The 2010 ‘Tax Act’ signed into law by President Obama on December 17, 2010 included significant estate tax changes. The following summarizes some of the key provisions and provides several planning considerations.
The key provisions for calendar years 2011 and 2012 include:
- $5 Million Unified Estate and Gift Exclusion You can now transfer, during life or at death, $5 million to children and others tax-free. Transfers to a spouse or a charity remain tax-free.
- Exclusion Portability A spouse’s unused $5 million exclusion can be later used by a surviving spouse.
- 35% Tax Rate The maximum estate tax bracket is reduced to 35% on the value of taxable estates exceeding $5 million.
- $5 Million Generation Skipping Transfer (GST) Tax Exclusion Individuals can transfer $5 million free from GST tax, either in trust or directly to younger heirs. Like the estate and gift tax, the maximum tax bracket will be 35%.
Perhaps the most favorable provision relates to the new concept of “exclusion portability”. Portability is great – it should really simplify estate planning for many married couples.
Prior to portability, you had to do careful planning to fully use each spouse’s exclusion. The most popular way was to fund a bypass trust (also known as a credit shelter trust or A/B trust) with assets at the first spouse’s death. Once assets are in a bypass trust the surviving spouse typically has access to income, but access to the principal in the trust would be limited.
Bottom Line: The $5,000,000 exclusion and portability feature increases the flexibility in planning for the disposition of your estate. Federal taxes may simply not be that big of a deal, allowing you to focus more on family distribution issues, and other practical considerations (though state estate taxes may still be an issue – Ohio still has a fairly burdensome estate tax).
What if you have a trust in place that was created before 2011 when the exclusion was less and portability didn’t exist? Now is a great time to review these documents, understand how your estate will be distributed under current law, and seek an attorney’s advice interpreting your current documents and any changes necessary to align the documents with your goals and objectives.
Consider the following simple example: A couple with $3 million of assets, and an old trust document that states the bypass trust should be funded with the “maximum applicable exclusion amount” in the year of death. When created, this likely meant that only $1 million would go to the bypass trust and $2 million would go to the surviving spouse. Now the entire $3 million would go to the bypass trust and your spouse would have perhaps no assets in his/her name and maybe limited access to principal in the trust. Most likely not what was intended.
While the portability clause may eliminate the need for a trust strictly to utilize each spouse’s lifetime exclusion, there are other compelling reasons to continue the use of a trust in your estate plan.
- Your Spouse Remarries: A trust would prevent your spouse from commingling assets with his or her new spouse and/or eliminating your children from future inheritance.
- Asset Protection: A trust can insulate assets from creditors of future beneficiaries. It can also stipulate various principal distribution dates to prevent a sudden windfall.
- Kids Divorce: A trust can segregate assets and prevent a child’s ex-spouse from benefiting from the assets in the event of divorce.
- Future Estate Minimization: Putting the funds in trust, rather than leaving them outright, ensures that neither the assets nor any future appreciation will be part of your spouse's estate. This is especially desirable if the surviving spouse’s assets are likely to increase above the exclusion amount.
- Generation Skipping Bequest: Portability does not apply to the $5 million exclusion from generation-skipping transfer tax; therefore, assets intended for future generations may require specially designed trusts.
It’s important to remember that like the previous estate tax law, these laws are temporary. Absent future legislation, the exclusion will revert to $1 million with a top rate of 55% on January 1, 2013. Additionally, the portability option will cease.
Despite this uncertainty, we think now is a great time to review your estate plan. Please give us a call if you would like to discuss your personal situation.