Insight on Estate Planning - February/March 2013: Fiscal cliff deal brings some certainty to estate planning

by Adler Pollock & Sheehan P.C.

Congress’s eleventh-hour deal to avert the “fiscal cliff” produced the American Taxpayer Relief Act of 2012 (ATRA). The act focuses on income taxes, but it also provides much-needed certainty for people engaged in estate planning.

After several years of uncertainty over whether estate tax rates and exemptions would revert to their pre-2001 tax law levels, ATRA offers a long-term fix. Among other things, the act makes the following estate tax provisions permanent: an inflation-adjusted $5 million exemption amount, portability of exemptions between spouses and a top tax rate of 40%.

In tax law, “permanent” is a relative term. There’s no guarantee Congress won’t make changes down the road. However, because the new estate tax laws have no expiration date or “sunset” provision, people can plan their estates with a greater level of comfort.

What’s changed?

The 2010 tax act had established a $5 million unified gift and estate tax exemption and a $5 million generation-skipping transfer (GST) tax exemption, both of which were adjusted for inflation ($5.12 million in 2012). It also had set a top tax rate of 35% for all three taxes.

These provisions were temporary, however. Absent ATRA, the gift and estate tax exemption amounts would have dropped to an unadjusted $1 million (the GST tax exemption would have been an adjusted $1 million) and the top tax rate would have increased to 55% (with an additional 5% surtax on estates between $10 million and just over $17 million).

ATRA preserves the $5 million indexed exemption amounts, with the 2013 amounts at $5.25 million, and bumps up the top rate to 40%. It also eliminates the surtax on larger estates.

Portability more valuable

The 2010 tax act also had made the gift and estate tax exemption “portable” in 2011 and 2012. This provision allowed an estate to file an election to permit the surviving spouse to use the deceased’s unused exemption amount.

It offered a simple alternative to more complicated estate planning vehicles, such as credit shelter trusts, for making the most of a couple’s combined exemptions. But its short time window limited its value. By making portability permanent, ATRA eliminates this disadvantage. So portability is now a viable alternative to credit shelter trusts for many couples.

Trusts continue to offer valuable benefits, however, including creditor protection, professional asset management, state tax benefits, and the ability to freeze asset values for gift and estate tax purposes. Also, portability isn’t available for the GST tax exemption, so trusts remain a more tax-efficient tool for transferring wealth to grandchildren.

Another potential disadvantage of portability is that it’s available only for the most recent spouse’s exemption. So, if a surviving spouse remarries, the deceased spouse’s exemption is no longer available.

More opportunities

ATRA makes permanent or extends several other estate planning benefits. The act preserves the ability of some estates of owners of closely held businesses to defer related estate taxes and pay them in installments. And it retains various GST tax protections, including deemed and retroactive allocation of GST tax exemptions and relief for late allocations.

The act also makes it easier to do “in-plan” Roth conversions of certain retirement accounts, including 401(k), 403(b) and 457(b) plan accounts, which can provide estate planning benefits. If your employer allows it, converting an account and paying any tax liability now allows you to create an income-tax-free source of wealth for your children or other beneficiaries. Previously, this option was available only to plan participants who were eligible for distributions — generally those who were over age 59½, had left the company or had become disabled.

Update your plan, if necessary

Consult your estate planning advisor to find out whether your plan needs to be updated to reflect ATRA’s changes and to be sure you’re taking full advantage of currently available gift, estate and GST tax benefits. And keep an eye on Congress: It’s possible that lawmakers will limit the benefits of certain estate planning techniques, such as grantor retained annuity trusts, later this year.

Sidebar: Charitable IRA rollover extended

The American Taxpayer Relief Act of 2012 extends a valuable tax incentive for charitable IRA donations through the end of 2013: the qualified charitable distribution, more commonly known as the “charitable IRA rollover.” It permits taxpayers age 70½ or older to annually make up to $100,000 in tax-free IRA distributions to qualified charities.

These distributions can be used to satisfy a taxpayer’s required minimum distribution for the year. And they provide a tax advantage for IRA owners who otherwise would be unable to deduct an equivalent charitable donation because, for example, they don’t itemize or they have already exceeded adjusted gross income (AGI) limitations on charitable deductions for the year.

If you’re considering a charitable IRA rollover, consult your estate planning advisor to be sure you meet the requirements. Among other things, the funds generally must be transferred directly from a traditional or Roth IRA to a public charity. In addition, the donation must be “otherwise deductible” (without regard to AGI limitations) and the distribution must be “otherwise taxable” (that is, it would be included in the owner’s taxable in

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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