Quarterly Newsletters

March 2011: The New Federal Estate and Gift Tax

In mid-December 2010, Congress passed and the President signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the "Tax Act"). The Tax Act makes some interesting modifications to the laws governing the federal estate and gift tax system.

The impact of the Tax Act on the federal estate and gift tax system will only last for two years, 2011 and 2012. After that, unless extended, the federal system will revert to the law as it existed in 2001.

A major change is actually a reversion to what existed in 2001, a unified estate and gift tax credit system. Starting in 2011, the exemption credit equivalent against both federal and gift tax is $5,000,000.

Although I have probably written fifty articles about gift tax, I know that most people still believe that a taxpayer can only gift $13,000 a year without paying gift tax. This is wholly incorrect.

Prior to 2011, a person could gift $1,000,000 to whomever he wished, in whatever dollar-increments he wished, without paying gift tax. For 2011 and 2012, a taxpayer can gift $5,000,000 without paying gift tax to whomever he wishes, in whatever dollar-increments he wishes.

In addition, each taxpayer can gift $13,000 a year to as many people as he wishes without reducing his $5,000,000 lifetime credit. So, for example, Mr. Smith could give $5,013,000 to his son in 2011 and would not pay any gift tax whatsoever for this gift.

I think it is safe to say that gift tax is not a concern for so many people in this country that I think people should just forget about it. With the $5,000,000 lifetime credit (assuming Congress extends the Tax Act in 2012), gift tax has become a non-issue for the vast majority of United States citizens.

The federal estate and gift tax system is, as I mentioned, reunified. What that means is that if Mr. Smith gifts $1,013,000 to his son this year, his lifetime credit against gift tax will be reduced from $5,000,000 to $4,000,000 and his lifetime credit against federal estate tax will be reduced from $5,000,000 to $4,000,000.

Another interesting change that the Tax Act contains is an option for estates of decedents dying in 2010 to elect two options for estate tax treatment. 2010-estates can elect to either have the estate treated under the rules that existed in 2010, which means that there was no estate tax and a $1,300,000 limitation on basis allocation, or have the estate subject to the $5,000,000 exemption equivalent that exists in 2011 with unlimited basis step-up.

The difference between these two methodologies is probably best explained through example. Assume that Mr. Smith dies with a $6,000,000 estate and his estate consists, mainly, of a house and stocks. Assume that Mr. Smith purchased this $6,000,000 worth of assets over the course of his life for a grand total of $2,000,000.

Mr. Smith's basis in his assets was $2,000,000, the amount of money that he paid for the assets. If Mr. Smith gifted those assets to his son, his son would receive Mr. Smith's basis in the assets. This is called "carryover basis."

In 2010, when there was no estate tax, the federal law only gave an estate $1,300,000 in basis step up to allocate to the estate's assets. Now, in 2011, all the assets of the estate receive a step up.

So, Mr. Smith's executor could choose either to have the estate subject to no estate tax, with a basis of $3,300,000 (the $2,000,000 original basis plus $1,300,000 basis allocation) or to pay tax on the $1,000,000 that exceeds the $5,000,000 exemption and receive full basis step up.

Having a basis equal to the current market value means that the estate will pay no capital gains tax when it sells the estate's assets. So, it becomes a trade-off: Pay no estate tax and more capital gains tax or pay some estate tax (depending upon the value of the estate) and no capital gains tax. The tax-calculation will have to be made by a professional.


In December 2010, the Congress passed and the President signed into law a new tax act that modified the federal estate tax system for 2011 and 2012. In a nutshell, the tax act increased the applicable exemption amount against the federal estate and gift taxes to $5,000,000. In other words, a person would have to die with more than $5,000,000 or give away more than $5,000,000 in his lifetime before his estate or he would pay any estate or gift tax.

The new tax act also contains an interesting provision called "portability." Essentially, portability permits a married couple to exempt $10,000,000 from federal estate tax. Portability would eliminate the need for a commonplace tax planning method that has been used for decades called "credit shelter trusts."

In the past, a couple could shelter twice whatever the exemption was by utilizing credit shelter trusts. A credit shelter trust is typically contained in the last will and testament of each member of the couple. Each trust states that it is for the benefit of the surviving spouse and the surviving spouse is often the trustee of the trust.

Credit shelter trusts work as follows: Mr. and Mrs. Smith are worth $2,000,000. Assume that the applicable exemption amount against federal estate tax is $1,000,000. Mr. and Mrs. Smith go to their lawyer and their lawyer drafts their Wills so that the documents contain credit shelter trusts.

A trust in a Will is called a "testamentary trust." A credit shelter trust would simply be extra words in the Will. For instance, the Will might contain a paragraph that says something to the effect of "my executor shall distribute to my trustee the amount that is exempt from federal estate tax to be held and administered for the benefit of my spouse." The spouse could be the trustee of this trust, so the spouse is holding the money in the trust for her own benefit and can distribute the money to herself for her health, support, and maintenance.

By leaving the amount of the credit to the credit shelter trust, the first-to-die spouse utilizes his credit against federal estate tax. On the other hand, had the first-to-die spouse simply left the entirety of his estate to his spouse, there would have been no estate tax-because there is no estate tax between spouses-but when the second-to-die spouse dies, her estate would consist of all the couple's assets and she would only have her credit to reduce the estate tax. In other words, the couple would have lost the benefit of the first-to-die spouse's credit.

So, assume that Mr. Smith had $1,000,000 in his name and the credit is $1,000,000, so $1,000,000 would pass to the credit shelter trust for his wife's benefit. The wife could utilize the money in the trust for herself, and she can utilize the money she holds in her name. There is no diminishment in her way of life.

When the wife dies, all of the money in her name and all of the money remaining in the credit shelter trust will pass to the couple's children, and since the couple utilized the husband's and the wife's credit against estate tax, there is no estate tax for the children to pay on the wife's death.

What portability permits is a simplified method of utilizing each spouse's credit. Instead of the assets of the first-to-die spouse having to pass to a credit shelter trust, the second-to-die spouse can simply elect on the estate tax return of the first-to-spouse to preserve his credit.

In other words, assume that Mr. and Mrs. Smith have $10,000,000. When Mr. Smith dies, he leaves the entirety of his estate to Mrs. Smith, instead of to a credit shelter trust. Mrs. Smith can file a federal estate tax return for Mr. Smith's estate and elect to preserve $5,000,000 of his $5,000,000 credit. Now, when Mrs. Smith dies, her children can file a federal estate tax return for her estate and claim $10,000,000 worth of credit.

Portability is nice, but it does require the filing of a federal estate return on the death of the first spouse, which can be expensive. It also is only the law for 2011 and 2012, so would I suggest it to clients instead of using credit shelter trusts? No.


You can't win them all. That's what they say and, unfortunately, that's true. This week, I received an opinion from the United States Court of Appeals for the Third Circuit in which I lost.

The case involved a planning technique called "reverse half a loaf planning." To understand reverse half a loaf planning, you must understand "half a loaf planning."

Prior to 2006, when the laws governing the Medicaid program were changed, an individual could gift assets and have a penalty period, or period of ineligibility for Medicaid, assessed against him.

Half a loaf planning worded as follows: Assume that Mr. Smith had $100,000 and was residing in a nursing home. Mr. Smith could have given away $50,000 of the $100,000, and the Medicaid Office would have assessed a penalty period against Mr. Smith for having given away the $50,000, irrespective of the fact that Mr. Smith retained $50,000 to pay the nursing home during the period of ineligibility that resulted from the $50,000 gift. Mr. Smith's children could have retained the $50,000 gift, and Mr. Smith would have retained sufficient assets to pay for his care.

In 2006, the Medicaid laws were changed. Now, in order for a penalty period to be assessed against an applicant, the applicant must be otherwise eligible for Medicaid but for the imposition of the penalty period. What this means is that the applicant must have less than $2,000 in resources (resource-eligibility), must need a nursing home level of care (health-eligibility), must have insufficient income with which to pay for his care (income-eligibility), and must file an application for Medicaid benefits.

You may be asking, Why do I want a penalty period assessed against me? Isn't a penalty period, or period of ineligibility for Medicaid, a bad thing? It is bad, but the sooner a penalty period begins, the sooner you can be eligible for Medicaid. If a person made a gift in the past five years, he will be ineligible for Medicaid someday, so the sooner the penalty begins the sooner it can be over.

Reverse half a loaf planning works as follows: Assume that Mr. Smith has $100,000 and is residing in a nursing home. Mr. Smith gives away his $100,000. He is now resource-eligible. Assuming he is also income-eligible, health-eligible, and makes an application for Medicaid benefits, the penalty period for the $100,000 will begin. After the penalty period begins, Mr. Smith's children return $50,000 to him. The penalty period is cut in half because half the funds were returned to Mr. Smith, and Mr. Smith uses the $50,000 to pay through the reduced penalty period.

I had a client who made approximately $200,000 in gifts before coming to see me. She wasn't planning for Medicaid eligibility, she just wanted to give her family members some gifts. When she applied for Medicaid, Medicaid assessed a penalty period against her.

I suggested that her family return half of the gifts to her, thereby reducing the penalty period by half and giving the client sufficient assets with which to pay for her care. The client was resource-eligible for four months, during which time she did not have the returned gifts.

The Medicaid Office refused to start the penalty period until the returned gifts were spent down. I filed a federal suit. The federal trial court held that the client had the funds that were returned to her during the four month period of time when she did not have the money. I filed appeal. The Third Circuit affirmed the trial court, holding that the client was only "technically resource-eligible" for that four month period of time. (The State conceded that the client was income-eligible and health-eligible.)

I am not sure what "technically resource-eligible" means. I have never heard of this concept and it has no foundation in the laws governing the Medicaid program.

The good news is, this case does not have a broad impact because the State abolished reverse half a loaf planning in May 2010 when it issued a policy requiring all of the returned gifts to be returned in order to eliminate a penalty period and will not permit a partial abatement of a penalty period for a partial return of gifted assets.


How long does it take to get approved for Medicaid? When your mother is in a nursing home and has no money, getting her approved for Medicaid benefits can be a very nerve-racking process, so you want the process to move along as speedily as possible. The problem is, the process is anything but speedy, and in recent years, the process has become excruciatingly slow.

Medicaid is a medical assistance program for individuals who cannot afford the cost of their health care. Essentially, Medicaid is a health insurance program for needy individuals; however, unlike most health insurance programs, Medicaid will pay for the costs of long-term care, such as care in a nursing home or an assisted living residence.

Since an individual must have limited means in order to qualify for Medicaid benefits, most Medicaid offices in New Jersey will not accept-or, at least, seriously process-an application unless the applicant is close to qualifying for benefits financially.

The problem is, if an applicant waits until she has very limited resources before applying for benefits and if she is residing in a nursing facility, it is highly likely that there will be a long lag between the date the applicant is eligible for Medicaid benefits and the date the applicant is approved for benefits. For instance, assume that Mr. Smith is residing in a nursing facility and has $50,000 in assets remaining. $50,000 will pay for approximately five months of nursing home care.

So, Mr. Smith's son goes to the Medicaid office to apply for benefits for his father, but the Medicaid office tells the son that his father has too much money and refuses to accept the application. They tell the son to return when the father is close to having only $2,000, which is the resource limit for Medicaid eligibility.

If the son returns in four months to apply for benefits, Mr. Smith will be much closer to being resource eligible, but he will actually need the Medicaid benefits within the month. Currently, the Medicaid office is taking anywhere from three months to a year-and-a-half to process Medicaid applications. So, Mr. Smith will have to sweat out his eligibility, accruing a monster nursing home bill during the wait.

Since Mr. Smith is in a nursing home, assuming he actually is eligible for Medicaid benefits, those benefits will be retroactive back to the first date of eligibility. In other words, if Mr. Smith is eligible on March 1, 2011, even if Medicaid doesn't actually approve him for benefits until December 15, 2011, the benefits will be retroactive to March 1st.

