Arden Dale for the Wall St Journal writes: New tax rules for 2013 are turning estate planning on its head. Instead of an emphasis on avoiding the estate tax, many plans now focus on trimming income taxes.
Top income-tax rates have risen to more than 43% for some people, while the federal estate tax affects fewer people because of a $5.25 million individual exemption for estates, up from $1 million in 2003.
For couples, that means an estate must be worth more than $10.5 million to face a federal tax, and that threshold rises a little every year.
Some trusts that used to be key in planning around the estate tax now are out of favor. Among them: qualified personal residence trusts, which are used to transfer ownership of a home to a family member, and credit shelter trusts, which hold an estate for a second spouse after the first has died.
"These trusts may no longer make sense for people if they are never going to have $5.25 million," says Leslie Thompson, an adviser at Spectrum Management Group in Indianapolis, which oversees about $450 million.
Dismantling Trusts
Still, Ms. Thompson doesn't believe people should rush to dismantle their trusts if they have more than $3.5 million in assets, as President Barack Obama has proposed shrinking the exemption back to that level. Many states also have lower thresholds for taxing estates, and the trusts can help protect assets from creditors.
Jay Messing, senior director of wealth planning at Wells Fargo Private Bank, sometimes recommends that wealthy parents make intrafamily loans to children who are in lower income brackets. The Internal Revenue Service sets the rates for these loans, and they are very low now. Any income the children receive from investing the money will be taxed at their lower rate.
The children "can take the full amount you've given them, and invest that in a diversified portfolio," says Mr. Messing, who is based in Summit, N.J.
In the past, he might have recommended that these parents give the money to the children, either directly or via a trust, to reduce the size of their estate and ensure they slipped under the estate-tax exemption.
With the exemption now so high, that wasn't necessary. They could keep ownership of their wealth, and simply lend it out for a time.
Mr. Messing says he emphasizes income-tax planning even for couples with a net worth that exceeds $10.5 million. With tax rates higher, it is important for anyone with substantial income, he says.
A New Role for Roth IRAs
Michael C. Foltz, a wealth manager at Balasa Dinverno Foltz in Itasca, Ill., which has about $2.1 billion under management, sees a bigger role for tax-deferred retirement accounts.
"Roth IRAs and 401(k)s will become more important in income-tax planning and estate plans overall," he says, noting that the new 3.8% investment tax to be imposed on high earners this year as part of the Affordable Care Act doesn't apply to distributions from these accounts.
In some ways, income-tax planning is less complex than estate planning through the use of vehicles like trusts. And it can be easier for advisers to convince clients of the benefits.
Jeff Feldman, a planner at Rochester Financial Services in Pittsford, N.Y., which manages some $125 million, notes that use of trusts can obligate clients to give up direct control of a chunk of their wealth.
"When you have to explain that, it's a hard sell," he says.
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