to cause an apportionment of the additional recapture tax to such beneficiaries. If the recipients of the taxable gifts are not beneficiaries, the donor could have the recipients enter into an agreement to pay the recapture tax.

Effective in 2011, the executor of a deceased spouse's estate may elect to transfer any unused estate tax exemption-equivalent amount to the surviving spouse. Portability does not exist with respect to any decedent dying during 2010. For the surviving spouse to obtain the additional "deceased spousal unused exclusion amount," the executor of the deceased spouse's estate must make an election on a timely-filed estate tax return. Thus, generally, even though an estate tax return is not required to be filed, an executor would normally want to file the return so in order to make this election. Only the most recent deceased spouse's unused exemption may be used by the surviving spouse. Thus, if the surviving spouse remarries after acquiring an increased exemption amount from the first spouse, the exemption amount could be lost and/or reduced if the new spouse also predeceases the original surviving spouse with a reduced exemption amount or no exemption amount. On the other hand, should the new spouse be the surviving spouse, the new spouse cannot acquire any of the increased exemption amounts from the very first spouse to die. For example, assume Sid dies and Wilma acquires Sid's unused exemption amount in addition to her own basic exemption amount. Wilma marries Thomas. If Wilma dies first, then Thomas may obtain Wilma's basic unused exemption amount, but may not utilize any of Sid's unused exclusion amount.

The increased exclusion amount may be used to apply against both gift and subsequent estate taxes. For gift tax purposes, the applicable exemption amount is determined based on the applicable exemption amount available for estate tax purposes as if the donor had died as of the end of the year. Thus, it appears that the surviving spouse can take advantage of the increased exemption amount even if the taxable gifts during the calendar year predated the death of the deceased spouse. It is important to note that portability does not apply to the GST tax exemption. Generally, for planning purposes most estate planners will still highly recommend the use of the credit-shelter or bypass trust as a technique to take advantage of the exemption amount of the first spouse to die. Although portability prevents the loss of the exemption, the increased exemption amount acquired from the first spouse to die will not increase with inflation. Assets held in the credit-shelter trust generally are protected from the creditors of the beneficiary. Likewise, assets held in a credit- shelter trust may be better protected in the case of a divorce action against the beneficiary. Furthermore, the future appreciation of the assets held in the credit-shelter trust will pass estate tax-free to the remainderman. If a GST tax exemption is allocated to the credit-shelter trust, the GST tax exemption of the first spouse to die will be preserved at least to the extent of the assets placed in the credit-shelter trust or the available exemption amount. An in-depth discussion of all the issues surrounding portability is beyond the scope of this Tax Bulletin.

The tax planning wills and revocable trusts for a married couple provides the most tax benefits. Married couples need to contemplate the future uncertainties surrounding the estate tax. The exemption amount could remain at $5 million or could be reduced to $1 million in 2013. There may continue to be legislative proposals to repeal the estate tax in light of the relatively small amount of revenue it generates. Regardless of any potential repeal, the drafting of wills or revocable trusts must contemplate these possibilities. In light of the uncertainty, it may be preferential to use Qualified Terminable Interest Property (QTIP) trusts or disclaimer funding provisions into credit-shelter trusts. Assuming a $5 million exemption-equivalent amount in 2013, many estates will no longer be exposed to federal estate taxes, in which case the wills and/or revocable trusts should be drafted with a bent toward any state death taxes and other non-tax aspects, such as management of assets and asset protection.

With the increase of the exemption-equivalent amount to $5 million for gift, estate, and GST tax purposes, clients with larger estates should contemplate estate planning techniques to utilize the increased exemption-equivalent amounts. Some techniques to consider include the following:

a. Outright gifts at lower than normal rates;
b. Gifts to qualified personal residence trusts (QPRTs);
c. Gifts to irrevocable dynasty-type trusts with an allocation of a GST tax exemption;
d. Sale of assets to an irrevocable dynasty-type trust designed to be an intentional grantor ( deemed owner) trust;
e. Gifts to self-settled trusts taking advantage of the law of those states that permit the assets of such trusts to be exempt from the creditors of the settlor; and
f. Gifts to life insurance trusts (ILITs) to provide adequate funds to make future premium payments on life insurance held by the trust.

The tax law changes established by the new Act will all expire at the end of 2012. Thus, all the concerns and issues that existed in 2010 will be resurrected, once again, in 2012 and possibly 2013. Congressional Super-Committee was unable to reach agreement on extending the current exemption amounts; thus, it is likely that Congress will reduce the Five Million ($5M) exemption down to the One Millioni ($1M) exemption amount before the end of 2012.