MARGARET K. WINFIELD, Ward and Smith, P.A. for wraltechwire.com write: Introduction
The American Taxpayer Relief Act
of 2012 ("ATRA") effectively eliminated federal estate taxes for all but
the wealthiest Americans. Not so long ago, planning to minimize
federal estate taxes was a necessary consideration for many people.
However, consistent with the immutable law of unintended consequences,
your pre-ATRA tax planning may actually increase the taxes your estate
may have to pay, leaving less for your family.
Tax Planning Pre-ATRA
A
major goal of your estate tax planning is to reduce the tax burden on
your estate to the greatest extent possible, so that more of your wealth
goes to your family and other recipients you choose, rather than to
Uncle Sam. Historically, your optimal estate tax planning hinged first
and foremost on taking advantage of your available estate and gift tax
exemption, the statutorily-defined amount of assets that you can pass at
death, or give during your life, to others without incurring estate or
gift taxes.
Generally speaking, except for assets passing to
your spouse or charities chosen by you, your assets in excess of your
exemption amount are taxed at the highest applicable rates when you die.
As recently as five years ago, your available exemption was $2,000,000
and your top estate tax rate was 45%. Ten years ago, your exemption
was $1,000,000 and your top estate tax rate was 49%. At those levels of
exemption, you, like many successful people, faced the real possibility
that your estate would owe significant estate taxes.
Pre-ATRA,
many faced with the specter of estate taxes engaged in a common estate
planning technique called "credit shelter" planning (your exemption
amount is conceived of in the Internal Revenue Code as a "credit"
against your estate tax liability, hence the term "credit shelter"
planning). The principal purpose of such planning was to allow couples
to leverage both spouses' exemption amounts against estate tax, when the
predeceased spouse's exemption might otherwise be lost should that
spouse's estate pass directly to the surviving spouse.
In a typical
credit shelter plan, the estate of the first spouse to die was divided
into two shares, one equal to the exemption amount and the other being
the remaining balance. The exempt share was directed to a "credit
shelter trust" and the balance to a marital trust or outright to the
surviving spouse. Whether the plan involved one trust or two, the
surviving spouse was typically the primary beneficiary and so enjoyed
the trust assets during the surviving spouse's life. At the surviving
spouse's death, however, the assets of the credit shelter trust and the
surviving spouse's assets, to the extent of that spouse's own exemption,
passed estate tax free to the next generation. Only the amount of
assets in excess of the couple's combined exemption amounts was taxed.
However,
the tax advantages of credit shelter planning came with tradeoffs. For
example, such planning is complex, requiring retitling of assets
between spouses to insure each spouse has sufficient assets to take
advantage of his or her full exemption amount. Some assets, such as
retirement benefits, are inconvenient to administer in a trust. Also,
surviving spouses sometimes experience a sense of insecurity when their
assets are tied up in a trust, no matter how available those assets are
for their enjoyment. Finally, the full utilization of the deceased
spouse's exemption amount in the credit shelter trust deprives those
assets of a step-up in income tax basis for appreciated assets at the
surviving spouse's death, which has the effect of increasing the capital
gains tax liability when those assets are utilized by the next
generation.
Until recently, the estate tax avoidance or
reduction goal trumped these countervailing considerations under the
then-prevailing tax rules.
Optimal Tax Planning Post ATRA
ATRA,
which became law at the beginning of this year, brought the following
changes in tax laws relevant to optimal estate planning:
● Five
Million Dollar Exemption. The $5,000,000 exemption amount that had
applied in 2011 and 2012, an all-time historically high amount, became
permanent. Moreover, the $5,000,000 exemption amount will now be
indexed for inflation on an annual basis. These annual inflation
adjustments are significant. For example, with indexing for inflation,
the exemption amount for 2013 is $5,250,000 and for 2014, $5,340,000.
●
Portability. Portability, the ability (subject to limitations) of a
surviving spouse to make use of the unused estate tax exemption of the
first spouse to die, first introduced in 2010 and temporary under prior
law, became permanent.
● Estate Tax Rate. The estate tax rate increased from 35% to 40%.
●
Higher Marginal Income Tax Rates. The top income tax rate increased to
39.6%, starting at $400,000 of single-taxpayer income ($450,000 for a
joint return). Trusts and estates are taxed at this top rate starting
at just $11,950 in income.
● Higher Capital Gains and Dividend Tax Rates. The capital gains and dividend tax rates are now 20%, up from 15%.
●
Medicare Surtax. The Patient Protection and Affordable Care Act,
effective January 2013 (not part of ATRA), imposes a 3.8% Medicare tax
on the undistributed net investment income of your estate or trust
("Medicare Surtax").
With a $5,000,000 individual exemption
amount which, with portability, is effectively a $10,000,000 exemption
amount for couples, credit shelter planning is no longer necessary for
most individuals. Also, with the top income tax rate increasing to
39.6%, the capital gains rate increasing to 20%, and the addition of the
Medicare Surtax, income tax has become for many people the more
important tax to be addressed in their estate plans.
Post-ATRA,
credit shelter planning for most people is no longer necessary to take
advantage of a couple's combined exemption amount. Given the attendant
increases in capital gains tax exposure and trust income tax liability
at the highest rate starting at less than $12,000 in income, credit
shelter planning will no longer produce the best tax results in many
cases. Instead, the greatest tax efficiency in transferring your assets
to your family may be achieved by passing your and your spouse's assets
through the surviving spouse's estate, thereby securing a second
income-tax step-up in basis in those assets at the death of the second
spouse and avoiding the unfavorable marginal income tax rates for
trusts.
What to Do with a "Credit Shelter" Plan?
If
you have credit shelter planning in place, you should review your
estate plan to determine if it still serves your estate planning
objectives. You may find that, post-ATRA, you will achieve better tax
results by abandoning your credit shelter planning in favor of a simpler
and more flexible estate plan, with any necessary tax planning achieved
through post-mortem elections and disclaimers of assets.
Conclusion
Post-ATRA,
the customary tax planning of the past decade may be truly antithetical
to your tax avoidance goals. A professional tax and estate planning
advisor can help you understand the tax consequences of your existing
estate plan and what options there are for improving it if necessary.
At the end of the day, you may find yourself with a simpler, more
convenient, and more flexible estate plan that is also more
tax-efficient.
Wednesday, December 18, 2013
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