On December 17, 2010, President Obama signed The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Act) into law. Included among its provisions are new estate and gift tax rates and limits. For 2011 and 2012, the maximum estate tax rate is 35% with a unified estate and gift exemption amount of $5 million.
Most planning documents are set up with formulas to comply with whatever estate or generation skipping transfer tax (GST) exemptions are in place at the time of one's death. These formula provisions can produce significantly different results in an environment where the exemption is $5 million, $3.5 million, or $1 million.
The new law provides for "portability" between spouses of any exemption amount that remains unused at the first spouse's death. This means that if John dies in 2011, having made taxable transfers during his lifetime or at death of $3 million, his wife, Jane, would receive his unused exemption amount of $2 million, providing her with a total exemption amount of $7 million.
The new law also includes gift tax provisions that were much more substantial than expected. For the first time in nearly 10 years, you can transfer gift tax-free, during your lifetime, the same amount that you can transfer estate tax-free at your death. This gives rise to a variety of significant opportunities to transfer wealth to your children and grandchildren while you're still alive.
Beginning in 2013, the estate and GST exemptions are scheduled to go back to the $1 million per taxpayer amount and a 55% maximum estate tax rate. Although we don't know for certain what will happen two years from now, we do know that the current climate affords a variety of planning opportunities. To help you plan, we’ve provided guidance regarding some key concerns.
Plante & Moran would be happy to assist you with your estate plan. We can provide feedback on your existing estate planning documents, assist you in developing a gifting plan, discuss wealth transfer techniques, offer guidance on insurance related matters*, and consult with you on any other personal financial planning matters. Feel free to contact us with any questions.
Questions and Answers
When was the last time you reviewed your estate planning documents?
It’s important to review how any formula clause in your will or trust impacts your spouse and other beneficiaries upon the first and second to die, especially if yours is a blended family. If your estate plan is set up to leave money to charity based on reducing your estate tax liability, review your documents to ensure they reflect your wishes in the current climate. In addition, pull out prenuptial and buy-sell agreements, and determine if they have any language that references the estate tax exemption.
Keep in mind that the 2010 Act is only applicable to the 2011 and 2012 tax years. Thus, you'll need to evaluate the cost of revising your estate plan against your particular facts and circumstances, including health concerns and family dynamics. At a bare minimum, your crisis plan should be intact, meaning that you should be comfortable with the provisions of your will and revocable living trust and have a health care patient advocate and a power of attorney in place.
Do you or your spouse have any serious health issues?
If so, your estate plan should be reviewed immediately to make sure that your crisis plan is intact, meaning that you should be comfortable with the provisions of your will and revocable living trust and have a health care patient advocate and a power of attorney in place. The key is making sure that your estate plan reflects your wishes if anything should happen to you. The 2010 Act includes tax provisions that may impact your estate plan. For example, tax-savings formulas are incorporated into the majority of trust documents. These formulas should be reviewed against your current balance sheet and perhaps even diagrammed so that you have an understanding of how your assets will transfer. Beneficiary designations should be reviewed on life insurance policies and your retirement plan. You should also make sure that your durable financial power of attorney and your health care power of attorney are up to date.
Does your trust document provide for your spouse and children if you become incapacitated?
Many people view their trust as post-death instructions for administering their estate, yet they haven’t looked at their estate plan to see how it would operate if they were incapacitated. Your trust document likely includes an incapacitation clause that indicates who the trust would provide for (and for what purposes) if you were disabled. If you haven’t done so already, you may want to consider explicitly providing for the health, education, maintenance, and support of your spouse and those dependent upon you.
Are your trustees or guardians still the right choice?
It’s important to review your guardian and trustee selections in your estate plan documents. Are you still comfortable with your selections? Have you clearly identified a successor trustee if your initial trustee is unable or unwilling to serve? You may also want to consider using a professional trustee like Plante Moran Trust to serve as a co-trustee if you’re concerned about family harmony or whether your children will have the time or the ability to effectively administer your trust or estate.
Is there a possibility that your children will have a taxable estate?
The answer to this question will likely depend upon what you believe the estate tax exemption will be when your children pass away and what you think their net worth might be at that time. Adding to the challenge is that, in the last few years, we’ve experienced a volatile planning environment.
For 2011 and 2012, the maximum estate tax rate is 35% with a unified estate and gift exemption amount of $5 million. Unless Congress acts, the estate and generation skipping transfer tax (GST) exemptions are scheduled to go back to the $1 million per taxpayer amount and a 55% maximum estate tax rate in 2013.
If you think any of your children will have a taxable estate, your estate plan should be reviewed to see what kind of GST planning is in place. For tax efficiency, you’ll want your estate plan to incorporate provisions that allow a portion of what you transfer to your children to avoid taxation in their estate.
Is charity a component of your estate plan?
There are various ways to transfer wealth outside of your estate to a charity that you want to support. You may be wondering about the pros and cons of creating a private family foundation vs. a donor-advised fund. If you want to establish a trust that makes payments to a charity for a certain period of time and then distributes the remaining asset to your children or grandchildren, charitable lead trusts are particularly effective in a low interest rate environment. A charitable remainder trust is another vehicle that can be useful, depending upon your philanthropic goals.
