Jan 2013
30

Estate Planning and Tax Updates

By Joe Day
January 30, 2013

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What follows is an update from Laura Hoexter and Xan Gerson of Helsell Fetterman regarding the American Taxpayer Relief Act of 2012, signed into law on January 2nd, 2013.  Helsell Fetterman is a local law firm located in Seattle, WA, whose Estate Planning and Probate group is headed by Laura.  Her group maintains expertise in many areas, including estate planning, trust administration, generation skipping transfers, and family business succession planning.

Estate Planning & Tax Updates

by Laura Hoexter and Xan Gerson

As the ball dropped in Times Square, many of us were sure that the country was headed over the fiscal cliff. But on January 2, 2013, President Obama signed the American Taxpayer Relief Act of 2012 (ATRA) into law. In addition to many income and business tax changes, ATRA extends the sweeping reforms that were made to the federal estate, gift, and generation-skipping taxes in 2010. This newsletter will focus on the estate, gift and generation-skipping transfer taxes, and outline our recommendations for updating your existing estate plans.

ATRA Transfer Tax Provisions

Estate, Gift, and GST Tax Exemptions

Under the 2010 law, the exemptions against estate, gift, and generation-skipping transfer (GST) taxes were unified and set at $5 million, indexed for inflation. However, the unified exemption was expected to expire at the end of 2012, dropping the estate and gift tax exemptions to $1 million and the GST tax exemption to $1 million, indexed for inflation. ATRA permanently unified the three exemptions and kept the rate at $5 million, indexed for inflation. For 2013, the inflation-adjusted exemption is $5.25 million, allowing each taxpayer to transfer this amount during his lifetime or upon his death, with no federal estate or gift tax consequences.

Estate, Gift, and GST Tax Rates

Under the 2010 law, estates in excess of the exemption amount were taxed at 35%. Without any Congressional action, the 35% rate was set to expire, leaving taxpayers facing a top estate tax bracket of 55%. ATRA provides a permanent flat estate tax rate of 40% for all transfers in excess of the exemption amount. This rate applies to all three transfer taxes: estate tax, gift tax and GST tax. Note that the 40% tax rate ensures that the flat transfer tax rate will continue to remain equal to or above the top income tax bracket (39.6% for 2013).

Portability of Unused Exemption

Under the 2010 law, a surviving spouse (as defined under federal law) could use his or her deceased spouse’s unused gift and estate exemption. This portability benefit allowed couples who failed to create tax-saving estate plans to take advantage of a full $10 million exemption (indexed for inflation). While the portability was set to expire at the end of 2012, ATRA made it permanent. However, this benefit only applies to federal estate tax. Neither the Washington State estate tax exemption nor the federal GST exemption is portable.

Deduction for State Death Taxes

Under the 2010 law, taxpayers could deduct against their federal estate taxes any amounts they paid to the state in the form of state estate taxes. Absent Congressional action, this deduction would have been replaced with a credit that had been previously phased out. ATRA made this deduction permanent. With some states imposing significant estate taxes, this deduction can be substantial. For instance, the effective combined federal and state estate tax rate in New York, a state with high state estate tax, is 49.6%, while in Texas, a state without a state estate tax, the effective rate is 40%. In Washington, our tax rate ranges from 10% to 19% for amounts in excess of $2 million.

Annual Gift Tax Exclusion

While not part of ATRA, it is important to note that in 2013, the annual gift tax exclusion increased from $13,000 to $14,000. This means that anyindividual can gift up to $14,000 per recipient without having to file a gift tax return.

  Federal Estate Tax Gift Tax GST Tax WA State Estate Tax
Year Rate EXMT. Rate EXMT. Rate EXMT. Rate EXMT.
2011 35% $5.0M 35% $5.0M 35% $5.0M 10% – 19% $2M
2012 35% $5.12M 35% $5.12M 35% $5.12M 10% – 19% $2M
2013 40% $5.25M 40% $5.25M 40% $5.25M 10% – 19% $2M
2014 40% $5M indexed for inflation 40% $5M indexed for inflation 40% $5M indexed for inflation 10% – 19% $2M

Estate, Gift, and GST Tax Table

The Effect on your Personal Planning

Many individuals are wondering whether ATRA will require them to update their wills.

Some news reports suggest that married taxpayers only need minimal planning if their combined estates are below $10.5 million. Additionally, some news coverage has also suggested that taxpayers can simplify their estate plans, remove the tax-saving trusts, and rely on the portability benefit to shelter an estate up to $10.5 million. We strongly recommend against this for many reasons: (1) the lack of portability of the state estate tax exemption; (2) the lack of portability of the GST tax exemption; and (3) the additional reporting requirements and increased audit exposure. These reasons are discussed below.

