More Than Just $5 Million

H.R. 4853, the bill that President Obama signed Friday to extend the Bush tax cuts, changes estate planning in some major ways besides increasing the exclusion amount to $5 million. Newspaper coverage of the estate planning sections of the bill has been superficial, leaving out important new provisions that will affect many estates.

l. The gift tax exemption has been increased to $5 million from the previous amount of $1 million. This means a married couple can give away $10 million of their net worth without paying any gift taxes. The drawbacks are the same as before, however: Gifts don't get a step-up in basis, and gifts made under this provision will reduce the unifed credit of $5 million per person.

2. Portability of the exemption from the estate tax is a subject that has been discussed, but never enacted until now. In the future surviving spouses get the benefit not only of their own $5 million exemption, but also their deceased spouse's $5 million exemption. This change benefits procrastinators who never get around to signing an estate plan, or updating their current plan. In the past the deceased spouse's exemption has been lost if it was not used in an A-B trust, for example, or inherited by someone other than the surviving spouse. This innovative change to the law could eventually make A-B trusts obsolete.

3. Estates of decedents who died in 2010 have been stuck in a tax world that did not have an estate tax, and also lacked a step-up in basis for assets exceeding $1.3 million (or $4.3 million for surviving spouses). Those estates now have the option of paying the estate tax and also getting a step-up in basis, or skipping the estate tax and dealing with the lack of step-up. The answers to these situations are less obvious than appear at first glance because of the difference in tax rates (35 percent for the estate tax and 15 percent for the capital gains tax), and the fact that some estates have few appreciated assets.

4. Indexing for inflation will be allowed for the $5 million exemption, which will go up in multiples of $10,000. The annual gift tax exclusion is already indexed for inflation at multiples of $1,000.

5. But there's a catch related to all of these developments: The Bush tax cuts and all of the new tax benefits will expire on Dec. 31, 2012. After that we're back to where we were in 2001, with a $1 million exemption from the estate tax. Will Congress give the Bush tax cuts a last-minute reprieve in 2012? Unfortunately nobody knows the answer, so don't give up on those A-B trusts yet.

What the Agenda Doesn't Include

The Senate will meet tomorrow (Saturday, Dec. 4) to discuss extending the Bush tax cuts for the middle class. The bill under discussion, H.R. 4853, was passed by the House on Thursday, but newspaper coverage of the details of the bill was, as usual, minimal.

But reading the summary of H.R. 4853 on Thomas shows that this is an income tax bill only. Although the estate tax was one of the original Bush tax cuts, it is not part of H.R. 4853. Whether the Senate passes this bill will make no difference to the estate tax, scheduled to return to 2001 levels in just 28 days.

The Senate would have to consider H.R. 4154, which is an estate tax bill, if it wanted to prevent the estate tax from affecting middle class taxpayers. H.R. 4154 would restore the estate tax to its 2009 levels, which include a $3.5 million exemption from the tax. But H.R. 4154, passed by the House last Dec. 20, doesn't seem to have much support in this lame duck session.

Of course, the provisions of H.R. 4154 could always be tacked onto H.R. 4853, which is already an odd collection of tax subjects, starting with the Airport and Airway Tax Fund. When it was strictly an airport bill, H.R. 4853 was passed by the Senate earlier this year and sent to the House, where it has stagnated until the House suddenly decided it really ought to be called the Middle Class Tax Relief Act of 2010. That's the bill that will be on the Senate calendar tomorrow.