On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (The 2010 Tax Relief Act). This legislation extended several income tax provisions and made significant changes to gift, estate and generation skipping transfer taxes.
While many of the income tax provisions will impact financial service professionals, perhaps the biggest impact will be felt in the area of estate planning.
The legislation made several significant changes for 2011 and 2012, including the following:
–Replaced one year modified basis regime with a 35% maximum estate and gift tax rate.
–Reunified the gift and estate taxes, with an applicable exclusion of $5 million in 2011. This is indexed for inflation in 2012.
–Restored generation skipping transfer (GST) taxes at 35%, with a $5 million exemption.
–Provided portability of estate tax exemptions between spouses.
These changes have created an opportunity for financial professionals to provide counsel to clients based on their specific situations. There are a variety of reasons to review an estate plan. But tax law changes provide a prime opportunity to make sure your client’s basic life insurance affairs are in order by ensuring he/she has enough insurance to replace a lost income stream, for example.
Because The 2010 Tax Relief Act changes are only certain for 2011 and 2012, the planning techniques must include flexibility. A plan that does not consider potential changes for 2013 and beyond could expose the client to unexpected negative consequences.
Let’s look at an example: Jim and Betty Smith have an estate worth $20 million. They own a business which is rapidly growing in value, and would like to utilize their applicable gift tax exclusions to transfer some of the growth to their children, and grandchildren. If they each make a maximum gift (excluding any annual gift exclusion amounts), they can transfer $10 million dollars worth of stock in 2011 or 2012. Any appreciation in value of the transferred stock will be for the benefit of the children and grandchildren.
Assuming the government passes legislation to make the changes permanent, this technique accomplishes what they intend, and the client would plan for estate taxes of 35% on the projected estate. Frequently the liquidity for the estate tax is funded using life insurance, meaning the purchase of a life insurance policy with a face amount of at least $3.5 million.
In addition to the estate tax, look to make sure your client’s other objectives can be met. For example, if Jim and Betty have three children and only one works in the business, determine what distribution would be considered equitable for each child. Life insurance is frequently used to provide this liquidity to equalize the amounts paid to each beneficiary.