The Repeal of the Repeal of the Death Tax: What is Going On and How Do I Plan?
The recent Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRUIRJCA, hereinafter called "The 2010 Tax Act") passed by Congress and signed by President Obama December 17, 2010, will create opportunities over the next two years to transfer assets tax-free to an extent not seen in the last seventy-five years. This legislation is effective only from January 1, 2011 through December 31, 2012. Hundreds of thousands of physicians in this country have sufficient assets to benefit from this new law. Physicians can potentially save up to $1,000,000 or more on death taxes if they act before this new law sunsets. Doctors and their advisors must understand the nuances of this new legislation in order to take advantage of this opportunity.
... a physician can benefit from changes in the gift tax for the remainder of his or her life for gifts made during the next two years...
You have no doubt heard about the extension of the Bush tax cuts for two more years. Most physicians understand that this legislation will continue the current income tax rates for the next two years. However, buried in this bill are dramatic changes in the estate tax, commonly known as the "death tax." Less commonly known are changes in the gift tax. The changes in the estate- and gift-tax laws also expire in two years. Physicians can benefit to a much greater extent from the changes made to the gift tax, as opposed to the changes made to the death tax. This is so because a physician will only benefit from the changes in the death tax if he or she dies during the next two years, whereas a physician can benefit from changes in the gift tax for the remainder of his or her life for gifts made during the next two years.
OVERVIEW OF DEATH AND GIFT TAX PRIOR TO 2011
A recent historical perspective of the death and gift tax is necessary in order to fully appreciate the dramatic impact The 2010 Tax Act will have on a physician's estate. The death tax is essentially a tax levied upon one's assets at death that exceed a threshold exemption amount, commonly called a coupon. Each taxpaying citizen is entitled to one coupon, which exempts him or her from death tax on assets up to the value of the coupon. In 2009, the coupon was worth $3,500,000 with a 45% tax rate on assets exceeding this amount. In 2010, the coupon was practically infinite, since the death tax was repealed (technically, then, the concept of a coupon was moot). In 2011, but for The 2010 Tax Act, the death tax coupon was to be reduced to $1,000,000 at a tax rate of 55% on assets exceeding that amount. In other words, prior to The 2010 Tax Act , someone dying with an estate worth $3,000,000 in 2011 or later would be assessed a tax of $1,100,000 (55% of $2,000,000, the amount of the excess over the $1,000,000 coupon). Because the Internal Revenue Service (IRS) taxes income used to purchase assets, the death tax is truly punitive and confiscatory, as it levies an additional layer of tax on assets that have already been taxed.
The federal government also levies a tax on gifts. Many physicians are shocked when they first hear this. You mean to say, I cannot give away my "stuff" that I have already earned and paid taxes on? Yes, that's right–with some limitations. In 2010, (and now in 2011 and 2012 as a result of The 2010 Tax Act) every taxpayer can gift up to $13,000 a year, to an unlimited number of individuals, gift-tax free. This is termed the "annual exclusion." Any amount of a gift over $13,000 annually will begin using up the taxpayer's lifetime "cumulative gifting exemption," which is the total amount the taxpayer can gift during his or her lifetime without paying gift tax. Prior to The 2010 Tax Act, the lifetime gifting exemption for 2009, 2010, and 2011 was $1,000,000.
The IRS requires a taxpayer to file a gift-tax return for any gift over $13,000 that uses up part of the taxpayer's lifetime exemption. However, prior to The 2010 Tax Act, the taxpayer owes no gift tax as long as the total amount of the gift, less annual exclusion gifts, was less than $1,000,000. Technically, under the Internal Revenue Code (Code), a taxpayer owes a gift tax on all gifts exceeding the lifetime gifting exemption. However, another part of the Code extends a credit for the tax due on all gifts up to the lifetime gifting exemption, thus negating any tax owed.
2011 AND BEYOND
Everything changed on December 17, 2010, when President Obama signed The 2010 Tax Act . However, all of the income-, estate-, and gift-tax provisions in this bill expire in two years. Congress has essentially kicked the can down the road for two more years, and now the Bush tax cuts will expire on December 31, 2012, rather than December 31, 2010.
Congress has essentially kicked the can down the road for two more years, and now the Bush tax cuts will expire on December 31, 2012, rather than December 31, 2010.
The 2010 Tax Act, effective January 1, 2011, raised the death-tax coupon from $1,000,000 to $5,000,000 while simultaneously decreasing the death tax rate from 55% to 35%, and added portability of the coupon from one spouse to the other. (Under the old law, there was no portability, meaning that a married couple may only have one coupon to utilize unless they utilized advanced estate planning techniques.) This means that if the first spouse to die has assets worth $3,000,000, the unused two-million-dollar portion of the coupon could be transferred to the surviving spouse, who would then have a $7,000,000 coupon upon his or her death. However, for this to happen, the estate of the first spouse to die would have to timely file a Form 706 with the IRS, which otherwise would be unnecessary since his or her estate would be less than $5,000,000. However, portability is not automatic, and would be lost if the estate tax return were not timely filed.
