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10 Steps to Take Now in Light of Estate Tax Legislation
Updated through September 24, 2013

PDF ARTICLE WITH EXHIBITS

By Barry A. Nelson

© 2013 Law Offices of Nelson & Nelson, P.A.

 
STEP 1

Estate & Gift Tax Rates

See Exhibit A for historical rates and Exemptions.

For the year 2013, tax free annual exclusion gifts can be made of $14,000 per person plus additional amounts for health paid to medical care providers and for education paid directly to educational institutions.

Gift and estate taxes are unified such that a single graduated rate schedule and effective exemption amount apply to an individual’s cumulative taxable gifts and benefits. The tax rate reaches 40% at $1 million of taxable transfers. The unified credit is $2,045,800 for 2013 and exempts a total of $5,250,000 of taxable transfers from gift tax or estate tax. The exemption was set at $5 million for 2010 and 2011 and is indexed for inflation. Exhibit E reflects the potential exemption amount based upon projected annual inflation rates of 2.5% and 5% to highlight how significant the exemption indexing is. Married couples each benefit from exemptions so for 2013, $10.5 million can pass free of estate tax to beneficiaries of married couples.

A separate generation skipping transfer tax on transfers to a beneficiary more than one generation below the transferor. For 2013, the GST tax rate is 40% of transfers in excess of $5,250,000.

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STEP 2 Portability

Until 2010, if a husband or wife did not take advantage of their respective unified credit amounts, they were wasted. As a result, planning required the creation of trusts upon the death of the first spouse so that the unified credit amount of the first spouse to die could be allocated into a trust, typically referred to as a Bypass Trust or a Credit Shelter Trust.  These trusts allowed the surviving spouse access, but if properly drafted, assets in such trusts were not includible in the gross estate of the surviving spouse.  In order to be certain the first spouse to die had sufficient assets to take advantage of his/her unified credit amount, clients were advised they needed to divide assets so both husband and wife had sufficient assets in their own name to take advantage of his or her unified credit amount. Couples were then forced to make decisions on occasion to restructure assets previously held by husband and wife as tenants by the entirety, a title that protects the assets against the claims of only one spouse and avoids probate, and instead, re-title such assets by placing such assets in the husband’s sole name or the wife’s sole name or part in each of their sole names. While this restructuring had potential estate tax benefits, it created asset protection and probate pitfalls. As a result of portability, advisors should review their client’s planning to determine if it is safer to hold assets in an asset protected format that avoids probate (e.g. tenants by the entirety) rather than have their clients hold significant assets in a husband or wife’s sole name.

The analysis is not simple.  There are many factors and already much has been written.  See Jonathan G. Blattmachr, Austin W. Bramwell, & Diana S.C. Zeydel, Portability or No: The Death of the Credit-Shelter Trust, J. of Tax. (May 2013). Howard M. Zaritsky & Diana S.C. Zeydel, New Portability Temp. Regs. Ease Burden on Small Estates, Offer Planning for Large Ones, J. of Tax. (Oct. 2012). Jonathan G. Blattmachr, Mitchell M. Gans, Howard M. Zaritsky, & Diana S.C. Zeydel, Estate Planning After the 2010 Tax Relief Act: Big Changes, But Still No Certainty, J. of Tax. (Feb. 2011). Howard M. Esterces, Should Portability Make One “Fugeddabout’ Credit Shelter Trusts?, Practical Tax Strategies (Apr. 2011). For those with larger estates (e.g., over $10.5 million), planning with Credit Shelter/Bypass Trusts still provides tax benefits as the assets passing into such trusts upon the death of the first spouse will not be includible in the estate of the surviving spouse regardless of future appreciation.  However, for those whose aggregated estates are not likely to exceed $10.5 million plus an inflation factor, it is probably better to have the lifetime benefits of tenants by the entirety ownership for greater asset protection and to reduce potential income tax after both parents pass away by gaining a full step up in basis upon the death of the surviving spouse. The reason is that assets owned (outright but not in a Credit Shelter/Bypass Trust) by the surviving spouse upon death are stepped up to fair market value as of date of death.  As a result, if the surviving spouse has an estate of $10.5 million and benefits from portability, then if all assets are sold upon the death of the surviving spouse, no capital gain would be incurred.  Instead, if upon the death of the first spouse, assets of $2.5 million were devised to a Credit Shelter/Bypass Trust for the benefit of the surviving spouse and such assets appreciated by $3 million from the death of the first spouse to the death of the surviving spouse, then when the children inherit the Credit Shelter Trust assets, they will only have $2.5 million of income tax basis.  As a result, a capital gain of $3 million would be incurred upon the liquidation by the children of assets in the Credit Shelter/Bypass Trust upon the death of the surviving spouse in the example above.

