Estate Tax Changes Require Immediate Attention

Few people are aware that as a result of “fiscal cliff” negotiations Congress also enacted permanent changes to the federal estate tax and gift tax laws.

Jason C. Walker

Many people likely recall Congress’ so-called “fiscal cliff” negotiations at the end of 2012, which resulted in a great deal of commotion regarding changes to the income tax. Most of us have encountered these changes to some degree, but fewer people are probably aware that as a result of the “fiscal cliff” negotiations Congress also enacted permanent changes to the federal estate and gift tax laws effective this year. Other than adjustments for inflation the new laws do not have any built-in changes, expiration dates, or reversions to prior laws.

As a result of these permanent changes, new planning opportunities are available. Many married couples that have previously established a revocable trust now have an opportunity to simplify their estate plan in a way that can alleviate a huge administrative burden upon the passing of the first spouse to die. Because this opportunity to simplify is forever foreclosed once the first spouse passes, immediate action should be taken before it is too late.

Some highlights from the new laws:

Unification of Estate and Gift Tax: Increases in the estate tax “exemption amount” started in 2004 and resulted in a disconnect between the estate tax and gift tax exemption amounts. For example, the estate tax exemption amount in 2009 was $3.5 million while the lifetime gift tax exemption was $1 million. The new law re-unifies the exemption amount and tax rate that apply to both lifetime gifts and the estate tax.

$5.25 Million Exemption: The exemption amount is actually a cumulative credit available on gift tax and estate tax returns that allows a person to transfer up to $5.25 million during life and at death without paying any estate or gift tax.
40% Tax Rate: Each dollar transferred in excess of the exemption amount is subject to the gift tax with the maximum tax rate being 40%.

Portability: The exemption amount is now “portable” between spouses, meaning that a surviving spouse gets to use a deceased spouse’s unused exemption amount.

This concept of portability leads to an opportunity to simplify estate planning for many people. Under the old estate tax laws the exemption amount was available only if utilized. Assets transferring directly from one spouse to another would not utilize the exemption therefore the deceased spouse’s exemption would have been lost. Many people implemented a special type of trust in their estate planning to prevent the loss of the first spouse’s exemption amount. These trusts are known as “credit shelter trusts,” “exemption trusts,” “bypass trusts,” or “A-B Trusts” and they necessitate the division of the trust into two separate trusts upon the death of the first spouse.

What Needs Immediate Attention and Why: In most cases an old A-B Trust can be replaced by a “disclaimer A-B” trust to simplify a married couple’s estate plan. This revised structure is advisable for the following reasons:

First, fewer couples are going to be impacted by the federal estate tax now that the combined exemption amount is $10.5 million; therefore the division of the trust does not provide any estate tax benefit.

Second, because of portability, the required division in the case of an A-B trust is an unnecessary complexity that can be eliminated using the disclaimer A-B trust.

Third, because the “bypass trust” is required to file an income tax return, the surviving spouse will have increased costs for preparation of income tax returns, and the possibility of an increased income tax burden. The income tax rules for trusts are somewhat peculiar and the highest tax rate is reached at only $11,950 of income. Residents of community property states that fund the “bypass trust” will find that the opportunity for a second step-up in cost basis at the death of the surviving spouse is lost and this can cause an increase in income tax burden for the beneficiaries of the trust.

About the Author

Jason C. Walker is an associate attorney at Jeffrey Burr, Ltd. He has a background in accounting and is licensed to practice in Nevada. Please contact the offices of Jeffrey Burr, Ltd. for a complimentary review of your estate plan and more information about the new estate tax laws at (702) 433-4455 or jeffreyburr.com.

Jeffrey Burr, Ltd., www.jeffreyburr.com