Changes to the Estate Tax Laws Create a Brief Window of
Opportunity to Reduce Tax Exposure, But Only for Clients
Who Will Commit to Review Their Estate Plan and Asset
Protection Posture.
We want to update you about certain estate planning and asset protection issues
that should cause you to review your asset protection posture and your estate plan
from both tax and non-tax perspectives.
2011 and 2012 may prove to be among the most advantageous years
in recent history for estate planning and asset protection clients
(and those of us who serve them). We believe that there are some
unique opportunities for estate planning strategies for
implementation in 2011 and 2012 to reduce exposure to taxation
that are unlike those in any year before or in the future.
We now know the laws for estate, gift and generation-skipping
transfer taxes during 2011 and 2012. On December 17, 2010,
President Obama signed the Tax Relief Act of 2010 (“TRA 2010”).
Along with income tax and unemployment insurance relief, TRA 2010 also
made major changes to the federal estate, gift and generation-skipping transfer
(“GST”) taxes. Significant uncertainty still remains, however, because the TRA
2010 sunsets on December 31, 2012.
Unless Congress acts before that date, the law will revert back to
its 2001 form.
It is important that you review your estate planning
documents at this time, and contact us to discuss how TRA 2010
affects your existing planning. Among other things, TRA 2010
provides a rare opportunity to take advantage of the new $5,000,000
gift tax exemption by making large lifetime gifts, before TRA 2010
sunsets at the end of 2012.
Estate Planning,
Pro-bate & Asset
Protec-June 2011
Tax Relief Act of 2010
The following is a summary of TRA 2010, which applies to persons dying in 2011 and 2012. The TRA sunsets on December 31, 2012. For 2013 and beyond, the tax regime that was in effect in 2001 is scheduled to return: $1,000,000 exemption for estate, gift and GST tax, and a maximum tax rate of 55%.
Estate Tax. Up to $10 Million Exempt
TRA 2010 provides that the federal estate tax is in effect for persons dying in 2010 (retroactively), 2011 and 2012. The estate tax rate is 35% (compare with a 45% rate in 2009, and a 55% rate that was previously scheduled for 2011, before enactment of TRA 2010). The estate tax exemption amount is $5,000,000 (up from $3,500,000 in 2009). For a married couple, the estate tax exemption amount can be up to $10,000,000 with proper tax planning.
TRA 2010 Allows Portability of Unused Exemptions
In an unprecedented development, TRA 2010 permits “portability” or carry-over of unused estate and gift tax exemption between spouses, beginning January 1, 2011.
For example, for a couple that has not made any taxable gifts during their lives: Husband dies in 2011 with a $2,000,000 estate, thereby using up only $2,000,000 of his $5,000,000 estate tax exemption. His executor may file an estate tax return and elect portability of the unused exemption amount of $3,000,000. Wife dies in 2012 with an estate worth $7,000,000. Wife has her own exemption amount of $5,000,000, plus husband’s unused exemption of $3,000,000, for a total of $8,000,000, which is $1,000,000 more than she needs to cover her entire estate. Wife’s estate passes estate-tax-free to her heirs.
Note that because TRA 2010 is only in effect through 2012, both spouses must die before the end of 2012 for portability to apply, unless Congress takes additional action to extend portability. In order to capture portability, an estate tax return must be filed for the estate of the first spouse to die. Further, portability does not apply to the GST tax exemption.
Basis Step-Up/Down
For persons dying in 2011 or 2012, the assets in the estate will receive what is called a step-up in basis (just as in prior years), which is generally advantageous for capital gains tax purposes. The heirs will receive the property with a tax basis of the property’s fair market value on the decedent’s date of death, which could be significantly higher (or in some cases lower) than the decedent’s basis in the property.