Is your trust either the primary or contingent beneficiary of your IRA?
Whenever there’s a change in the estate tax exemption amount, beneficiary designations should be reviewed. If you named your trust as the primary or contingent beneficiary of your IRA or 401(k) to optimize your estate tax savings, you may want help evaluating this in light of the increased estate tax exemption for 2011 and 2012.
Generally speaking, naming your trust as the beneficiary of your IRA or 401(k) can result in administrative complexity that may not be desired. Moreover, to avoid adverse income tax results that can occur when a trust receives these types of beneficiary-designated assets, your trust should be reviewed to ensure that it contains special provisions that qualify it as a “see-through” trust.
Changing your beneficiary designation is fairly straightforward. Typically, all it takes is filling out a change of beneficiary designation form with your plan provider.
Are your assets titled in a way that would make your estate as tax efficient as possible? How does portability factor into this?
While your estate tax exemption is portable, your generation skipping transfer tax (GST) exemption is not. Therefore, if you anticipate that any of your beneficiaries may have a taxable estate when they pass away, you’ll likely still want to make sure that you have enough assets titled in the name of your trust to fully fund your credit shelter trust when you pass away.
It’s also important to evaluate the income tax implications of titling your assets to fund the first to die’s credit shelter trust or, alternatively, relying upon portability to employ each spouse’s estate tax exemption. For example, funding a credit shelter trust on the first spouse's death allows any appreciation of trust assets to avoid estate taxation at the death of the surviving spouse. However, if portability were to become permanent, those with estates under the allowable exemption amount may opt to revise their estate plan so that a credit shelter trust is not automatically funded; instead, they may want all of their assets to flow to the surviving spouse, so those assets have the potential to receive an additional step-up in cost basis to fair market value when the surviving spouse passes away.
Are you currently making annual exclusion gifts? Have you made annual exclusion gifts yet this year?
Each person is allowed to gift an “annual exclusion” amount (the annual amount that can be transferred to a beneficiary free from gift tax). For 2011, this amount is $13,000 per beneficiary. These gifts are not taxable and do not use up any portion of the $5 million exemption available in 2011 and 2012. Annual exclusion giving is an easy, tax-free way to transfer wealth and future appreciation of that wealth out of the donor’s gross estate.
What are some ways that I could give to a minor to provide for their education?
Annual exclusion gifts can be made to fund 529 Plans for the benefit of a child or grandchild. Funds set aside in a 529 Plan grow on a tax-free basis and may be withdrawn on a tax-free basis for qualified educational expenses.
Tuition and other educational expenses paid directly to a college for the benefit of your child or grandchild are not limited to the annual exclusion amount. These gifts may be made in any dollar amount, tax-free.
Other modes of providing for a child’s or grandchild’s education are 2503(c) trusts, Crummey trusts, and health education exemption trusts. We’d love to discuss these more in depth with you.
Do you want to provide directly for your grandchildren?
There are several ways to accomplish this objective. Some options to consider are:
- You could give your grandchildren money directly.
- You could establish an educational savings account for them.
- You could fund a trust for a grandchild that allows the trustee to distribute income and principal to them for the purposes that you specify. Providing for a grandchild’s health, education, support, and allowing the trustee to distribute funds for special purposes such as buying a home or starting a business are common examples of desired distribution purposes. As far as the term of the trust is concerned, the money could be held in trust for a grandchild’s lifetime or distributed at ages that you specify in the trust.
- You could establish one “pot” trust for the benefit of several grandchildren for administrative ease. This trust may give the trustee the discretion to distribute funds to grandchildren for designated purposes while the grandchildren are under a certain age and then make equal distributions of the remaining assets to all grandchildren at a point in time designated by the trust document.
We can help you evaluate the pros and cons of all of these transfer techniques.
Do you have any family members with special needs?
We often think estate planning is about taxes, and sometimes that’s true. However, if you have a child or grandchild with special needs, you know that it’s much more than that. If you’re providing for a person with special needs, it’s very important that you have trusts designed for their situation. Trusts can also be designed to dovetail with government-funded programs.
Do you have any family property that you’d like to transfer?
The increase in the amount that individuals can transfer during their lifetime from $1 million to $5 million provides planning opportunities for those considering transferring a family home or a piece of property to their children. If you wanted to transfer family property to a child, but have only wanted to do so if you could transfer assets of equivalent value to your other children, the $5 million lifetime exemption provides you with increased flexibility.
For example, if you have two children and would like to transfer a home worth $1.5 million to one of them during your lifetime, you can now make an equalizing transfer of $1.5 million to your other child without paying gift tax. The gift is simply recorded on a form 709 gift tax return and deducted from your $5 million gift tax exemption amount. Once you make a gift, the gifted asset is no longer part of your taxable estate. Furthermore, any growth in the asset’s value will not be taxable to you. If you don’t have other assets that are of sufficient value to equalize distributions, life insurance remains as an option to accomplish this objective.
Have you ever wanted to transfer assets but not done so because of gift tax limitations?
