Developments of Interest

Estate Planning Newsletter 2014

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The significant estate tax reform in the American Taxpayer Relief Act of 2012 (“ATRA”), enacted by Congress in January of 2013, has changed the landscape of estate planning, and resulted in many clients revising and simplifying their estate planning documents.  ATRA includes provisions making significant changes in law governing federal estate tax, gift tax, and generation-skipping tax.  These changes are on the whole beneficial for the taxpayer.

The estate tax exemption has been set at $5,340,000 for 2014, indexed for inflation.  In other words, there will be no estate tax imposed on the estate of a person dying with an estate under $5,340,000.  The estate tax rate on assets over the exemption amount is a flat rate of 40%.  These provisions are permanent in the sense that they are not set to expire at a certain future date, although they can, of course, be changed in the future by action of Congress.  In addition to the exemption, the unlimited marital and charitable deductions remain available for assets passing to a spouse or charity.

Another important benefit is the "portability" of a deceased spouse's unused estate tax exemption, meaning that the unused portion of the predeceased spouse's estate tax exemption can be added to the surviving spouse's estate tax exemption on the surviving spouse's death.  For example, a husband dies in 2014, leaving the entire estate to his wife.  This transfer qualifies for the unlimited marital deduction, so none of the husband's $5,340,000 estate tax exemption is used.  On the wife's subsequent death, her estate can have available not only her $5,340,000 exemption (as increased by the inflation adjustment), but the $5,340,000 exemption of her deceased husband.  Portability is not automatic.  An election must be made on an estate tax return (Form 706) filed at the first spouse's death, even if the size of the estate would not otherwise require filing of the return.  Portability of a predeceased spouse's exemption can be lost if the surviving spouse remarries and that second spouse dies prior to the surviving spouse's death.

The increased estate tax exemption and the availability of portability have significantly affected estate planning alternatives for married couples.  Traditional estate planning for a married couple has often involved the funding of an irrevocable tax shelter trust called the "Exemption", "Credit Shelter", or "Bypass" Trust on the death of the first spouse.  Now with the increased exemption of $5,340,000, and the availability of portability, a married couple can pass $10,680,000 of assets on the second death with no estate tax without the need for the funding of an irrevocable Exemption Trust on the first death.  Some couples who now have a revocable trust with Exemption Trust provisions may prefer to adopt a simpler scenario of a revocable trust providing that on the first death the entire trust will continue as a revocable trust for the surviving spouse, the "Survivor's Trust", thereby saving the surviving spouse the expense and inconvenience of funding an irrevocable Exemption Trust.  Also, assets of the Survivor's Trust receive a full step-up in basis for capital gains tax purpose on the death of the surviving spouse, whereas the assets of the Exemption Trust do not.  Revocable trusts with Survivor's Trust provisions can also contain a "Disclaimer Trust" provision, that is, the surviving spouse is given the option to "disclaim" certain assets to an irrevocable tax shelter trust.  This plan gives the surviving spouse, with the input of his or her advisors, the ability to make the decision at the time of the first death as to whether or not an irrevocable trust should be funded, based on the size of the estate and the estate tax laws at that time.  This flexibility makes the revocable trust with Disclaimer Trust option the best plan for some couples.

However, there may be other tax and non-tax reasons that may make it advisable to have Exemption Trust (or other irrevocable trust) provisions in the revocable trust.  The Survivor's Trust is totally revocable by the surviving spouse, whereas the beneficiaries of the irrevocable trust cannot be changed by the surviving spouse unless such a power is included in the trust document.  For example, a couple in a second marriage with children of prior marriages may prefer an irrevocable trust provision to ensure that the children of the deceased spouse are not disinherited by the surviving spouse.  The inclusion of an irrevocable trust could also be desirable if the couple is concerned that the surviving spouse might leave the estate to a new husband or wife in the event of remarriage.  Also, for larger estates, the increased estate tax exemption and portability may not eliminate estate tax on the second death.  Funding of the irrevocable Exemption Trust would prevent subsequent growth from being subject to estate tax.

The lifetime gift tax exemption has also been set at $5,340,000, plus, if elected, the portability amount.  The gift tax rate on the excess is a flat 40%.  Please bear in mind that the gift tax exemption is not in addition to the estate tax exemption.  Gifts during life over and above the annual exclusion amount use up the estate tax exemption on death.  The gift tax annual exclusion has been set for 2014 at $14,000 per donor, per donee, and will continue to increase.

The generation-skipping transfer tax exemption has also been set at $5,340,000.  The generation-skipping tax rate on the excess is a flat 40%.  Portability does not apply to the generation-skipping tax exemption.

ATRA opens new planning possibilities and increases the options for simplification of the estate plan.  However, as before, there is not one option which is best for every person.  As always, we would be pleased to meet with you for a review of your plan and determination if any changes are advisable.

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