Midyear Tax Update & Planning Guide
ScottHulse
PCYear of Death
or Transfer Estate Tax GST Tax Gift Tax Inheritance Tax TX & NM
2011 and 2012 $5,000,000 exemption, 35% rate, unlimited basis step-up/down
$5,000,000 exemption,
35% rate $5,000,000 exemption, 35% rate, no basis step-up/down
No tax
2013 & beyond $1,000,000 exemption, 55% maximum rate, unlimited basis step-up/down
$1,000,000 exemption (indexed for inflation), 55% flat rate
$1,000,000 exemption, 55% maximum rate, no basis step-up/down
When an heir later sells the property, the heir will pay capital gains tax on the difference between the sale price and the heir’s basis in the property. This difference will likely be reduced because of the heir’s step-up in basis. However, because basis can also be stepped down at death for depreciated property, the effect of the step-up/step-down rule is uncertain, and the heir should consider the tax basis when determining whether or when to sell an inherited asset.
Gift Tax Exemption of $5 Million
Gift tax applies to gifts made during life. Beginning January 1, 2011, the gift tax exemption amount is $5,000,000. The gift tax rate is 35%.
GST Tax Exemption of $5 Million
Like the estate tax exemption, the GST exemption amount for 2011 and 2012 is $5,000,000. The GST tax rate for 2011 and 2012 is 35%. However, there is no portability of the GST exemption.
Beginning January 1, 2012, the exemption amounts for all three taxes—the estate, gift and GST taxes—will be indexed for inflation, in $10,000 increments. This makes little difference under TRA 2010, since it sunsets at the end of 2012 anyway; but perhaps this is an indication that Congress contemplates extending TRA 2010into future years.
Sunset of TRA 2010 and EGTRAA
Under current law, both TRA 2010 and the Economic Growth and Tax Relief Act of 2001
(EGTRAA, or the “Bush Tax Cuts”) sunset on December 31, 2012. This puts us right back in the
same position of uncertainty as at the end of 2009, when EGTRAA was set to expire, and in fact did
expire, and Congress did not do anything about it until December 2010.
If TRA 2010 and EGTRAA do expire at the end of 2012 as scheduled, then for 2013 and beyond we will return to a $1,000,000 exemption for the estate, gift and GST taxes, with the GST tax exemption indexed for inflation. The maximum tax rate will be 55%, including a 5% surcharge on estates over $10,000,000. In addition, the Texas and New Mexico state inheritance taxes will return.
Gift Tax Planning With Exemption of $5 Million
TIME-SENSITIVE INFORMATION
In the long term, we still have great uncertainty regarding transfer tax planning. However, in the short term, the $5,000,000 gift tax exemption amount provides a window of opportunity to make large gifts in 2011 and 2012, free from gift tax. The estate and gift tax are unified, meaning lifetime gifts reduce the amount of the $5,000,000 estate tax exemption that is available at death. However, gifts can still be very beneficial for tax planning purposes, because any future appreciation of the gifted asset will be excluded from the donor’s taxable estate at death. Planning for gifts in 2011 and 2012 should be started as early as possible to ensure that full and careful consideration is given to all the tax and non-tax ramifications of the proposed gifts
Take Action. A “Wait and See” Approach Could Be Costly
REVIEW YOUR ESTATE PLAN NOW. This is a good time for you to ensure that the fiduciaries you
Midyear Tax Update & Planning Guide
have named (executors, personal representatives, trustees and agents) are still appropriate. You also should review the disposition of your estate to ensure it comports with your wishes. Consider how your family has changed since your last review. If you have minor children, consider whether you have appointed appropriate guardians if they are left orphans. Consider whether a trust might be appropriate for your surviving spouse or children (trusts are very important for minors). Regardless of whether you have an estate tax issue, trusts can provide significant protection for your loved ones from creditor claims (including divorcing spouses) and prevent loss of governmental benefits for disabled and incapacitated loved ones. Also consider whether a charitable bequest might be appropriate.