  1. Portability and the State Estate Tax. While the federal government allows portability of the federal estate tax exemption, the state does not allow portability of the state estate tax exemption. Therefore, by eliminating tax-saving trusts in your estate plan such as the Credit Trust (also known as the Credit Shelter Trust, Bypass Trust or A/B Trust), you may be increasing the state estate tax due upon the surviving spouse’s subsequent death.

  2. Portability and the Generation-Skipping Tax. It is important to note that while the federal government allows portability of the federal estate tax exemption, it does not allow for the portability of the generation-skipping transfer tax exemption. If your estate plan includes gifts to grandchildren or trusts that will last multiple generations, it may be imprudent to rely on the portability benefit.

  3. Filing Requirements to Preserve Portability. In order for a surviving spouse to properly make the election to use the deceased spouse’s unused estate tax exemption, the surviving spouse must file an estate tax return (IRS Form 706) for the deceased spouse’s estate, even if one is not otherwise due. This means that the surviving spouse must incur the additional time and expense to marshal all assets, gather substantiating documentation for these assets, value each asset and provide appraisals as required, and hire an attorney or CPA to prepare and file the estate tax return. In return, the surviving spouse exposes himself or herself to audit. The portability benefit was adopted to provide those couples who don’t do proper planning with a way to minimize the estate tax liability. We would encourage couples to keep their estate plans up to date and view the portability benefit as an option only in the event that their planning fails.

Recommendation: If your will contains a Credit Trust and the will was drafted after 2005 (when Washington State created its state estate tax), then it was probably drafted to float with many of the foreseeable changes brought about by ATRA. If this is the case, no updates should be needed due to the change in the tax laws. However, ATRA does raise additional concerns for some clients. For individuals who have wills that contain bequests to different beneficiaries based on the amount of exemption available, there may be a need to revisit this division to ensure that it is still desirable. In other words, if your will states that your grandchildren receive an amount equal to your unused generation-skipping tax exemption, and your children get the remainder, this amount would have had very different results had you died in 2009 when the exemption was $3.5 million, versus 2013 when this exemption is $5.25 million.

Recommendation: The portability benefit only allows a person to claim the unused exemption of the last spouse. Widows and widowers who are contemplating a second marriage should consider the economic consequence. For instance, assume Mary was married to Abel. When Abel died in 2013, Mary inherited their combined estate of $7 million, tax free due to the marital deduction. Mary claims portability, hoping to use her $5.25M as well as Abel’s $5.25M and shelter the combined estate at her death. Three years later, Mary is in a relationship with Ben who she is considering marrying. Ben has an estate worth $5M. If Mary does not marry Ben, each of them will have an exemption larger than his or her respective estate, and at death, no tax will be due. If Mary marries Ben, she will lose the ability to use Abel’s $5.25M exemption at her death. Instead, she and Ben will have a combined estate of $12 million and a combined exemption of $10.5 million.

Recommendation: Certain strategies used by taxpayers to move funds to the next generation in a very tax-favorable way have been targeted for termination by the current Administration. These strategies include short term grantor retained annuity trusts (GRATs), gifts of discounted interests in passive businesses, and sales to irrevocable grantor trusts. While these techniques were not eliminated in ATRA, we feel they are still in possible jeopardy, and we are encouraging clients to take advantage of them before they disappear.

Despite the nail-biting suspense and the last minute legislation, we are thankful that we finally have permanent estate tax laws. While each person’s situation is different, and there may be a need for some individuals to update their estate plans, we can now plan with some permanence.

This entry was posted on Wednesday, January 30th, 2013 at 09:35 am and is filed under BlogGivingPlanning Perspectives. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

 

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bio3Joe Day, CFA is the Founder of Bear Mountain Capital. Joe started the company after spending many years advising high net worth clients with a leading global wealth management firm. Joe earned the right to use the CFA designation from the CFA Institute in 2011. He also holds a degree in Business Administration, with a Major in Finance from Gonzaga University.

Luke Collova is an Investment Advisor Representative for Bear Mountain Capital focusing on planning, investment strategy, client development and operational support. Luke’s prior career included providing commercial insurance coverage for a global insurance firm. Luke maintains his Series 65 license and holds a degree in Business Administration, with an emphasis on Finance and International Business from the University of Puget Sound.