It’s an uncertain period for senior clients’ estate plans because some key tax provisions are scheduled to change at year end. For example, in 2012, the law allows estate-, gift- and generation-skipping transfer (GST) exemptions of $5.12 million. The maximum rate on taxable estates is 35% and a surviving spouse can use his or her predeceased spouse’s unused estate- or gift-tax exemption (i.e., the exemption is “portable”).
But those amounts could change significantly on Jan. 1, 2013. Here are several possible scenarios:
Congress does nothing and the current extensions end. If that happens, the estate tax exemption drops back to $1 million, the GST exemption falls to $1.39 million, exemption portability between spouses ends and the top tax rate reverts to 55%.
The current law is extended. That means this year’s exemptions and rates will continue to apply next year.
The administration’s proposal passes. This would return exemptions and rates to their 2009 levels, among other provisions. That would result in $3.5 million estate and GST exemptions, a $1 million gift-tax exemption and a top tax rate of 45%. Portability would be retained, but valuation discounts and severable taxpayer-friendly planning strategies, such as grantor retained annuity trusts (GRATs) and dynasty trusts, would face new restrictions that could significantly curtail their value.
The estate tax is repealed completely. That’s hard to imagine given the budget deficit and political gridlock.
Congress and the administration reach a compromise. In that case, it’s impossible to predict the outcome with any certainty.
So Senior Market Advisor and LifeHealthPro asked several estate-planning advisors for strategies that can help your clients preserve their estates in this uncertain tax environment.
Strategy: Update estate planning documents to account for the portability provisions.
The 2010 tax act provides for portability of the estate- and gift-tax exemptions between two spouses. (Note: the portability provisions do not apply to the generation skipping tax.) This provision allows a surviving spouse to take advantage of the unused portion of the deceased spouse’s exemption for the very first time in tax law history. As a result, a married couple can effectively pass on to their heirs $10.24 million, free of federal estate tax, in 2012. Careful drafting of documents should allow this. The provision is limited to those who die in 2011 and 2012, and it will expire after Dec. 31, 2012. Portability is not automatic — it’s elective. So make sure that this has been addressed for in your clients’ planning and your legal documents.
— Jonathan Gassman, CPA, CFP, CAP; director of tax & wealth management, Gassman & Golodny, New York
Strategy: Consider gifting in 2012.
Once the planning window closes on Jan. 1, 2013, certain planning opportunities and strategies — which could potentially result in millions of dollars in tax savings — are lost forever. For example, the 2012 federal gift-tax exclusion amount is $5.12 million per individual, or $10.24 million per married couple, with a maximum rate of 35% for gifts above these thresholds. In 2013, the federal gift-tax exclusion reverts back to $1 million per individual, with a maximum rate of 55% for gifts above this threshold. In an estate plan where gifting is a prudent strategy, there are significant advantages, and tax savings, to do so in 2012. There is the potential to save millions of dollars of estate tax. Consider planning strategies that leverage this gift-tax window of opportunity, including the use of irrevocable life insurance trusts (ILITS) and grantor retained annuity trusts (GRATS).
— Christopher A. Fraga, J.D., CFP, CLTC, CRPC; Fraga Wealth Management Group, Raynham, Mass., and Naples, Fla.
See also: 8 Estate Planning Mistakes to Avoid
Strategy: Consider doing a large Roth IRA conversion in 2012.
Doing a Roth conversion in 2012 will not only pay tax at the lower tax rates of 2012, but it will also reduce the size of an estate struggling with estate tax limits. Example: Assume one remaining parent and children are both at the top tax bracket. A $10 million estate split as $5 million in a traditional IRA and $5 million in a taxable account would be liable next year in 2013 (when the estate taxation limit drops to $1 million) to 55% beyond $1 million or $4.95 million in tax ($9 million times 0.55). That leaves the heir with $50,000 in cash and an IRA on which they are still liable for the entire tax at their 39.5% rate, where they will owe an additional $1.9 million in federal tax ($5 million times 0.395). Total after tax value would be just over $3 million.
Now assume that they do a Roth IRA conversion in 2012. They convert the entire $5 million traditional IRA to a Roth IRA. They owe tax at the lower tax rate of 35% (2012) and pay the $1.75 million tax ($5 million times 0.35) from the taxable account. This leaves them with a $5 million Roth account and $3.25 million in a taxable account for a total estate worth $8.25 million. Now the parents die in 2013. They owe 55% on the amount over $1 million, or $3.9 million ($7,250,000 times 0.55). This wipes out their taxable account, and an additional $737,500 from their Roth account, leaving them with a Roth account of $4.2 million.
The savings is twofold. First, the heirs will have $1.1 million more if the parent does the Roth conversion. Second, they will have the money in a Roth IRA, where it will never be subject to the increased tax rates, higher capital gains rates and lack of dividend qualification.
— David John Marotta, CFP, AIF; Marotta Wealth Management, Charlottesville, Va.
Strategy: Make gifts to generation-skipping trusts.
Generation-skipping trusts (GSTs) allow the person setting up the trust and making the gift to allocate his or her GST exemption ($5.12 million in 2012 but potentially dropping to $1.4 million in 2013) to keep the trust’s assets out of the transfer tax system forever. President Obama’s budget proposal has suggested limiting the time period for which GST allocations would be effective. This would make dynasty trusts impossible, but getting it done now will hopefully grandfather it.
— Martin M. Shenkman, PC; Paramus, N.J.
For more on the estate tax, see: