Under the law in effect before the enactment of the 2010 Tax Relief Act, the estate tax was scheduled to be repealed in 2010, and then to return in 2011 with an exemption of $1 million and graduated rates reaching a top rate of 55% on transfers over $3 million. The 2010 Tax Relief Act reinstates the estate tax retroactively to the beginning of 2010, except where the executor of the estate of a decedent dying in 2010 makes an election (described below) to opt out of the estate tax and be subject to the modified carryover basis rules instead.

For estates of decedents dying after 2009, the 2010 Tax Relief Act provides that the estate tax exemption is $5 million (indexed for inflation after 2011) , and the tax is imposed at a flat rate of 35% on all transfers exceeding the exemption amount.

In conjunction with the repeal of the estate tax, pre-2010 Tax Relief Act law would have provided “modified carryover basis” rules for property acquired from decedents dying in 2010. Under the modified carryover basis rules, the basis of property acquired from a decedent (increased by allocable dollar allowances) would have been the lesser of the property's adjusted basis in the hands of the decedent, or its fair market value on the date of the decedent's death. Except where the executor makes the special election described below, the 2010 Tax Relief Act repeals the modified carryover basis rules retroactively to the beginning of 2010, and reinstates the stepped-up basis rules that applied before 2010, under which the basis of property acquired from a decedent is stepped up (or down) to the property's fair market value at the date of the decedent's death.

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The 2010 Tax Relief Act allows the executor of the estate of a decedent dying in 2010 to elect not to be subject to the estate tax, and to have the modified carryover basis rules (instead of the stepped-up basis rules) apply in determining the basis of property acquired from the decedent .

For estates of decedents dying after 2010, the 2010 Tax Relief Act makes the estate tax exclusion (but not the GST exemption) portable between spouses, by allowing the estate of a surviving spouse to use any unused portion of the deceased spouse's exclusion, in addition to the surviving spouse's own exclusion.

Under pre-2010 Tax Relief Act law, the generation-skipping transfer (GST) tax was scheduled to be repealed in 2010. The 2010 Tax Relief Act reinstates the GST tax retroactively to the beginning of 2010. For transfers in 2010 only, the tax rate for GST tax purposes is zero). The amount of the GST exemption is the same as the estate tax exemption ($5 million in 2010 and 2011, indexed for inflation after 2011). The GST exemption may be allocated to a trust created or funded in 2010.

The gift tax was never scheduled to be repealed. For gifts made in 2010, the 2010 Tax Relief Act leaves the gift tax exemption unchanged at $1 million. For gifts made after 2010, the 2010 Tax Relief Act reunifies the gift tax exemption with the estate tax exemption ($5 million, indexed for inflation after 2011). The 2010 Tax Relief Act also leaves unchanged the separate gift tax rate schedule that applies to gifts made in 2010, which reaches a top rate of 35% for gifts in excess of $500,000. For gifts made after 2010, the 2010 Tax Relief Act reunifies the gift and estate tax rate schedule, which (as mentioned above) imposes tax at a flat rate of 35% on all transfers exceeding the exemption amount.

For estates of decedents dying after December 31, 2009, and before December 17, 2010 (the date of enactment of the Act), the 2010 Tax Relief Act provides extensions of time for (1) filing an estate tax return, (2) paying the estate tax, and (3) making a disclaimer of an interest in property passing by reason of the decedent's death. The due date for taking any of those actions is not earlier than the date which is nine months after the date of enactment .

The 2010 Tax Relief Act provides that several estate and gift tax changes that were made by EGTRRA, which had been scheduled to sunset on January 1, 2011, will now sunset on January 1, 2013 instead. The 2010 Tax Relief Act provides that the EGTRRA sunset date (as extended to January 1, 2013) also applies to the estate, gift, and GST tax changes made by the 2010 Tax Relief Act. This means that, after 2012, unless further legislation is enacted:

• the estate, gift, and GST exemption will be $1 million (the amount that, under pre-EGTRRA law, had been scheduled to apply in 2006 and later years);
• the maximum estate and gift tax rate will be 55% on transfers in excess of $3 million; and
• the rules allowing for the portability of the estate tax exclusion between spouses will not apply.

