Cecil Smith, JD Apperson Crump PLC Member of WealthCounsel

Carol Gonnella, JD Gonnella Adamason, PC Member of WealthCounsel

The estate tax laws are in a state of flux, and no one is sure what Congress will do in the near future.  This article is about the laws today, and the importance of planning now rather than waiting until Congress may ... or may not ... act.  It addresses tax liability in a broad sense, and does not take into account the impact of state death taxes, if any, or the implementation of advanced estate planning strategies such as LLCs, QPRTs, BERTs, ILITs, GRATs, Charitable Gifts, etc, to not only creditor protect assets during life, but to reduce or eliminate the estate tax bite upon death.

The “Basic THREE” 

There are three ways to reduce (or even eliminate) federal estate taxes just by using Internal Revenue Code exclusions and/or exemptions that are available to everyone:

1. Unlimited Marital Deduction.  This is a tax deduction that allows assets to be given estate tax-free to a spouse, and deferring those estate taxes until the surviving spouse's death.
2. The Basic Exclusion Amount.   This is an amount that may pass to an individual (other than the spouse when the unlimited marital deduction is used) that is free from federal estate tax.  Generally with a married couple, upon the first death an exclusion trust, called a Family Trust, Credit Shelter Trust, or A-B Trust, is created to shelter the decedent's available federal estate tax exclusion.  The surviving spouse may use the funds in this trust, but they will not be subject to federal estate taxes upon the surviving spouse’s death.  This exclusion is often also called "the Federal Estate Tax Exemption".  
3. Portability.  This is a new provision in the Code that allows the surviving spouse in certain situations to use the deceased spouse's remaining basic exclusion amount.  This portability concept is fraught with potential dangers and is beyond the scope of this article. 

The Law Today 

The federal basic exclusion amount in 2011 is$5,000,000, scheduled to increase on January 1, 2012 to $5,120,000.  The tax rate of 35% will remain only for that year for assets over the exclusion amount. 

This $5,120,000 exclusion is scheduled to “sunset” (expire) on January 1, 2013.  At that time, the exclusion will be reduced to only $1,000,000 and the tax rate will be increased to 55% for assets over this $1,000,000 exclusion amount.

Even if a husband and wife properly plan (but fail to do the more sophisticated strategies mentioned in the first paragraph), they can only shelter $2,000,000 in assets before federal estate taxes are assessed if their deaths occur on or after January 1, 2013. 

Three Hypothetical Examples 

In all three of the examples below we will use the following assumptions:

• H is worth $3,000,000.
• W is worth $3,000,000.
• Both spouses have done basic estate planning and have used a marital deduction formula to create a Family Trust and a Marital Trust in order for both of them to be able to utilize the federal estate tax exclusion.
• H dies first.
• The value of their estates does not appreciate from the time of the first death to the time of the second death.

Hypothetical 1 

Both Deaths Occur in 2012

Husband dies in 2012 when the federal estate tax exclusion is $5,120,000.  His $3,000,000 estate would be distributed pursuant to a formula in his will or trust as follows:

Family Trust                                                       Marital Trust
$3,000,000                                                                Zero
Not taxable at first death and
Not taxable at second death

No tax is due at H’s death.

Wife dies later in 2012 when the exclusion is still $5,120,000.  No tax is due at W’s death because the exclusion amount is sufficient to include the entire value of her estate.

Hypothetical 2

H dies in 2012, and W dies in 2013 or Thereafter

Husband dies in 2012 when the exclusion is $5,120,000.  His $3,000,000 would be distributed pursuant to a formula in his will or trust as follows:

Family Trust                                                     Marital Trust
$3,000,000                                                                Zero
Not taxable at first death and
Not taxable at second death

No tax is due at H’s death.

W later dies in 2013 when the exclusion is only $1,000,000 and the tax rate is 55% for assets over the exclusion amount.  The assets includable in her estate are worth $3,000,000. 

After deducting W’s $1,000,000 basic exclusion amount, $2,000,000 will be taxable at 55%.  Thus, her estate tax will be approximately $1,100,000.

Hypothetical 3 

H & W Both Die in 2013 or Thereafter

Husband dies in 2013 when the exclusion is only $1,000,000.  His $3,000,000 estate would be distributed pursuant to a formula in his will or trust as follows:

Family Trust                                                                        Marital Trust
$1,000,000 (The basic exclusion amount)              $2,000,000 (The excess amount)
Not taxable at first death and                                     Not taxable at first death, but
Not taxable at second death                                      Taxable at second death

No tax is due at H’s death because the exclusion amount is tax-free and the excess amount passes to the Marital Trust, which qualifies for the marital deduction and is also tax-free.

Wife later dies in 2013 when the exclusion is still only $1,000,000 and the tax rate is 55% for assets over the exclusion amount.  Assets includable in her estate are worth $5,000,000 ($2,000,000 in the Marital Trust and her assets of $3,000,000). 

After deducting W’s $1,000,000 basic exclusion amount, $4,000,000 will be taxable at 55%.  Thus, her estate tax will be approximately $2,200,000.

Hypothetical 1	Hypothetical 2	Hypothetical 3
Estate Taxes -- 0 --	Estate Taxes $1,100,000	Estate Taxes $2,200,000
It doesn’t pay to put off planning to see what Congress will do ... because no one knows what they will do.

Watch our recorded webcast on the Most Compelling Opportunities Now: Making Two Years Last a Lifetime.  With the enactment of new estate, gift tax and GST tax (but possibly temporary) laws, how should professionals and their clients think about estate planning over the next two years?  What might be lost if clients wait to act?  Who should act now?

What You Will Learn: The likely state of the transfer tax system in 2013 and beyond. The most compelling estate planning techniques based upon the current state of the capital markets. The two techniques that solve the biggest risk that exists for estate planning clients today. What might be lost if clients wait to act. The clients in your roster that should be acting now.