Estate Tax Planning in Texas

Austin TX Estate Planning Law Firm

Historically speaking, the federal estate tax is an excise tax levied on the transfer of a person's assets after death. In actuality, it is neither a death tax nor an inheritance tax, but more accurately a transfer tax. There are three distinct aspects to federal estate taxes that comprise what is called the Unified Transfer Tax: Estate Taxes, Gift Taxes, and Generation-Skipping Transfer Taxes. Legal planning to avoid or minimize federal estate taxes is both a prudent and an important aspect of comprehensive estate planning.

The latest iteration of the federal estate tax was signed into law on December 17, 2010, as part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRA 2010).

Good news: The federal estate tax exemption (ETE) is $5 million for singles and (a nearly “automatic”) $10 million for married couples, with a 35% maximum tax rate.

Caution: This law expires on December 31, 2012 (along with the nearly “automatic” $10 million ETE for married couples). So, what changes does this new law bring and, more importantly, what steps should you take to ensure that your overall estate planning will stand the test of time?

Tax Repeal Repealed?

Federal Estate Tax Exemption & Stepped-Up Basis

Under the previous law (the Economic Growth and Tax Relief Reconciliation Act of 2001), the federal estate tax (FET) and the generation skipping transfer tax (GST) were declared dead for all of 2010 and scheduled to return on January 1, 2011, with a $1 million estate tax exemption and maximum 55% tax rate. The new law (TRA 2010) reinstates both the federal estate tax and the generation skipping transfer tax, retroactively to January 1, 2010 — with a $5 million exemption ($10 million for married couples) and a 35% maximum tax rate.

But wait, there’s more.

TRA 2010 generally repeals the (confusing) modified basis rules and replaces them with a stepped-up basis regime. Step-up means the tax basis of the estate’s assets rise to whichever is lower: either cost or their fair market value at the date of death – or optionally, six months after death (if the overall estate value is lower). This step-up is important for two types of estate assets – those that have appreciated significantly (thus earning a capital gains tax status), and those whose costs are difficult to prove, perhaps because records have been lost. The beneficiaries receive the inherited assets at their new stepped-up basis, so should they choose to sell those assets they could do so and avoid the 15% capital gains tax. The stepped-up basis rules apply regarding decedents in 2011 and 2012.

Finally, for 2010, 2011 and 2012, estates subject to federal estate taxes will be allowed a “deduction” for any state death taxes paid.

Gift Taxes & Generation Skipping Transfer Tax Exemptions

Gift Tax

The new law restores the concept of a unified exemption that ties together the gift tax and the estate tax. This means that, to the extent you utilize your gift tax exemption while living, your federal estate tax exemption at death will be reduced accordingly. Your lifetime gift and estate tax exemption in 2011 and 2012 is $5 million. Note that your annual gift exclusion does not count against your lifetime limit. The annual gift exclusion is currently $13,000. Married couples can combine their annual gift exclusion amounts to make tax-exempt gifts totaling $26,000 to as many individuals as they choose each year.

Generation Skipping Transfers

The GST exemption under TRA 2010 is $5 million, with any excess taxed at 0%. This effectively eliminates application of the generation skipping transfer tax for 2010 decedents.

For 2011 and 2012, however, the GST exemption mirrors the federal estate tax exemption amount and tax rate ($5 million and 35%, respectively). Additionally, the generation skipping transfer tax allocation rules continue through 2012.

If you are concerned about how your current estate plan may function during 2011 and 2012, and thereafter, then we encourage you to schedule a consultation. Additionally, to stay informed about legislative developments and how they may affect your estate planning strategies, be sure to re-visit this website often, subscribe to our monthly e-newsletter, and follow my blog.

Texas Estate Taxes

Texas’s estate tax system is commonly referred to as a "pick up" tax. This is because Texas picks up all or a portion of the credit for state death taxes allowed on the federal estate tax return (federal form 706 or 706NA). Since there is no longer a federal credit for state estate taxes on the federal estate tax return, there is no longer basis for the Texas estate tax. Texas has neither an estate tax — a tax paid by the estate — nor an inheritance tax —a tax paid by a recipient of a gift from an estate.