Business Counselor February 5, 2013

New Legislation: State and Gift Tax Certainty at Last

After much dissension and political maneuvering, Congress finally provided some certainty regarding estate and gift taxes at the end of 2012 by continuing permanently the $5,000,000 estate and gift tax exemption. The exemption, originally adopted for 2011, is adjusted for inflation and after adjustment the exemption was $5,120,000 in 2012 and is $5,250,000 for 2013. The adjustment will occur annually so that it will keep pace with inflation over time. The top marginal estate and gift tax rate increased from 35% to 40% under the new law. The new law avoided part of the “fiscal cliff” which would have reduced the exemption to only $1,000,000 and a 55% tax rate.

A “portability” feature that was added in the 2011 two-year “patch” legislation was continued under the new law. Portability gives the surviving spouse the ability to use later the unused portion of his or her deceased spouse’s estate tax exemption. In order to take advantage of this feature, the surviving spouse must file an estate tax return for the deceased spouse to make the election, even if the deceased spouse’s estate was below the $5,250,000 estate tax filing threshold. If the return and election is not filed by the surviving spouse, then the unused portion of the deceased spouse’s exemption is lost. The loss of the unused exemption would be important if the surviving spouse’s estate eventually exceeds his or her remaining exemption at his or her later death.

Before this portability feature was added, it was important for married couples with combined estates larger than the exemption to have separate revocable trusts with tax provisions and to divide their assets between their two trusts to make sure that the exemption of the first spouse to die was not wasted. For example, before portability, if a couple owned all their property jointly or left it to each other directly by beneficiary designations, upon the first spouse’s death, his or her exemption would be wasted. Then upon the surviving spouse’s death, there would only be one exemption available. The estate in excess of the one exemption would be subject to the estate tax. If that same couple had executed and funded separate trusts, they would be able to utilize two exemptions to shield twice the amount of assets from estate tax. Now, the portability election may avoid the necessity of couples having to create two trusts in order to minimize taxes. However, for couples whose combined estate is well in excess of the exemption (now $5,250,000), the two trust plan may still be advisable because the separate trust plan may also avoid estate tax on all of the appreciation on the assets in the first spouse’s trust from his or her date of death through the date of the second spouse’s death. In addition, the two trust plan can help a wealthy couple utilize the generation skipping exemption for both spouses. The portability feature applies only to the estate tax exemption – not to the generation-skipping tax exemption. The decision of whether or not a married couple should have two trusts is still best made with the advice of an experienced estate planning attorney.

Remember that when we refer to your combined estate, it includes all of the assets that you own and control including real estate, financial accounts, retirement plan accounts and life insurance at death benefit values (rather than cash value).

So, what does this all mean to you? If you are a single person, then your plan may not need to change at all as a result of the new law. If you are a married couple with combined assets under the current exemption ($5,250,000) and you already have separate trusts to minimize estate taxes that were drafted when the exemption was much lower, then you may be able to simplify your estate plan. Unless there are other reasons to have separate trusts (second marriages being one example), couples with estates under the exemption amount typically would prefer having one trust together or even joint ownership. The two trust plan might add additional accounting and an additional tax return that is now unnecessary. Those expenses were worth it when it was necessary to avoid an estate tax of around 50%. If the estate tax exposure is removed by the new law, going back to a simple plan may be beneficial.

In closing, please give us a call if you would like to review your estate plan in light of these changes. Our approach is to recommend those changes that are best for you under your particular circumstances, if any changes are needed at all. The good news is that we now have some certainty and can be more confident in our direction with this new law. It is certainly a positive development for almost all of our clients.

Let’s start a partnership worth keeping.