Unless you have been mired down with holiday gift buying and year-end celebrations, you have heard that on December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, or H.R. 4853, a bill that extends the President G. W. Bush-era tax cuts, including retaining favorable tax rates on long-term capital gains and qualified dividends, providing estate and gift tax relief and an AMT “patch” for all Americans for another two years.  In addition, the bill will extend unemployment insurance benefits for 13 months and cut payroll taxes by 2% in 2011 and provide favorable first-year write-offs for qualifying property placed in service during certain key dates.

What this Act Means for Family Businesses

As we have heard many times, there are only two things that are certain in life – death and taxes.  And it seemed that we spent most of 2010 in uncertainty about taxes in general.  However, for family businesses, keeping taxes at a minimum is not the only thing to be concerned about.  Keeping the family dynamics under control, protecting the family’s accumulated assets and establishing a good family bond are just some examples of how and where to place focus on the family, instead of where to cut corners.

Unfortunately, over the past year it seems we spent a lot of time on tax decision and planning, sometimes for naught, as there seemed to be many question marks on what was to happen to many of the expiring tax provisions.  From what we now know, families with wealth and especially business families can relax, at least for a little while, as the new bill alleviated the uncertainty about the future of favorable tax law, but unfortunately only for two years.

Estate / Inheritance / Gift Tax Ramifications of Old vs. New

Especially for estate tax planning, we have seen quite a transformation over a short period of time. Under the old law, the lifetime exemption rose from a low of $675,000 to a pre-2010 amount of $3.5 million.  2010 called for no estate tax, but then estate and other transfer taxes were scheduled to rise quite substantially for post-2010 transfers.  Thankfully, for the next two years under the new law, the estate tax rate will be at a top rate of 35% for inheritances above $5 million for individuals, and the ability to have a step up in basis on transferred assets.  Top rates under the old law were heading to a sizable 55% in 2011.

For 2010, the basis rules for inherited property were to be similar to the gift tax rules, with many opportunities for heirs to receive increases in basis.  The so-called modified carryover basis rules would have permitted the basis of assets received from a decedent to be increased by $1.3 million with an additional $3 million for assets going to a spouse.  Quite uniquely, the 2010 Tax Relief Act allows estates of decedents dying in 2010 to choose between:

Estate tax based on a $5 million exemption and 35% top rate and a step-up basis, or

No estate tax and the use of the modified carryover basis rules

Therefore, the executor must decide which strategy would produce the best result of the lowest combined estate and income taxes for those dying in 2010.  The election will have no effect on the applicability of the Generation-Skipping Transfer Tax.  In addition, the IRS is to determine the time and manner for making the election and once made, the election is revocable only with IRS consent.

The gift tax rules also changed with this recent legislation.  Under the old rules, for gifts made in 2010, the lifetime exemption was $1 million and the gift tax rate was 35% on gifts in excess of $1 million.  Under the new rules, the gift tax exclusion is reunified with the estate tax amount of $5 million and a top estate and gift tax rate of 35%.

And Still More Changes for Spouses…

A very unique feature of the new rule has to do with the portability of unused exemption between spouses.  Any exemption that remains unused upon the death of a spouse who dies after December 31, 2010 is generally available for use by the surviving spouse, as an addition to the surviving spouse’s exemption.  Therefore, a surviving spouse may use the predeceased spousal carryover in addition to their own $5 million exclusion for taxable transfer upon their death.  The ability to afford oneself of the deceased spouse’s unused exclusion amount and election is to be made on a timely filed estate tax return of the predeceased spouse regardless if a return must be filed.  In addition, the IRS has the ability and authority to examine the return of a predeceased spouse for purposes of determining the deceased spousal unused exclusion amount available to the surviving spouse.

In addition, important dates to remember under the new rule are for a decedent dying after December 31, 2009 and before December 17, 2010, the due date for certain tax action is not to be earlier than September 17, 2011.  These actions include filing an estate tax return, paying the estate tax and making any disclaimer of an interest in property passing by reason of the death of such a decedent.

So, we are somewhat certain where the tax law stands, but only for two years.  However, we are far more certain that the focus on the family should continue as follows: keeping family dynamics in check, protecting the family wealth and establishing a good family bond.  Those factors will help to sustain a family business through the turbulent times, come what may.