Clarity Comes to Estate Planning With Tax Bill's Passage

"If the value of the decedent's estate is $5 million or less (including gifts made during life in excess of annual exclusion gifts), an executor should not elect out of the application of the estate tax. No tax will be due, and a full basis step-up will be permitted.

If the value of the decedent's estate is over $5 million, the executor should opt out if the benefits of the additional basis step-up are outweighed by the estate tax that would otherwise be due."

"President Obama's agreement with the Republicans was a little surprising to all of us," said Ben Ledyard (left), director of wealth strategies at Silver Bridge, referring to the Obama-GOP compromise on the tax bill. The firm hosted a year-end tax planning call late Wednesday during which Ledyard and Andrew Correia, Silver Bridge's director of finance and taxation, noted that the original expectation was that the Congress would restore the estate tax to where it was in 2009, with a "$3.5 million to $7 million exemption and 45% [top tax] regime."

Ledyard walked a reporter through the decision process that heirs of someone who died in 2010 would need to consider. The question is when to retroactively apply the stepped-up basis and $5 million exemption and 35% rate for the 2011 estate tax retroactively, and when to use the carryover basis and capital gains tax that had been the only tax on estates for 2010—since for 2010 there was no "estate" tax. He was asked to apply this to a $5 million gross estate and a $15 million gross estate for the heirs of a person who was married and the first member of the couple to die.

Choices for Heirs to a 2010 Estate

For example, said Ledyard, with the $5 million gross estate from a death in 2010, the heirs would receive  the $5 million (no estate tax) at, say, a "cost basis of zero," and then "pay the capital-gains tax of 15%, or $750,000.".

Under the bill passed by the House on Thursday, that same $5 million estate, with a $5 million exemption and 35% maximum estate tax rate, would be exempt from the tax, so it would make sense for the heirs to "go back and retroactively re-file or amend the estate-tax return," and pay no capital gains or estate tax—thereby inheriting the whole $5 million.

For the $15 million estate, under the 2010 rules, at a "cost basis of zero, with the 15% capital gains rate," the estate would have paid about $2.25 million in capital-gains tax.

Under the new 2011 rules (applied retroactively), the estate would "exclude $5 million, and pay the 35% on the other $10 million, a $3.5 million estate tax payment." So heirs to this larger estate would be better off under the capital gain rules of 2010, rather than use the 2011 regime retroactively, Ledyard suggested.

But all of this supposes there was no other estate planning, while in fact there are other steps that could be taken to bring the gross estate amounts down.

For 2011, there are new provisions for arranging gifts to children under new, re-unified rules. Those rules would allow the first $5 million for individuals (and $10 million for married couples) given to children to not be subject to gift tax. Charitable donations are also a way, "from the heart," as Ledyard puts it, to reduce the size of the estate.

The bottom line may well be that, as Ledyard notes, "the next two years are huge opportunities for clients with more than $10 million" and for the advisors who work with them, to plan for their estates.