REVIEW YOUR BENEFICIARY DESIGNATIONS. Retirement accounts, annuities and life insurance are not controlled by your will or living trust. Rather, they are controlled by beneficiary designations. Make sure those designations are still appropriate.
REVIEW THE TITLE OF YOUR ASSETS. Many times, bank and securities accounts are held as joint tenants with rights of survivorship. Stock certificates and real estate also may be held in the same fashion. In New Mexico, real estate owned by a husband and wife almost always is held as “joint tenants,” which also means “with rights of survivorship.” Property also may be held as “pay on death” or “transfer on death.” Property held in any of these fashions bypasses your will or living trust. Except in rare circumstances, we recommend that you hold property as “tenants in common” if you have a will based plan, and as Trustees if you have a living trust based plan.
REVIEW FUNDING OF YOUR LIVING TRUST. If you have an estate plan based on a living trust, you should ensure that you have fully funded the trust. Review your bank accounts, CDs, securities accounts, and other financial assets to ensure you own them as Trustee of your trust. You also should review any stock certificates, small business interests and real estate holdings to ensure you own each as Trustee. Failure to transfer these assets should not defeat your plan if you have a will, but will require probate (one of the things we try to avoid with living trusts). Historically, we recommended that Texas residents not transfer their homesteads into the trust. The federal courts were taking the position that a homeowner who transferred the home to a living trust lost the homestead exemption from creditor claims. In September 2009, Texas law was changed to remove this concern. We now advise that Texas residents do transfer their homesteads to their revocable trusts.
REVIEW YOUR LIFETIME PLANNING DOCUMENTS. No estate plan is complete unless you have appointed agents to act on your behalf if you become incapacitated or are otherwise unable to act yourself. Texas residents should have at least three documents current within three years: (1) a Durable Power of Attorney (for financial decisions); (2) a Medical Power of Attorney (for medical and personal care decisions); and (3) a Directive to Physicians (for end of life decisions). New Mexico residents should have two: (1) a Durable Power of Attorney (for financial decisions); and (2) a Health Care Directive (a combined document for both medical and personal care decisions and for end of life decisions). Other documents we suggest include those that appoint guardians and/or conservators and give your health care providers permission to share information about your medical condition with loved ones. For parents of minor children, we also suggest a power of attorney appointing an agent to make medical decisions for the child if the parent cannot.
2011 ACTION PLAN
CHECKLIST
Review your estate plan now.Review your beneficiary designations.
Review the title of your assets.
Review funding of your living trust.
Review your lifetime planning documents Review your current financial status. Review your insurance coverage and liquidity. Consider your risk from lawsuits and creditors’ claims.
Review the status of business entity
documentation and practice. Review the succession plan for your business.
LET US REVIEW YOUR PLAN. CALL US WITH YOUR QUESTIONS.
Midyear Tax Update & Planning Guide
REVIEW YOUR CURRENT FINANCIAL STATUS. If you have not done so recently, you should create a current financial statement. The financial statement should include the face value of the death benefits of any life insurance you may own as that value will be included in your estate. Note that the assessed value of real estate for property tax purposes really is not helpful in the analysis. You should use your best estimate of its fair market value. The same holds true for any closely held businesses and other assets (like assessed value, book value typically is not very helpful). You also should account for any separate property you might have as compared to community property. Do not forget liabilities, as well.
REVIEW YOUR INSURANCE COVERAGE AND LIQUIDITY. Especially if you have a taxable estate, life insurance is an important planning tool. Life insurance can provide liquidity to pay expenses and taxes and avoid fire sales of property. Before you purchase new insurance, consider whether an irrevocable life insurance trust would be appropriate. You also should consider whether long term care insurance is appropriate. With the rising costs of both home health care and nursing home care, preparing to fund this type of care is extremely important. Failure to consider long term care insurance means that you have chosen to self insure by default.