RIA viewpoint: Howard M. Zaritsky, J.D., Rapidan, Virginia, independent estate planning consultant and author of numerous estate planning articles and treatises, including the soon to be published Practical Estate Planning in 2011-2012 notes the following:

These changes are significant and, in many cases, very, very useful, but they continue only until December 31, 2012. On Jan. 1, 2013, we are still scheduled to return to a 55% top estate and gift tax rate, a flat 55% GST tax rate, a $1 million estate and gift tax exemption amount, a $1 million GST exemption (indexed for inflation), and no portability of the first deceased spousal unused exemption amount. Obviously, no one believes that we will permanently return to that level, but the uncertainty of the last few years is likely to continue for two more years. This is a particularly acute problem in estate planning, which is, by nature, a long-term proposition. Income tax planning often involves considering events likely to occur several years after the planning date; estate planning involves considering events likely to occur several generations after the planning date. Estate planners cannot reasonably expect the law to remain static for generations, but they can expect a reasonable level of consistency and stability. This has been lacking since 2001, and it will not likely be achieved until near or after Jan. 1, 2013.

Certainly, persons with an estate of $5 million to $10 million will benefit by the newly increased estate tax exemption. They will be able to have simpler and more understandable estate plans, and the cost of their estate planning should decline significantly.

The real beneficiaries of the new law, however, are the very rich, whose estates are large enough to permit substantial lifetime transfers. The new law not only increases the gift tax exemption from $1 million to $5 million for transfers in 2011 and 2012, but it includes none of the proposals that Congress had been considering that would have restricted the use of family limited partnerships and limited liability companies to produce valuation discounts, and the continued use of short-term zero-gift grantor retained annuity trusts.

Very wealthy clients who are inclined to make large taxable gifts are given a new reason to do significant additional giving in the next two years. There is little political chance that the estate tax exemption will drop back to $1 million permanently, but it could be reduced to $3.5 million, if certain legislative factions are successful in the 2012 elections.

Furthermore, the increase in the GST exemption to $5 million should prompt these same donors to create perpetual trusts of $5 million to $10 million to create an endowment for their descendants that will last without further estate taxes or GST taxes, forever.

Life insurance professionals will find the new law disappointing, because it eliminates the need for most estates to buy life insurance to pay estate taxes at the surviving spouse's death. Only relatively large estates (above $10 million) will still need life insurance for this purpose. This will eliminate a significant portion of the market for survivor life insurance policies.

On the other hand, an individual who does want to buy life insurance to help pay estate taxes, provide assets to take care of the insured's family, pay estate administration expenses, pay state death taxes, or any of the other functions for which life insurance is used, will find that the new law makes it far easier to prepare an irrevocable life insurance trust that will operate simply and efficiently. The increased gift tax exemption of $5 million will permit insureds to fund these trusts with sufficient assets to finance all of the policy premium costs, with no current gift tax liability. Split-dollar arrangements to help fund large premiums will be far less important. Also, insureds may seriously consider creating these trusts without Crummey powers, because their lifetime gift tax exemption will be sufficient to cover the premium costs without the complexity and occasional hostility engendered by the operation of Crummey powers.

Mr. Zaritsky also notes that the primary losers under these new rules, if they become permanent, will be estate planning practitioners, the bulk of whose clients do not have estates over $10 million. The combination of a $5 million basic exemption amount and portability of the first deceased spouse's unused exemption amount (the “deceased spousal unused exemption amount”) will convince most of these clients that they do not need sophisticated estate tax planning.

As a result, many clients will insist on a simpler estate plan with fewer trusts and much less tax planning. This is likely also to result in a deficiency in disability asset management planning (the use of powers of attorney and revocable trusts), probate avoidance planning, and asset protection planning. Such simpler estate plans may also expose these estates to unnecessary state estate taxes and, if the estates grow significantly in value in the future, to additional federal estate taxes.

Some clients certainly will begin to consider using documents they create themselves through either software packages or online services. These sources have traditionally denied that they include significant tax planning, and some persons with significant estates are likely to believe that these sources are now sufficient for their purposes. Estate planners will have a serious responsibility for reeducating their clients, but this may be a difficult and extended process. The hardest job for most estate planners will be getting their clients to agree even to revisit their estate plans, in light of these higher exemption levels.