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Wednesday, December 15, 2010


With the passage of the tax bill today in the Senate, it is looking more and more likely that the Bush tax cuts will be extended for 2 more years, and favorable changes to estate, gift, and generation skipping taxes will be enacted into law. Consideration by the House is next.

The new estate tax rules will introduce a new concept – portability of exemption amounts. To the extent a spouse does not fully use the new $5 million exemption during lifetime time and at death, the surviving spouse can use the unused portion as well as his or her remaining exemption. One quirk of the pending law is that it will require estates of the first spouse to die to file an estate tax return, even if no taxes are due by reason of full coverage under the decedent’s exemption amount, so as to allow portability of the unused exemption to the surviving spouse. This will provide work to accountants that might otherwise see a significant diminution in estate tax return work due to the increased exemptions. Further, the IRS will be able to audit the return of the first spouse at any time to adjust the remaining exemption amount, even after the statute of limitations for the assessment of tax have expired.

In a provision very favorable to taxpayers, the $5 million exemptions will be indexed for inflation starting in 2012. Of course, the measure of inflation is the government’s computation, which many believe significantly understates actual inflation (see But a half a loaf is much better than no loaf.

At first blush, it might seem that the new portability rules do away with the traditional dual arrangement of a by-pass trust and a marital gift/trust to make use of the first spouse to die’s exemption. However, there are still reasons to use such arrangements – principally to help prevent appreciation in assets pushing the family above the combined $10 million exemption, and to allow full use of the first spouse to die’s $5 million GST exemption. However, the use of a by-pass trust eliminates the ability to get a step-up in basis on the trust’s assets at the death of the first spouse. Thus, disclaimer trust arrangements may be the way to go, allowing the decision of whether and how much to fund into a by-pass trust for the surviving spouse to be made after the death of the first spouse based on the circumstances at that time.

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