opportunities for estate planning
IN 2012 AND BEYOND IN LIGHT OF
CURRENT FEDERAL ESTATE AND GIFT TAX LAW
 | Since 2001 the federal estate tax has been in a state of short-term fluctuation and long-term uncertainty. In December 2010 Congress temporarily increased the estate tax exemption to $5 million for decedents dying in 2011 and 2012. As of January 1, 2013, however, the exemption is due to revert back to $1 million, unless Congress intervenes in the meantime. The 2010 legislation also made substantial changes to the federal gift tax and how married couples might use their combined exemption amounts, both of which are discussed below. |
| The failure of Congress to set a permanent federal estate tax exemption amount is unfortunate, since it prolongs the element of uncertainty in the estate planning process, especially for married couples. |
| Note on Pennsylvania Inheritance Tax. These changes in federal estate tax law will not affect the Pennsylvania inheritance tax, which will continue to be imposed on the transfer of taxable property at death (other than to the surviving spouse), at rates that are based on the relationship between the beneficiaries and the decedent. There is no exemption amount applicable to the Pennsylvania inheritance tax. |
| This article discusses the current rules governing the federal estate and gift tax, and the planning opportunities arising from them. |
CURRENT ESTATE PLANNING OPPORTUNITIES
Given the $5 million exemption available for gifts made in 2012, and the uncertainty of what the federal estate and gift tax exemption amounts will be after 2012, what are the planning choices that married couples and individuals should now consider?
Take Advantage of the $5 Million Gift Tax Exemption in 2012
| Gifts of assets made during lifetime can save significant taxes when compared to passing such assets at death, since all post-gift appreciation in value will escape taxation. |
| Taking advantage of the $5 million exemption for gifts made in 2012 will allow donors to make significant transfers of wealth. This opportunity may be lost if the gift tax exemption amount is reduced for 2013 and beyond. |
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In any event, lifetime gifting should continue each year within the limits of the annual gift tax exclusion (currently $13,000 per donee) or the unlimited exclusion for tuition or medical expense payments. Such gifts can be made over and above the gifts that will take advantage of the gift tax exemption. |
Plan for the Contingency of Fluctuating Estate Tax Exemption Amount
| Given that the federal estate tax exemption could range from $1 million to $5 million, flexibility is the key principle in designing estate plans that aim to minimize the federal estate tax at a time (i.e., the year of death) when the amount of the exemption is unknown. Here are two planning ideas: |
| Spousal Disclaimer Trust |
One flexible solution for married couples is to have an initial "all to my spouse" bequest in each spouse's will, but then provide for a contingent "credit shelter" or "bypass" trust that the surviving spouse could trigger by making a post-mortem disclaimer of all or a specific percentage or amount of the outright bequest. With the disclaimer approach, the surviving spouse can choose exactly how much (if any) of the first spouse's estate to place into the trust in order to utilize some part or all of the first spouse's estate tax exemption. The surviving spouse would be both the lifetime beneficiary and a co-trustee of this trust.
| Partial QTIP Trust |
As an alternative to the spousal disclaimer trust, planning could involve the creation of a single trust to receive the entire estate of the first spouse to die. The surviving spouse would be the sole beneficiary of this trust. The executor could then elect how much of the single trust to qualify as QTIP property for the marital deduction. This partial QTIP election would take into account both the first spouse’s exemption amount, and the likelihood of an estate tax being imposed at the surviving spouse’s death.
Update Spousal Estate Plans in Light of the New Concept of Portability
| The new tax law provides significant relief for married taxpayers by enhancing their ability to use both spouses’ exemption amounts regardless of the order of deaths. A common problem had been that the exemption of the first spouse to die would be partially or even totally wasted if he or she did not individually own assets that were at least equal to the exemption amount. The new law now provides that the surviving spouse’s estate can use both his or her own exemption amount, plus any unused exemption amount from the first spouse’s estate. |
| This change eliminates the need for spouses to unwind jointly owned property as part of the estate planning process in an attempt to ensure that each would own significant assets. Now they can continue to own their property jointly if they wish. |
| One important caveat to this portability concept is that the surviving spouse’s estate’s use of the first spouse’s unused exemption amount will not be automatic. In fact, the executor of the first spouse’s estate must file an Estate Tax Return in which the unused exemption amount is computed and an election is made allowing such amount to be used by the surviving spouse’s estate. In addition, the return must be timely filed (usually nine months after the death of the first spouse.) Thus, planning for the preservation of the unused exemption amount must be done at the first spouse’s death. If not done then, it will be too late to claim the unused exemption amount at the surviving spouse’s death. |
| This portability provision is due to expire at the end of 2012. However, portability may prove to be so popular a concept that it will be continued in the law regardless of what other changes may occur as of 2013. |
Use a Valuation Discount Entity
| Even if the estate and gift tax exemption amount remains at $5 million, there will still be good reasons, particularly with an active family business or family investments that are closely managed, to shift existing assets and future appreciation to younger family members while allowing the senior family members to retain control. The use of Family Limited Partnerships and Limited Liability Companies will remain excellent solutions for these clients, as well as for clients who are seeking to protect their assets from future creditors of either themselves or their children. |
NON-TAX REASONS FOR ESTATE PLANNING
| Even if the federal estate tax exemption amount has been increased to a level that is well above the size of a couple's assets, there are still many non-tax reasons why you should have your estate plan periodically reviewed and updated. At a minimum, you need to have documents in place that adequately answer the following questions: |
"What will happen if during my lifetime I become unable to take care of my own personal and health care needs"?
"What will happen if during my lifetime I am no longer able to manage my property"? "Who do I want to receive my property at my death"?
"Who should wind up my affairs after my death"?
"How can I lower the federal and state taxes that my family will have to pay"?
| As to your intended beneficiaries, Congress obviously cannot legislate away problem areas such as spendthrift heirs, handicapped children, substance abuse, divorce, and immaturity. Protecting beneficiaries in these situations will remain an important estate planning goal. |