There are limitations on the amount that can be gifted to your beneficiaries during your lifetime without paying gift tax. Each person is allowed to gift an “annual exclusion” amount (the annual amount that can be transferred to a beneficiary free from gift tax). For 2011, this amount is $13,000 per beneficiary. Beyond annual exclusion gifts, individuals can use their lifetime exemption amount for gifting which, up until the passage of the 2010 Act, was $1 million. The increase of the lifetime exemption amount from $1 million to $5 million provides opportunities to transfer wealth to your beneficiaries now, without paying gift tax. Ideal assets to transfer could include marketable securities, closely held business interests, or real estate investments.
Do you have an interest in a closely held business that you’d like to transfer through either gift or sale?
The combination of low interest rates, depressed values of some assets, and the increased lifetime exemption amount to $5 million per person makes this an ideal time to review your business transition strategy. Business transition is a process of gifting or selling your ownership to your beneficiaries in a strategic way over the course of time. Now is a great time to review that plan and continue to move it forward.
If you could gift potential future appreciation of an asset to save estate tax, would you want to?
Many people believe that in order to save estate taxes, they need to give away the entire asset to have executed effective planning. However, this isn’t necessarily the case. Some of the most successful planning techniques don’t involve shifting the actual assets to your beneficiaries but rather shifting the appreciation of the assets to your beneficiaries. These techniques allow you to retain your wealth at your existing level but allow your beneficiaries to share in the “upside,” thereby accomplishing what can be significant estate tax savings.
How can I employ interfamily loans for wealth transfer?
An intra-family loan, often from a parent to a child, is a simple, yet highly effective, wealth transfer technique. Loans can be made to family members at the applicable federal rate (AFR) with no gift tax cost and minimal income tax cost. If the child earns a return on the use of the loaned funds that exceeds the AFR, the child keeps the return or growth in excess of the AFR. Current AFRs continue to be extremely low. In light of the near record low AFRs, new intra-family loans or refinancing higher interest rate loans can be very powerful estate planning tools.
Do you own real estate in more than one state?
Not all estate planning issues are tax driven; probate or estate administration costs can be minimized with a little lifetime planning. Owning real estate in multiple states can significantly increase the cost to administer an estate. Real estate must be probated in the state in which the property is located, even if the deceased person is a resident of another state. This trap for the unwary often arises unexpectedly in the ordinary course of our lives. Vacation and second homes are prime examples of how we inadvertently fall into this trap. The process of probating the transfer of real estate in a state other than a deceased person’s state of primary residence is known as “ancillary administration” and is an unnecessary expense and complication that can be easily avoided.
Transferring ownership of real estate to a trust removes it from the probate process. If you desire to transfer ownership of a residence from one generation to the next in a tax-efficient manner, you may want to explore establishing a qualified personal residence trust to accomplish this goal. Likewise, transferring vacation homes or rental properties to LLCs can eliminate ancillary administration and can also provide vehicles for the tax-leveraged transfer of properties between generations.
Are you interested in making sure that your estate plan maximizes asset protection for your spouse, your children, and other beneficiaries?
Asset protection brings to mind elaborate legal structures set up in far off lands to thwart the potential threat of lawsuits. Asset protection comprises much more than this and should be considered in every estate plan. Oftentimes, it can be as simple as transferring ownership of assets from one person or spouse who’s in a high-liability profession or position to another person or spouse who has lower-liability exposure.
Trusts can be used to protect gifted or inherited assets from the claims of a beneficiary’s (usually a child’s or grandchild’s) creditors, including claims of spouses in divorce. This is one reason why you may consider opting to continue to use trusts in your estate plan, even if portability becomes permanent, and you don’t foresee having a taxable estate. Not only is a credit shelter trust still useful for your heirs’ creditor protection, but if your spouse remarries, a trust will help to avoid commingling of assets with an unknown effect on your children.
Family limited partnerships and family limited liability companies with well-drafted partnership or operating agreements are other vehicles that can be used for asset protection. These entities can make gifted or inherited assets far less attractive targets in lawsuits or divorces. Many states have recently adopted statutes that permit individuals to set up trusts for themselves that protect assets from the claims of creditors. Everyone can benefit from some level of asset protection planning.
Do you own any life insurance that should be reviewed?*
Many people buy life insurance and never look at it again. The new estate tax rules are a great reason to pull them out and take a look. It could be that you no longer have the same needs, especially if the insurance was purchased to provide for liquidity to fund estate taxes. You may also find with the major economic changes over the past 10 years the policy performance is significantly different than was originally projected.
Have you considered structuring your life insurance so that it’s not part of your taxable estate? *
Many people buy life insurance for estate liquidity. The last thing we want to see is insurance create more taxes. Life insurance is one of the easier assets to remove from your taxable estate, as the value during your lifetime is often much less than the death benefit. If you haven’t protected your life insurance from taxation in your estate, now is the time to correct this oversight. If you transfer an existing policy, you must survive three years to have it removed from your taxable estate.
*Insurance consulting and services offered through Plante Moran Insurance Agency, an affiliate of Plante & Moran