Finally – – Certainty About the Federal Estate Tax

Much to the surprise of many, the “fiscal cliff deal” brought much needed certainty to the federal estate tax. At the end of 2012, the federal estate tax exemption amount (temporarily at $5.12 million) was scheduled to revert to $1 million. Many expected that Congress would temporarily continue the $5.12 million exemption amount or some time later in 2013 make it permanent at $3.5 million. The permanent $5.12 million exemption (indexed for inflation) was a welcomed compromise for many. The fiscal cliff deal also made permanent the “spousal portability provision.” Under that provision, a surviving spouse can tack onto his or her federal estate tax exemption amount any unused exemption of the deceased spouse. As a result, married couples in a first-time marriage may no longer need to divide their assets into separate revocable trusts to minimize federal estate taxes. Although some states, including Maine, Vermont and Massachusetts, impose a “state” estate tax, New Hampshire currently has no estate tax.

The exemption amounts as indexed for 2013 are as follows:

• The federal estate tax exemption and federal gift tax exemption are both $5.25 million each. However, the estate tax and gift tax are unified, which means that the estate tax exemption and the gift tax exemption are tied together. An individual can give away a total of $5.25 million of his or her estate either all during life, all at death or a combination of some during life and some at death. For example, an individual who gives away $1 million during his lifetime can give away only $4 million at death without incurring an estate tax. Any amount over $4 million that passes at death would be subject to the federal estate tax. Married couples can give away $10.5 million.

• The generation-skipping transfer tax exemption is now $5.25 million.

• The annual gift tax exclusion amount is now $14,000 per recipient ($28,000 for married couples). Any gifts to individuals at or below the annual exclusion amounts will not “count” towards the lifetime limit of $5.25 million per person or $10.5 million per couple.

People who put off estate planning in the past because of the uncertainty of the federal estate tax may now wish to put their affairs in order. Those that created revocable or irrevocable trusts that incorporate tax planning provisions – such as a family or marital trust for a surviving spouse, a lifetime trust for an adult child’s inheritance to avoid estate taxes at the child’s death, or a life insurance trust to pay estate taxes – may want to review whether those provisions or trusts are still necessary in light of the higher exemption amounts. While minimizing estate taxes may have been a major impetus for including such trusts or provisions for a spouse or child, there may have been other non-tax reasons to have them, too. Of most importance usually is the protection of the trust assets for a surviving spouse or child in the event the surviving spouse or child were to have creditor problems due to an accident or divorce, or protection of trust assets for the couple’s children if, after one of the couple passes away, the surviving spouse were to remarry and change the couple’s estate plan to divert some or all of the couple’s assets away from the children or a child or were to remarry someone who has insufficient assets to pay for nursing home care and thus consumes the deceased spouse’s assets to pay for that unrelated person’s care. Such a trust would also protect the couple’s assets if a child or surviving spouse had liability risk from a business or profession or had spendthrift tendencies.

Some Guidelines

Bearing in mind the above non-tax reasons for having a trust for a surviving spouse or an adult child, if those reasons do not exist, the following are some general guidelines to consider in deciding whether your estate plan should be reviewed.

• Joint Trusts. Simple joint trusts for married couples that are fully revocable by either spouse until the second spouse’s death should be fine as is. Some joint trusts have tax planning provisions in them. With the higher exemption amount, under one type of trust, all of the deceased spouse’s share will pass to the surviving spouse or his or her “survivor’s trust.” Under another type, all of the deceased spouse’s share will pass to a “family trust” or “marital trust” for the benefit of the surviving spouse. If the family or marital trust was included solely to avoid estate taxes, a couple may wish to amend their trust to be a simple joint trust or, like the first type of joint tax planning trust, have all of the deceased spouse’s share pass to the surviving spouse or his or her survivor’s trust.

• Separate Revocable Trusts. When the federal estate tax exemption amount was low, many married couples created separate revocable trusts that upon the first spouse’s death fund a “family trust” for the surviving spouse up to the state or federal estate tax exemption amount. If there are no other non-tax reasons to have a “family trust” for the surviving spouse, couples may wish to amend their trusts to provide that upon the first spouse’s death, all of the property passes to the surviving spouse outright, eliminating the expense of administering a trust for the surviving spouse during his or her lifetime, including preparing annual trust accountings and income tax returns. Some revocable trusts already have this type of dispositive plan and are sometimes referred to as “disclaimer planning trusts.” That type of planning allows the surviving spouse to receive the deceased spouse’s assets but disclaim them back to the family trust if tax planning is needed. Those types of trusts may remain as is.

• “State” Estate Tax Planning. Couples who own real estate in a state that imposes a “state” estate tax (such as Maine, Massachusetts, or Vermont) may need to review their plans to see if a “state” family or marital trust should be included to avoid or minimize a state estate tax at the first or second spouse’s death.

• Trust for An Adult Child’s Inheritance. To avoid subjecting the parents’ or grandparents’ estates to estate taxes again at a child’s death if the inheritance passes outright to the child under the parents’ or grandparents’ estate plan, many parents or grandparents include in their plan a trust to hold the adult child’s inheritance in trust for such child’s benefit during his or her lifetime. If saving estate taxes was the sole reason for such a trust, the higher estate tax exemption amount may eliminate the need to retain a child’s inheritance in trust.

Disclaimer: This article is intended for general informational purposes only and is not intended as legal, financial or tax advice. In accordance with IRS Circular 230, the information in this article is not intended or written to be used, and cannot be used, by any recipient for the avoidance of penalties under Federal tax laws.