Estate Planning: Now What? A Must Read For Everyone

How Do I Create An Estate Plan Combining All of These Assets?

How Do I Create An Integrated Estate Plan?

We now know what the federal estate tax laws will be this year and in the future.  Our federal government has stated that these estate tax rules are now permanent after a decade of uncertainty.  (A cynic may say that these federal tax laws are permanent until our federal government says they are not!). Anyway, here are some of the more important federal estate tax law changes made on December 31, 2012 along with some related estate planning strategies:

  • The federal estate and gift tax exemption is now permanently (there is that word again) $5,000,000, with annual inflation adjustments.  These inflation adjustments generate exemptions of $5,120,000 in 2012 and $5,250,000 in 2013.
    • A husband and a wife each have this exemption, so a family can transfer $10,500,000 free of federal estate taxes in 2013. These very generous tax exemptions will allow the opportunity to transfer large amounts of wealth during lifetime or at death free of federal taxes.
    • Planning Point:  Taxpayers who used their full $5,120,000 exemption in 2012 can now make more gifts of $130,000 in 2013.
    • Planning Point:  With inflation adjustments each year, taxpayers can continue to transfer more each year.
    • Important Shift in Focus To State Inheritance Taxes:  Understand that we are only talking about federal estate and gift taxes and that these large exemptions are only applicable at the federal level. With these large federal exemptions, for most people, estate tax planning now will focus more on minimizing state inheritance taxes. For example, Pennsylvania does not follow the federal exemption rules and taxes almost all assets owned by a decedent.  To learn more about Pennsylvania inheritance tax rules see Pennsylvania Inheritance Tax: The Basics.
  • Once assets are above the exemption threshold the estate tax rate is 40%.  This results in a very heavy tax bite and is a real concern for anyone above the threshold.  The following taxpayers may end up above the threshold:
    • A taxpayer or a surviving spouse with assets above the exemption threshold or
    • A family (husband and wife) that has accumulated wealth above the $10,500,000 threshold, or
    • A taxpayer that has made lifetime gifts that have exhausted or substantially depleted their exemption.  See the following Example 1.
  • The tax law changes have once again unified the exemption for lifetime gifts and transfers at death.  So, if you use your exemption during your lifetime it is not available when you die.
    • Example 1:  Generous John, gave away his shares of stock of his business corporation valued at $5,000,000 to his son in 2012.  He uses his $5,000,000 exemption to transfer such shares free of gift tax.
    • Example 1A: Generous John dies in 2013 with other assets of $1,250,000 that make up his taxable estate. In 2013, he has a remaining exemption of $250,000 (2013 exemption of $5,250,000 less the $5,000.000 of his exemption used in 2012). Generous John has a taxable estate of $1,000,000 which results in a $400,000 in federal estate tax liability.
  • Portability is now permanent.  Portability allows for the exemption that was not used by the first spouse to die to be used by the surviving spouse.  In theory, this provision protects those who have failed to plan or for those who have made errors in estate planning.
    • Important Planning Point:  Portability should be looked at as a fallback position where there was no estate planning done.
      • Employing traditional estate planning techniques may prove more advantageous and in some cases is essential in crafting a well conceived estate plan. For example, in most situations the combined use of a unified credit and a marital deduction trust (or the use of a disclaimer trust mechanism) would result in better tax outcome than relying on portability.
      • In second marriages, it is often imperative to use  a certain form of marital deduction called a Qualified Terminable Interest Property (QTIP) trust, to provide for both the surviving spouse and children of a first marriage.
      • Where assets are expected to appreciate in value over time, use of a by-pass or unified credit trust would offer a better result than relying on portability.
    • There are some very important limitations and concerns with using portability, especially in second marriages or where the surviving spouse remarried.  These issues are more fully explored in my article entitled Estate Planning Mistakes: 5 Not So Easy Pieces.
    • Portability Does Not Save the GST Exemption:   The new tax act provides that the Generation-Skipping Transfer (GST) tax exemption also remains at the same level as the gift and estate tax exemption ($5,000,000, adjusted for inflation). The GST tax, which is in addition to the federal estate tax, is imposed on amounts transferred (by gift or at death) to grandchildren or others more than one generation below the decedent.  The important point here is that “portability” does not apply to the generation skipping transfer (GST) tax rules. Where grandchildren and future generations are part of an estate plan, portability will not save the unused GST tax exemption of the first spouse to die.  In such cases, using something called a “dynasty” or GST exempt trust is the better course of action.
      • Caveat:   In situations where there the estate size is large and there are many generations who are going to share the estate, failure to understand and use the more traditional dynasty trust could result in a very expensive and disastrous mistake.
  • Annual Donee Exclusion:  Although not part of the tax law changes, this traditional estate and gift tax planning tool allows for annual tax-free gifts of $14,000 in 2013 (up from $13,000 in 2012 as a result of the annual inflation adjustment).  As a result, taxpayers can now give up to $14,000 to as many people as they wish each year and not use up their unified credit or pay a gift tax.
    • Important Note:  Only gifts that qualify as “present interest” gifts are eligible for the annual donee exclusion.
    • Planning Point:  If you are married, your spouse can join you and, together, you can give up to $28,000 per person per year.
    • Planning Point:  This exclusion is in addition to the $5,250,000 estate tax exclusion and can be combined with such exclusion.  For more insight into how to combine these exclusions as well as the lack of marketability and minority interest discounts please read Gifting Shares of Stock In A Bad Economy.
  • Capital Gains and Basis Implications:  Lifetime Gifts versus Transfers At Death:  Although not an estate tax rule, under the new federal tax rules, capital gains on appreciated assets will now be taxed at a 20% rate for taxpayers with income above certain thresholds.  Capital gains below these thresholds will be taxed at the previous 15% rate.  These rules bear heavily in the estate tax planning context especially where recipients receive lifetime gifts versus gifts received at death.
    • Important Tax Basis Rule:  Taxpayers who receive appreciated property by a lifetime gift take a carryover basis, while beneficiaries who receive assets at the decedent’s death get a step up in basis to the date of death value of such assets received.
    • Tax Disaster for the Uninformed, Do It Yourself Estate Planners:  Many times elderly people transfer real estate to children during their lifetime in trying to avoid probate.  For a recipient of such lifetime gift, a disastrous income tax result awaits the uninformed taxpayer as illustrated by the following Example 2.
    • Example 2:  Sam Senior is very sick and wants to avoid probate.  He transfers by quit-claim deed his real estate to his son, Sad Son.  Sam Senior bought his house in the 1970s for $17,000 and made improvements over time of $23,000.  As a result his adjusted basis is $40,000.  The house is now worth $540,000.
      • Sam Senior transfers the house to Sad Son in 2012.  Sad Son takes a carryover basis for the house of $40,000. Sad Son sells the house for $540,000 shortly afterwards and has a capital gain of $500,000 which he surprisingly and sadly finds out will cost him $100,000 (20% x $500,000) in federal taxes alone.  His accountant tells him there will also be state income taxes on this gain. Since he is a Pennsylvania resident, he will pay an extra $15,350 in Pennsylvania income taxes.
      • Alternate Universe:  Sam Senior consults with his tax/estate attorney who drafts a will that transfers the house to son at death. Sad (who now legally changes his name to Happy), has a basis of $540,000 upon his receipt of the house from the estate.  Happy, now sells the house and has zero, yes, zero capital gain (Sale Price, $540,000 less basis of $540,000 = 0)!
        • Note, state inheritance taxes may be applicable in certain states.  For example, in Pennsylvania there would be a 4.5% inheritance tax on the real estate, but this is a lot smaller cost than the capital gains that results from taking a carryover in basis via a lifetime gift.

