Paradigm Shift in Estate Planning

The American Taxpayer Relief Act of 2012 (ATRA) ends a tectonic shift in estate planning that began many years ago with the 2001 Bush tax cuts.  ATRA now provides every taxpayer with a $5 million estate tax exemption, adjusted annually (since 2011) for increases in the cost of living, and a top estate tax rate of 40%.  Married taxpayers may claim the unused estate tax exemption of his or her deceased spouse (commonly referred to as “portability”), thereby allowing married couples to easily utilize $10+ million worth of estate tax exemptions.  For most taxpayers, the new estate tax regime allows for more simplicity in their estate plans and, as will be discussed below, puts a premium on drafting for post-mortem flexibility.

Prior to 1997, the estate tax exemption was $600,000 (which was not portable between spouses) and the top estate tax rate was 55%.  Every client we met with either had an estate that would be subject to the estate tax or could have an estate that size sometime in the future.  Thus, tax planning was incorporated into practically every estate plan.  A common approach for a married couple was to divide the estate of the first to die into two shares, one share equal to the amount of the estate tax exemption and the other share for the balance of the assets.  This division was done primarily for tax reasons.  The estate tax exemption share would be held in a credit shelter trust and the balance would be held in a marital trust.  The surviving spouse would be the primary beneficiary of both trusts.  This type of planning also necessitated that the couple’s assets be divided between them prior to death so that each owned sufficient assets to fully utilize his or her estate tax exemption.  For most couples, this type of planning is no longer necessary, and, in fact, may not produce the best tax results.

With the top income tax rate increasing to 39.6%, the capital gains tax rate increasing to 20% and the addition of the 3.8% healthcare surtax, income tax planning has become a more prevalent concern.  For many years, it was generally acknowledged that estate tax savings would be more beneficial than income tax savings given the tax rates then in effect.  Today, this determination cannot be made so easily.  It is now necessary to reassess whether utilizing a credit shelter trust, which shelters assets from estate tax at the death of the surviving spouse but precludes a step-up in the income tax basis of those assets at that time, is more or less beneficial than passing such assets in a manner that allows for a step-up in the income tax basis at the death of the surviving spouse.  Because the considerations are not easily determinable today, it is important to provide for flexibility in tax planning through post-mortem elections and disclaimers.  It can no longer be assumed that the creation and funding of a credit shelter trust will provide the best overall tax result.

For affluent estate planning clients, the landscape has not changed as dramatically, but they will need to place more emphasis on income tax planning given the current environment of increasing income taxes.  Of particular importance will be income shifting opportunities through the use of trusts, family limited partnerships and family limited liability companies.

With respect to transfer tax planning, many affluent clients have used their entire transfer tax exemptions.  The new laws provide them with an important estate planning opportunity.  Like the gift tax annual exclusion amount (which increased to $14,000 per person in 2013), the estate, gift and generation-skipping transfer exemptions also will increase as the cost of living rises.  The $5 Million transfer tax exemptions of 2011 increased by $120,000 in 2012 and by $130,000 in 2013 and are almost certain to significantly increase in the years ahead.  Thus, for our clients who have used all of their transfer tax exemptions, they may make additional gifts this year and in future years when exemptions are increased for inflation without incurring gift tax.

Many clients may currently be considering more advanced estate planning techniques, such as grantor retained annuity trusts (GRATs), family limited partnerships and installment sales to grantor trusts.  For those currently considering advanced tax planning, we note that many of these beneficial techniques may be impaired by forthcoming legislation.  For years the government has wanted to eliminate valuation discounts on intra-family transfers of interests in closely-held entities.  Recently, there have been rumors circulating that legislation which would eliminate such discounts has been drafted and will likely be incorporated into a bill in the near future.  Also, the benefits of GRATs, grantor trusts and a number of other beneficial planning initiatives have been targeted by the government.  Although these changes would not generate a material amount of revenue for the government, we would not be surprised if legislation limiting these beneficial planning techniques became law in the near future.

In the event you have not had your estate plan reviewed recently (perhaps due to the uncertainty in the law that has existed for many years) now is a good time to do so.  The current laws provide for more certainty and there are new considerations that may warrant a change in your plan.  For those clients who have been considering advanced planning techniques, we encourage you to address that planning soon as many opportunities that currently exist may be eliminated or curtailed by future changes in the law.

About the Author:  Matt Ahearn is Board Certified in both Wills, Trusts & Estates and Tax Law by The Florida Bar Board of Legal Specialization. He has extensive experience in the areas of estate and business succession planning, asset protection planning, charitable planning and planning to minimize or avoid wealth transfer taxes. Mr. Ahearn handles all aspects of probate and trust administrations, including estate and gift tax audits before the Internal Revenue Service. He represents both beneficiaries and fiduciaries in contested matters. He may be reached at