Assuming a 20% capital gains rate, creation of a Credit Shelter/Bypass Trust could result in income taxes of $600,000, in the example above, that would not be incurred if the family relied on portability.  Wills should be updated to direct a personal representative to elect portability and an estate tax return needs to be filed upon the death of the first spouse even if the estate is less than $5.25 million, as adjusted.

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STEP 3 Planning for Same Sex Couples in Light of the Defense of Marriage Act (“DOMA”)

The federal estate tax and the Defense of Marriage Act (“DOMA”) collided in a Supreme Court Case, Edith Schlain Windsor v. U. S., 833 F.Supp.2d 394 (S.D.N.Y. 2012), aff’d. 699 F.3d 169 (2nd Cir. Oct. 18, 2012), aff’d. 570 U.S. __ (June 26, 2013).

DOMA was a federal law that required same sex spouses to be treated as unmarried for purposes of federal law, including but not limited to federal tax matters regardless of the recognition of same sex marriage under a number of state laws. The facts in Windsor were that a same sex couple, Windsor and Spyer, lived together in New York for 30 years when they registered as domestic partners in New York City and then married in Canada in 2007.  Spyer died in February 2009 and left her estate to Windsor. Because of DOMA, no estate tax marital deduction was allowed and estate taxes of about $363,000 were incurred.  Windsor paid the estate tax and brought suit in the Southern District of New York, saying DOMA violated the Equal Protection Clause of the Fifth Amendment.  The Federal District Court and the Federal Court of Appeals held in favor of Windsor. The case went to the Supreme Court where a majority of the court held that Section 3 of DOMA was unconstitutional. 

For the 13 states that recognize same sex marriage, Windsor results in the couple’s benefiting from federal benefits and exemptions in the same way as a married husband and wife would. 

The court in Windsor seemed to go out of its way to not rule on whether states will be required to give any recognition to same sex marriages, or to specify the federal law status of same sex marriages not recognized in the state of domicile. On August 29, 2013, the United States Department of the Treasury and IRS announced that all legal same sex marriages would be recognized for federal tax purposes.

Under Revenue Ruling 2013-17, for federal tax purposes, the terms “husband and wife,” “husband,” and “wife” include an individual married to a person of the same sex if they were lawfully married in a state whose laws authorize the marriage of two individuals of the same sex, and the term “marriage” includes such marriages of individuals of the same sex. As such, for federal tax purposes, the IRS now recognizes the validity of a same sex marriage that was valid in the state where it was entered into, regardless of the married couple’s place of domicile. However, Revenue Ruling 2013-17 also made it clear that for federal tax purposes, the terms “spouse,” “husband and wife,” “husband,” and “wife” do not include individuals (whether of the opposite sex or the same sex) who have entered into a registered domestic partnership, civil union, or other similar formal relationship recognized under state law that is not denominated as a marriage under the laws of that state, and the term “marriage” does not include such formal relationships.

Revenue Ruling 2013-17 and the Windsor decision have no consequence on application of Florida law issues such as tenants by the entirety or a spouse’s homestead rights. 

Same sex couples, or a same sex surviving spouse, should consider amending tax returns now or the filing of “protective claims” to avoid any lapse of statute of limitations to take advantage of gift and estate tax marital deductions and joint income tax returns.  Failing to file amended returns or claims for refund could result in a statute of limitations bar.  Same sex couples should also consider amending their Wills to take advantage of same planning typical couples benefit from.

See Exhibit B for an excellent article entitled “George Karibjanian & Federal Law for Same-Sex Married Couples after Windsor: Equality for All or Only for Some?” published in Steve Leimberg's Estate Planning Email Newsletter - Archive Message #2118 on July 23, 2013.

See Exhibit C for a copy of the August 29, 2013 U.S. Department of the Treasury and IRS joint press release announcing that all legal same sex marriages will be recognized for federal tax purposes, and Exhibit D for Revenue Ruling 2013-17 (same sex marriages recognized for federal income tax purposes).

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STEP 4 Review of Existing Estate Plans to Avoid Surprises of Excess Gifts as a Result of Increased Unified Credit

See Exhibit E for the projected unified credit amount increases.

When the unified credit was $1 million and increased to $3.5 million in 2009, some very wealthy couples decided they could afford to leave the unified credit amount to their children and/or grandchildren upon the death of the first spouse to die.  This planning typically was based upon the assumption that funds remaining after the gift to children/grandchildren would be sufficient for the surviving spouse.  However, in 2010 when the unified credit amount increased to $5 million indexed by inflation, the gift by a formula in an older Will of the maximum amount that can pass free of estate tax could result in the children/grandchildren receiving too much and the surviving spouse too little. Without review of Wills and Trusts while the spouses are living, adverse consequences to the surviving spouse and family relatives are likely. 