Final Thoughts and Recommendations:

Federal Estate Tax Implications: The federal estate tax law changes provide for some very generous federal estate tax breaks.  For those close to or above the federal estate tax threshold, the discussion above has explored some of the many planning opportunities to save federal estate taxes.  Such taxpayers should not rely on portability and should meet with an estates attorney to plan the proper course of action based on their particular family situation, needs and goals.

Shift In Focus To State Inheritance Tax Matters: Taxpayers below the federal estate tax thresholds also must continue to plan but the tax focus needs to shift to minimizing state inheritance taxes.

Create An Estate Plan That Fits Your Particular Family and Financial Situation:  It is most important to recognize that everyone has a unique situation with various assets, family members and ideas on how their family members are to be provided for and who should be in charge once they are gone.  As a result, all taxpayers still need to set up an estate plan for non-tax issues such as making sure their assets go to their loved ones in the way they wish.  They need to choose the proper people to administer their estates and any trusts they create.

Young Families:  In younger families, determining a proper guardian for their children and setting up trusts for the protection of their assets and a distribution scheme for such children is of paramount importance and has little to do with taxes.  An objective and unbiased assessment of how much life insurance is required is often needed.

Second Marriages:  Many with second marriages face unique challenges.  An estate plan needs to be developed and implemented to meet the diverse needs and goals of such blended families.

Special Needs Trust:  Those with disabled children or those receiving government benefits may need special needs trusts.

Do Not Try This On Your Own:  Get an Experienced Estate Attorney:  Having experienced estate counsel explore these issues and offer various strategies is at the heart of estate planning.  Coordinating probate and non-probate assets into an integrated estate plan is often overlooked and little understood.