A physician and his or her spouse can now exclude up to $10,000,000 from death tax, but only if both spouses die by December 31, 2012– before the Bush tax cuts expire again. However, if a physician and his or her spouse survive the next two years, the old law with a $1,000,000 coupon will be reinstated, and portability will be lost. Thus, unless there is a death in the next two years, the death tax provisions in the new law are meaningless for most physicians, whether single or married.
One other important item included in this recent legislation: an increase in the gift tax exemption from $1,000,000 to $5,000,000; and a gift tax rate reduction from 55% to 35%. Throughout most of the last decade, the gift tax exemption was $1,000,000–this meant that any individual who gifted more than $1,000,000 cumulatively during his or her lifetime would pay gift tax on any amounts exceeding the $1,000,000 threshold. However, The 2010 Tax Act increased that threshold to $5,000,000 ($10,000,000 per couple). This is a potential windfall for physicians to dramatically reduce their estate size and consequently reduce death taxes upon their eventual deaths. Though this gifting opportunity is only available for the next two years, the benefits of gifting, and consequent estate reduction, will not sunset with the new legislation. For a physician with a large cash value life-insurance policy, the time has never been better to set up an irrevocable life insurance trust, gift-tax free.
One caveat: under section 2035 of the Code, any gifts that are made within three years of the donor's death will be brought back into the donor's estate. Therefore, if significant gifts are made over the next two years, it is necessary that the donor (the one who makes a gift) actually survive three years from the date of the gift.
This legislation also increased the generation-skipping tax exemption from $1,000,000 to $5,000,000, which comes into play when transferring assets to grandchildren. The generation-skipping tax is an extremely punitive tax, which is superimposed upon death and gift taxes. There is no deduction on the estate or gift tax return for any generation-skipping tax that is assessed. This is a very complex area of estate-planning law, and it is imperative that any physician who wishes to contribute a substantial amount to a grandchild seek professional advice.
WHAT DO I DO?
Assuming the new legislation expires at the end of 2012 (resulting in both the death- and gift-tax coupons decreasing from $5,000,000 to $1,000,000), and assuming a couple does not die over the next two years (thus "wasting" the $5,000,000 death-tax coupon), is there anything that can be done to minimize or eliminate the death tax, and to insure that assets are transferred death-tax-free to the next generation? The answer is a resounding yes. For this to occur, one would need to avail oneself of the tremendous gifting opportunities that have been created for the next two years.
Many physicians and their spouses are concerned that gifting assets will mean giving up control, and risking they will not have enough to live on in their later years. Is it possible to transfer assets out of your estate over the next two years while still maintaining control? Is it possible to transfer assets and somehow be assured that some of these assets could be used in your later years without risking the IRS pulling these assets back into your estate and assessing death taxes? Yes, there are numerous sophisticated estate-planning techniques available to address the above issues. The IRS will closely scrutinize such techniques and if the donor exercises too much control, the IRS will treat the asset as having never been transferred out of the donor's estate. In addition, if the donor exercises any right to reclaim the assets, the IRS will likewise include the transferred assets in the donor's estate. Such planning needs to be done by a professional with expertise in this area.
Without proper planning, most physicians will pay punitive and confiscatory death taxes upon their eventual deaths.
What is a physician to do if he or she has more than $1,000,000 in assets (or more than $2,000,000 with his or her spouse), but is not comfortable gifting significant amounts away during the next two years, and is healthy, making it unlikely he or she will die in the next two years? This is a pivotal question, and it points out the dangers of inaction regarding estate planning over the next two years. In the absence of significant gifting during the next two years, and if a physician and his or her spouse do not die within the next two years, he or she will be in the same predicament as if the estate and gift tax laws had not changed at all. Therefore, it is imperative that physicians and their spouses undergo a thoughtful analysis of their assets and how they wish those assets to pass upon death. Without proper planning, most physicians will pay punitive and confiscatory death taxes upon their eventual deaths.
Judicious planning over the next two years may well determine whether a physician and his or her spouse can pass on assets to future generations...
Saving taxes is not the only reason to plan. Other legitimate reasons to plan include passing your assets to whom you want, when you want, how you want, and in what amount upon your death. Additional concerns include transferring assets to children from previous marriages, and ensuring assets that are passed on are protected from creditors, bankruptcy, lawsuits, divorces, etc. Remember, without a proper plan or a will, a judge who does not know you or your family will decide how your assets will pass. Surely, you must and can do better.
Given the current nature of the economy and the tremendous national debt in which the nation is mired, together with the insatiable appetite of the government for higher taxes upon the wealthy, this two-year tax holiday may not last forever. However, the one thing we know for sure is the laws that are currently on the books, and it would be wise to plan based upon current laws. Judicious planning over the next two years may well determine whether a physician and his or her spouse can pass on assets to future generations, or whether those assets may have to be sold to pay death taxes. It would be a mistake to conclude that the death tax problem has been taken care of by The 2010 Tax Act and to simply sit back and do nothing.