The federal estate tax returns a kinder, gentler tax than anticipated this year. At the end of 2010, practitioners and taxpayers prepared for a return of the constrictive pre-2001 rate of 55% on estates greater than $1 million. However, Congress did act in December and the result - for the next two years, the federal estate tax will be assessed at a maximum rate of just 35% on estates over $5 million. Moreover, beginning in 2012, the exclusion amount will be indexed for inflation, resulting in a marginally higher (and therefore more taxpayer friendly) exclusion for estates that year. The legislation also allows a surviving spouse to take advantage of an unused portion of her deceased spouse’s exclusion amount. In order to do so, the deceased spouse’s unused exclusion amount must be calculated on his estate tax return. This means that to take advantage of the exclusion portability, a form 706 must be filed regardless of whether an estate tax is due on the deceased spouse’s death. Like the lower rate and higher exclusion, this portability feature is applicable through the end of 2012.

The annual gift exclusion remains at $13,000 per donee this year (or $26,000 per donee where a married couple who files a joint tax return splits the gift between them). The lifetime gift tax exclusion has risen from $1 million in 2010 to $5 million and it will also be indexed for inflation beginning in 2012. The increased exclusion amount provides potential for those with significant wealth to transfer considerable value out of their estates. The current legislation is set to expire at the end of 2012. Caution should be exercised whenever large gifts are contemplated because in the event the exclusion amount is then reduced, the value of gifts made between now and the end of 2012 greater than a reduced exclusion amount may be subject to estate tax upon the donor’s death. However, the benefit of removing any prospective appreciation of those gifted assets and the corresponding additional tax exposure remains.

The Generation Skipping Transfer (GST) Tax has also returned this year. GST tax is imposed in addition to the estate and gift tax on certain transfers made to individuals or classes of individuals deemed to be more than one generation below the person who makes the transfer. Like the federal estate tax, the GST tax was repealed in 2010. Also like the federal estate tax, the GST tax exclusion amount is $5 million this year.

The Illinois estate and generation skipping transfer tax is back this year. Like the Federal Estate tax, it was repealed in 2010. Illinois now recognizes only a $2 million exclusion amount with a maximum tax rate of 16%. The practical effect of the Illinois tax is that while an estate of $5 million can escape federal estate tax liability altogether, absent planning, the estate will be subject to an Illinois estate tax of $352,158. The unlimited marital deduction exists for Illinois estate tax purposes as well. Moreover, legislation enacted in 2009 allows for an Illinois Qualified Terminable Interest Property election for Illinois estate tax purposes that qualifies the property for the unlimited marital deduction for Illinois estate tax purposes. Illinois does not impose a state gift tax.