CONSIDER YOUR RISK FROM LAW SUITS AND CREDITOR CLAIMS. Are you operating a business as a partnership or a sole proprietorship? Are you part of a joint venture? Are you the general partner of a limited partnership? Do you own rental property? Do you own raw land or recreational property? Are you a professional (especially the type whom lawyers love to sue)? Are you simply concerned about protecting your assets? All of these issues, and more, should cause you to review whether your assets are exempt or otherwise insulated from creditor claims. The first line of defense is adequate liability insurance coverage. Accordingly, you should visit with your insurance agent for a coverage review. But you also should consider whether a business entity such as a limited liability company might be appropriate. Certain types of assets also are automatically exempt from creditor claims. Several strategies are available for reducing your risk. Keep in mind, however, that transferring assets in the face of a threatened or existing claim is considered to be fraudulent and will be reversed.
REVIEW THE STATUS OF BUSINESS ENTITY DOCUMENTATION AND PRACTICE. If you have established a legal entity such as a corporation, limited liability company, limited partnership or professional association, consider whether you are respecting the form of the legal entity. These legal entities insulate the owners from the creditors of the entity, but only if the owners treat the company as a separate entity from themselves. Owners who pay personal expenses from company bank accounts and otherwise abuse the form are at risk for personal liability.
REVIEW THE SUCCESSION PLAN FOR YOUR SMALL BUSINESS. The failure of business owners to consider what happens when the person or persons who started the business or key players leave the business because of death, disability or retirement is one of the major causes of business failure. Do you have a Buy-Sell Agreement in place? Do you have life insurance or other funding with which to fund the requirements of the Buy-Sell Agreement? What effect does the agreement have on your estate tax exposure? Have you addressed liquidity to pay potential taxes at the death of the owner? Have you addressed disability in the agreement? Have you considered how to pass ownership of the business to the next generation? Are all members of the next generation interested in the business, or only a few? How can you give the business to those who are interested, but adequately provide for those who are not? As you can see, there are many significant legal and practical issues to address.
AUTHORIZE US TO REVIEW YOUR ESTATE PLAN. With your authorization, we will review your extant planning documents for potential problems caused by the issues raised above and provide you with written recommendations. By providing us a current financial statement, you will greatly enhance our ability to offer the right advice.
IF YOUR ESTATE LIKELY WILL BE SUBJECT TO THE ESTATE TAX REGARDLESS OF WHAT CONGRESS DOES, VISIT WITH US. There are many strategies that may be appropriate for
Midyear Tax Update & Planning Guide
your unique situation that will reduce your exposure to the tax. The historically low fair market values of many types of assets together with low interest rates provide several opportunities to transfer wealth to lower generations at significantly reduced tax cost.
CALL US. If you have any questions or concerns about your plan or any other legal issues, please call us. We want to be of assistance.
A Window of Opportunity to Review Your Situation and the
Implications of Pending Changes to the Tax Laws
We hope you will view the current status of the law as an opportunity to review and reconsider your current situation. Let us know how we can help.
Sincerely,
The ScottHulse Estate Planning and Wealth Preservation Group:
This Information is Provided as a Courtesy – Not as Legal Advice.
We think it is most unfortunate that we are forced to make the following statement, but like you, we also are interested in protecting our assets for our families. Please know that we are writing you and raising the above issues as a courtesy and for informa-tional purposes only. We do not intend for this letter to be legal advice, and you may not consider it as such. This letter simply cannot replace a legal review of your particular circumstances, and you should not take any action simply on the basis of this letter. Further, we will take no action unless you have engaged us to do so. The firm has always limited its scope of representation of clients to spe-cific matters or tasks and this limitation includes estate planning and asset protection matters. Once we have completed a matter, the attorney-client relationship ceases. However, the nature of estate planning and asset protection requires regular review and adjustment, and you should never consider your planning to be complete once and for all. Therefore, it is your responsibility to initiate further action by engaging the firm to review your plan.