This is not the case if Mr. Smith resides in an assisted living residence or at home. If Mr. Smith is apply for benefits in an assisted living residence or at home, there are no retroactive benefits. So, if the Medicaid office takes twelve months to process Mr. Smith's application for benefits and Mr. Smith resides in an assisted living residence, then Mr. Smith better come up with a way to pay the assisted living residence during those twelve months.

All of this begs the questions of whether or not there is a law dealing with how long the Medicaid office can take to process a Medicaid application. And there is. There is a section of the federal Medicaid Act that says that an application for benefits must be processed with reasonable promptness.

This law is known as the "promptness requirement." The federal government published regulations effecting this statute that essentially says "prompt" means no more than forty-five days.

Given the law, why does the Medicaid office almost always violate the law? Because no one holds their feet to the fire. The promptness requirement is the law and by failing to adhere to the law, the Medicaid office does harm applicants for benefits.


This past December, the federal government enacted the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the "Tax Act"). In part, the Tax Act changed the laws governing the federal estate and gift tax system. Today, I wanted to write about the changes the Tax Act brought to the federal gift tax system and about the interplay of the gift tax laws and the Medicaid asset transfer rules.

Individuals with whom I meet are always confused about the federal gift tax. Most people believe they can only gift $13,000 a year. People seem to believe they will pay a tax of some sort on the amount they gift over the annual exclusion amount.

I have always told clients that this belief is incorrect. The fact of the matter is, prior to the passage of the Tax Act, each person had a $1,000,000 lifetime credit against gift tax, meaning that a person could gift $1,000,000 before he would have to pay gift tax. And it is the maker of the gift who would have to pay the gift tax, not the recipient of the gift.

In addition to the $1,000,000 gift, a taxpayer can make the annual exclusion gift to an unlimited number of individuals without reducing his $1,000,000 lifetime credit. For instance, Mr. Smith could gift $13,000 each and every year to an unlimited number of people without reducing his $1,000,000 lifetime credit.

If Mr. Smith gifted more than $13,000 to any one person, the amount that was gifted over $13,000 would reduce his $1,000,000 credit proportionately. So, for instance, if Mr. Smith had gifted $23,000 to his son, Mr. Smith's lifetime credit against gift tax would have been reduced from $1,000,000 to $990,000.

The Tax Act did not change the annual exclusion amount. The Tax Act did not change the impact of gifting more than the annual exclusion amount to any one person. What the Tax Act did change, however, is the amount of the lifetime credit. The Tax Act increased the lifetime credit amount from $1,000,000 to $5,000,000.

Obviously, for most of us, being able to gift $5,000,000 is simply a dream because we'd have to have $5,000,000 to give away. And how much money would you have to have before you wanted to give away $5,000,000?

After the passage of the Tax Act, I think it is safe to say that for most Americans, the fear of paying gift tax is a non-issue. Most of us could give away every asset we own without the fear of ever having to pay gift tax.

Moreover, if you are married, you and your wife can each give away $5,000,000 without paying gift tax. So, a married couple can gift $10,000,000 without paying gift tax.

But how do the gift tax rules interplay with the Medicaid asset transfer rules? In other words, can a person gift $13,000 a year without fear that the gifts will affect his eligibility for Medicaid?

Medicaid is a health insurance program for needy individuals. Unlike most health insurance, though, Medicaid pays for long-term care costs, such as nursing home care, assisted living care, or home health aides. Since Medicaid is only available to needy individuals, Medicaid punishes those individuals who give away money within a five-year period of time prior to apply for benefits by making those individuals ineligible for Medicaid benefits.

Gift tax rules have nothing to do with Medicaid asset transfer rules. While a person can make $13,000 a year gifts to an unlimited number of individuals, each of those gifts made within the five-year period prior to applying for Medicaid benefits will count against the individual and cause him to be ineligible for Medicaid.

The bottom line is, if you're rich, feel free to make a gift. If you're like most of us, those gifts could come back to haunt you.