Thursday, June 30, 2011

Estate Planning Under New Tax Law

Congress recently enacted a new law which radically alters estate tax law, but only for a period of two years. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, signed into law on December 17, 2010 increased the amount which can pass to heirs Federal Estate Tax free to $5,000,000 per spouse, and established a top estate tax rate of 35%. This is an increase from the $3,500,000 Exemption Equivalent in 2009, and a big leap from the $1,000,000 Exemption Equivalent that was set to become law on January 1st, had Congress not acted.

Additionally, surviving spouses can now utilize any unused amount of their deceased spouse’s $5,000,000 if certain elections are made on a timely estate tax return. Again, this new “portability” provision seems like a great planning opportunity, but it also expires December 31, 2012, so unless both spouses die within the next two years, it could disappear.

While many families may now feel their estates are “untaxable,” the new law presents the need for estate plan reviews, despite the perceived tax relief.

It must be stressed again that the law as it is written will expire on December 31, 2012 if no additional Congressional action is taken. Without Congressional action, the exemption equivalent will be reduced to $1,000,000 with a top tax rate of 55%. Considering the uncertainty of the future of tax legislation, it is more important than ever to have flexibility in your estate plan.

If you have an estate that is less than $1 million, you should consider having your plan reviewed. You probably don’t need complicated plans with trusts and formulas. You don’t want to place the bulk of your assets in a complicated trust that is expensive to administer, and which ultimately offers no tax advantage. However, if you have assets less than $1 million, you may still need planning to address insurance ownership, guardianships, powers of attorney, medical directives, and other matters.

Many clients with estates between $1 million and $5 million have current wills that are written as an A/B trust structure wherein assets in the amount of the exemption equivalent are allocated to a credit shelter trust. Assets placed in this trust, as well as any appreciation, are generally not subject to estate tax upon the death of the second spouse. During the surviving spouse’s lifetime, he or she is entitled to the income of the trust with discretionary distributions of principal in the judgment of the trustee. For a decedent with an estate value of less than $5 million and a surviving spouse with limited assets of his or her own, using a formulaic credit shelter trust may restrict the surviving spouse’s use of these assets.

Conversely, the Generation Skipping Transfer Tax Exemption for 2011 and 2012, while also $5 million, is not portable. If couples do not make GST transfers during their lifetimes, and rely on portability by passing all property outright to the surviving spouse, GST tax sheltering opportunities may be missed.

Also, a credit shelter or family trust may be beneficial to families in the event of a widowed spouse remarrying. The predeceased spouse controls the disposition of the trust, and may wish to protect the interests of his or her children in the case of remarriage. The trust also provides creditor protection for the beneficiaries, and in Pennsylvania can continue in perpetuity without limitation.

Those who wish to have more flexibility may choose to utilize a disclaimer trust. With a disclaimer trust, a married couple’s will or revocable living trusts leave the deceased spouse’s entire estate to the surviving spouse. The family trust is funded only if the surviving spouse then disclaims (refuses) part of the deceased spouse’s estate. This enables the surviving spouse to decide how much to keep outright (to be taxed at the second death) and the amount to be allocated to the family trust (which is shielded from estate tax at the second death).

In making an informed decision to disclaim and how much to disclaim, one must examine the size of the combined estate, the surviving spouse’s age and health (which impacts the spouse’s needs for funds), whether minor children will be beneficiaries of the family trust, the potential appreciation of the assets not disclaimed, and the implication of Pennsylvania inheritance taxes (currently 4.5% for transfers to children, but can be as high as 16% for transfers to certain beneficiaries).

In addition, the actual disclaimer must meet certain legal and filing requirements, and the surviving spouse must not accept any benefits from the assets disclaimed before filing the disclaimer.

Business owners should also keep in mind that while the new tax legislation freezes the current 15% maximum capital gains tax rate through 2012, unless Congress acts to change the law, in 2013, long term capital gains will increase to a maximum of 20% with an additional 3.8% in Medicare tax on all capital gains income. With interest rates currently remaining historically low, it is a great environment to be considering a combination of gifting and business succession strategies such as sales to defective grantor trusts. If structured properly, business owners can receive income from these trusts for life, while passing business interests onto family members outside of the taxable estate.

Although the high Exemption Amounts and low rates seem to simplify and eliminate the need for estate planning, the reality of the situation is that what will happen in two years is anyone’s guess. The current law provides numerous reasons to review your current estate plan with your professional adviser and make sure you don’t miss out on this temporary window of opportunity to transfer wealth and reduce tax liability.

Wolf, Baldwin & Associates, P.C. is a general practice law firm in Pottstown, PA, founded by Jack F. Wolf in 1972. The firm’s areas of practice include Workers’ Compensation matters, Business and Corporate Law, Family Law, Estate Planning, Estate Administration and Probate, Real Estate, and General Civil Litigation. For more information, call 610-323-7436 or visit the firm’s website at

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