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STEP 5 Planning Opportunities That Could Be Gone Soon. Loopholes Closed

For years a number of tax savings techniques have been on a “Loophole List” which could result in legislation taking away these techniques.  It is possible some loopholes may be closed.  Typically, loopholes are closed prospectively.  Some of the techniques that could no longer be available are: (i) short term Grantor Retained Annuity Trusts (“GRATs”) (See Exhibit F); (ii) sales to Intentionally Defective Grantor Trusts; (iii) discounting gifts using limited liability companies (LLC)s, limited partnerships, and gifts of undivided fractional ownership; and (iv) use of Dynasty Trusts.

As a result of inflation, the unified credit increased from $5,120,000 in 2012 to $5,250,000 in 2013.  Thus, every client who previously used  his or her unified credit amount in full prior to 2013 still have the ability to initiate additional 2013 gifting of at least $130,000 before the loopholes are closed.  The benefits of making use of all or a portion of the $5.25 million unified credit amount by gift to shift appreciation are illustrated in Exhibit G.

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STEP 6 Make Use of Low Interest Rate

We have been benefitting for many years from low interest rates that allow parents to make low interest loans to their family members.  Interest rates have already begun to increase. See Exhibit H for the 7520 rates over prior years to reflect interest rate trends and why it is most likely a good time for intra family loans or installment sales. Consider simple planning with intra family loans, see Exhibit I. Note interest rates have increased about .7% on mid and long term rates from July 2013 until October 2013.

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STEP 7 Examine Existing Partnership Structures to Determine if Costs Still Warrant Tax Benefits

Many clients initiated partnerships, discounts, and other more complex planning when exemptions were significantly less than $5,250,000 ($10.5 million for couples). Some have done an excellent job administering their planning documents. Others have not respected the formalities. Now is the time to review. If the client is not likely to be subject to estate tax in light of existing exemptions and projected increases, then it may be time to consider how to unravel for simplicity, administrative savings, and possibly even future income tax savings.

   
STEP 8 Review Credit Shelter Trusts To See If Generous Discretionary Distributions Should Be Made To Spouse

As noted above, assets in a Credit Shelter Trust/Bypass Trust do not benefit from a step up in income tax basis. Therefore, when children inherit appreciated assets from such a trust upon death of a spouse, the beneficiaries will be subject to income taxes that possibly would have been avoided if the trust assets were includible in the surviving spouse’s estate since, in such event, income tax basis would be stepped up to date of death value. Accordingly, if the Trustee distributes assets to the surviving spouse under a broad power, and assuming such outright distributions to the surviving spouse will not result in increasing her estate to $5,250,000, such transfers would result in no additional estate tax and reduced income tax.  Many issues need evaluation such as whether the beneficiaries of the surviving spouse are the same in his/her Will as in the Credit Shelter/Bypass Trust, whether there are concerns about creditors, and whether the surviving spouse may be subject to end of life manipulation. If the facts are favorable, the tax benefit may be material. 

   
STEP 9 Modifying Estate Plans to Protect Gifts to Beneficiaries

See Exhibit J.

   
STEP 10 Use of Inter Vivos QTIP Trusts to Maximize Asset Protection for Families with Net Worth of $10.5 Million (+/-)

See Exhibit K.

   
EXHIBITS

PDF ARTICLE WITH EXHIBITS

EXHIBIT A.......................................... Estate, Gift and GST Tax Rates and Exemptions
EXHIBIT B.....Steve Leimberg's Estate Planning Email Newsletter - Archive Message #2118
EXHIBIT C........................................................ IRS Ruling IR-2013-72, Aug. 29, 2013
EXHIBIT D.................................................................................. Rev. Rul. 2013-17
EXHIBIT E............................................................. Projected Unified Credit Increases
EXHIBIT F................................................................................................... GRAT
EXHIBIT G........... Advantage of Lifetime Gift of Unified Credit to Shift Future Appreciation
EXHIBIT H..................................................................... 7520 Interest Rates & AFRs
EXHIBIT I..................................................................... Intra-Family Loans and AFRs
EXHIBIT J.......................Are Trust Funds Safe From Claims for Alimony or Child Support?
EXHIBIT K......New §736.0505(3) Assures Tax/Asset Protection of Inter Vivos QTIP Trusts

   
   

Barry A. Nelson is founder of the law offices of Nelson & Nelson, P.A. and The Victory School for Children with Autism, both in North Miami Beach. He is Florida Bar board certified in both taxation and wills, trusts, and estates. Mr. Nelson is a member of the American College of Trust and Estate Counsel and serves as chair of its Asset Protection Committee. He received his LL.M. and J.D., cum laude, from the University of Miami School of Law.

 

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