Attention To Details and Documentation: Finally, make sure that you have an experienced estate attorney that can create an integrated estate plan.  Such attorney should have the skills to draft appropriate wills, trusts, durable powers of attorney, living wills and other related documents tailored to your specific family and financial needs.

Please feel free to post comments or ask questions.

Liking and sharing this blog with others in cyberspace is always welcomed and appreciated.

As always, do not hesitate to contact me if you want further insight or need my advice or legal assistance.

Copyright © 2013 – Steven J. Fromm & Associates, P.C., 1420 Walnut Street, Suite 300, Philadelphia, PA 19102. All rights reserved.

As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm’s full disclaimer.

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153 responses to “Estate Planning: Now What? A Must Read For Everyone

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  100. Thanks for your kind words. Hope this article was of value to you. Thanks for stopping by and hope you visit my blog again.

  101. Thanks for stopping by and I am glad this is helpful to my attorney friends across the pond.

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  103. So if we have combined worth of less than 5 million, we can trash our bypass/marital trust – right?

    • Probably but I would not make a decision via anything you read. I would have an estate/tax attorney give you specific advice based upon your particular situation and the factors explored above. In certain cases by-pass trusts still make sense, especially where there may be assets that will appreciate over time, or a spouse lacks the financial acumen. Also the specific needs of children are part of the equation as well as relatives with special needs. So before trashing any documents a review with your estates attorney is prudent if not essential.

  104. Thank you for the excellent update on the federal estate tax laws. I do estate planning but am not a tax attorney, so I appreciated the information you provided us.

    With 37 years of experience dealing with families, I find your comment below absolutely correct and one of the most important recommendations in your article:

    “Create An Estate Plan That Fits Your Particular Family and Financial Situation: It is most important to recognize that everyone has a unique situation with various assets, family members and ideas on how their family members are to be provided for and who should be in charge once they are gone. As a result, all taxpayers still need to set up an estate plan for non-tax issues such as making sure their assets go to their loved ones in the way they wish. They need to choose the proper people to administer their estates and any trusts they create.”

    My firm belief is that the bottom line of any estate plan is “TO MAKE YOUR BENEFICIARIES LIVES BETTER, NOT WORSE”.

    I have seen too many families split apart BECAUSE of inappropriate planning of how assets are to be allocated/divided. Yes, the children are better off financially, but when you see the family fight start because members have different ideas on how a particular shared asset or business should be handled, it’s very sad. I’ve seen sibling who got along very well before their parents died, end up never speaking to one another after because they can’t agree on how a jointly-owned asset/business is to be handled.

    One mechanism I try to encourage the parents to consider is to divide up assets so that they are not owned jointly.

    For example, I try to see if there are ways to give each child equal, but SEPARATE assets, or in some cases to liquidate all assets that cannot be distributed in kind, and just divide the net proceeds, so each can go their own way.

    Anyone else out there have any other mechanisms they use to avoid such tragic “family fights”?

    Thanks,
    Randy

    • Very nice points here Randy. Family fights are sometimes inevitable regardless of how well documents are drafted. But having documents that meet the client and family needs are the starting point. Sometimes communication while alive is helpful. Additionally, an “in terrorem” clause can be a deterrent for disputes. But nothing even a completely equal distribution of assets can stop argumentative and disruptive and mean spirited family members. Parents who have these type of children need to talk with their estate planning attorney to explore various options.

  105. Great article. What most clients don’t know is that life insurance can be used as part of the planning process to reduce or eliminate the surviving family’s estate tax. For pennies on the dollar, estates can be transferred efficiently and with proper use of trust and agreements, can actually be done while alive without losing “effective” control of those assets.

  106. Valuable information. Fortunate me I discovered your website unintentionally, and I am shocked why this twist of fate didn’t happened earlier! I bookmarked it.

  107. i’ve heard this before but i’ts interesting nonetheless.

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  109. Its like you read my thoughts! You appear to understand a lot of this, like you wrote the e book on this subject matter or something. This is a wonderful blog. An excellent read. I’ll definitely be back.

  110. Thanks, Steven! Great information in easy-to-read-and-understand format! I applaud your willingness to inform and educate all levels of the tax professional industry! Best regards. . .

  111. I simply couldn’t depart your website prior to suggesting that I extremely enjoyed the useful information you supply to your visitors! I am going to be back continuously in order to check up on new posts.

  112. Pingback: Estate Planning 2013: Now What? A Must Read For Everyone by STEVEN J. FROMM, ATTORNEY, LL.M. (TAXATION) | Lugen Family Office

  113. Thanks for sharing, Steve. Great article- I will definitely be passing this on. A well written, easy-to-read summary of the current state of things. Truly a must-read for lawyers and non-lawyers alike.

  114. Thank you. Well written and such an easy read.

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