General Comments
The availability of the marital deduction should be understood in the new TRA context. It provides a different and more powerful benefit than the marital deduction under prior law because of inflation indexing. Under prior law, if assets were owned by, or bequeathed to, the surviving spouse, that spouse would have to address planning if the assets would grow in value beyond his or her estate tax exemption. The TRA inflation indexes the $5 million estate tax exclusion. Many, perhaps even most, older taxpayers in retirement are in a spend-down mode whereby their earnings post-retirement decline or are eliminated and they live off the earnings, and if needed, the principal, of their savings. Many retirees will invest in a manner that is more conservative than pre-retirees. They will often invest to protect their principal and generate cash flow (income). The growth of their savings is likely to be slower, if not negative. Thus, the inflation-adjusted estate exclusion may help minimize the estate tax faced by the surviving spouse.
Married taxpayers can use gift splitting, in case one spouse has substantial assets, but the other spouse does not have excess assets for making gifts. For a married couple, both can make gifts of $13,000/year (plus direct payments of qualified tuition and medical expenses for anyone they seek to benefit). If one spouse has substantially larger assets, that spouse can make the gifts and the less wealthy spouse can join in the gifts. Over time, an aggressive gift program can dampen estate growth and even be used to erode estate value, thus reducing the likelihood of future estate taxes.
Married Taxpayers with a Net Worth under $3 to $5 Million
Married taxpayers in this approximate asset range, may view themselves as safe from the estate tax, and, in fact, they might be. These taxpayers need to focus on all the many non-tax aspects of estate planning that were always considered and addressed by estate planning specialists:
- Asset protection. On a simple level, review property and casualty coverage. Assure that any business is operated with appropriate entity formalities. Having permanent insurance products held in irrevocable trusts. Use trusts in both wills to protect assets bequeathed to the surviving spouse, and other measures.
- Personal issues ranging from planning for known or anticipated health concerns or disabilities, integrating religious issues into estate planning, and so on.
- Planning for disability, including consideration of disability income replacement policies, savings.
- Succession planning for a family business.
- Charitable planning.
Their tax issues are about: to what extent their wealth will grow sufficiently, to subject them to the estate tax. Depending on age and whether or not their net worth is likely to grow, they may not even be concerned about the risk of a 2013 return of a lower exclusion and higher rate with significant worry.
Using wills and/or revocable trusts to mandate funding a bypass trust on the first death will obviate the need to worry about whether the executor of the first-to-die spouse’s estate will make the necessary election for that deceased spouse’s estate tax exclusion to be portable. This could be an important level of assurance. Funding a bypass trust will avoid the risk of no inflation protection on assets simply left to the surviving spouse. If there is a state estate tax, using the bypass trust may have state estate tax planning advantages. If the couple is engaging in prudent estate planning, they will bequeath assets to the surviving spouse in trust and not outright in any event. So the incremental cost in terms of dollars and planning complexity to fund a bypass trust and divide assets to permit this may be insignificant.
If the couple has life insurance, holding that insurance in an irrevocable life insurance trust is prudent financial, asset protection, and general estate planning. There is really no incremental cost in having that insurance trust and plan structured to avoid any possible estate tax.
In short, for a married couple of moderate wealth, planning similar to that historically recommended to such taxpayers continues to generally make sense. One difference might be that a couple with a $5 million net worth that might have purchased survivorship insurance when the estate tax exclusion was $2 million would not likely purchase survivorship insurance even at a higher wealth level. However, if there is an insurable need, or if life insurance is desired for a number of other factors besides funding the cost of a federal estate tax, then the insurance plan could be pursued accordingly.
Married Taxpayers with Net Worth over $5 to $10 Million
Married taxpayers in this approximate asset range, may view themselves as potentially safe from the estate tax, and in fact they might be. But there are serious risks that they will not be able to avoid estate tax:
- State estate taxes may be a factor. A $5 million estate could trigger $300,000+ in state estate taxes in a number of decoupled states. While that amount of tax may not motivate a client to undertake a complex note sale transaction, it will certainly motivate some tax planning steps.
- Inflation and growth in asset values may push the estate above the taxable threshold.
- 2013 may present a great risk since even a reduction in the estate tax exclusion to the $3.5 million level many experts expected for 2011 could trigger a substantial estate tax.
- A mere elimination of the inflation indexing of the estate tax exclusion may suffice to push this couple’s estate into a taxable situation, over time.
- If the executor of the first-to-die spouse’s estate fails to make the required election for portability to apply, the surviving spouse’s estate may lose that tremendous tax benefit.
- If assets are bequeathed outright to the surviving spouse and the increase in the value of those assets due to inflation outstrips the portable exclusion from that first spouse’s estate, a significant tax could be due.
The issues are to what extent their wealth will grow sufficiently to subject them to the estate tax especially if both exclusions are secured. However, at this wealth level, the risk of a 2013 return of a lower exclusion and higher rate should be treated with some concern. At this level of wealth, the calculus of the potential cost of a lower 2013 exclusion versus the cost of some planning may result in a different conclusion then for a lower wealth taxpayer. Taxpayers with this level of wealth may also view their advisers as crying “Wolf” with the 2013 warning, but they can afford to take protective action rather than risking the chance that their advisers warnings turn out to be correct.
Using wills and/or revocable trusts to mandate funding a bypass trust on the first death will obviate the need to worry about whether the executor of the first-to-die spouse’s estate will make the necessary election for that deceased spouse’s estate tax exclusion to be portable is worthwhile at this level of wealth. Funding a bypass trust will avoid the risk of no inflation protection on assets simply left to the surviving spouse. At this level of wealth, that risk is more significant than at lower levels. If there is a state estate tax using the bypass trust may have state estate tax planning advantages. If the couple is engaging in prudent estate planning generally, they will bequeath assets to the surviving spouse in trust and not outright in any event. So the incremental cost in terms of dollars and planning complexity to fund a bypass trust and divide assets to permit this may be insignificant.
If the couple has life insurance, holding that insurance in an irrevocable life insurance trust is prudent financial, asset protection, and general estate planning. There is really no incremental cost in having that insurance trust and plan structured to avoid any possible estate tax.
For a married couple of wealth, planning similar to that historically recommended to such taxpayers continues to generally make sense. A couple with a $5 - $10 million net worth might evaluate the purchase of survivorship insurance to address the possibility of an adverse estate tax change in 2013. This could be a simple method to address this risk. It may be feasible to structure the policy to minimize premiums in the initial two years. Then the trustees can reassess what to do when the law in 2013 becomes clear. Alternatively the plan may be structured to call for particularly large premiums in the first several years, which could be paid with gifts that would be covered by the $5 million gift exclusion that applies in 2001 and 2012.
Married Taxpayers with Net Worth over $8 to $12 Million
At this net worth range, the couple has a significant likelihood of an estate tax, even if in 2013 the TRA estate tax generosity is made permanent. These taxpayers have a level of wealth such that even the availability of portability won’t prevent tax, so aggressive planning should be pursued. This would entail an arsenal of planning acronyms, including: GRATs, sales to IDITs (grantor trusts), creative uses of life insurance, charitable planning, and the like. And just like before the TRA, having a bevy of acronyms in your estate planning arsenal will make for great chatter on the greens. See Chapter 6 for some additional comments.
Several key concerns should be carefully evaluated by these clients. The estate tax generosity of TRA ends in two years and 2013 could bring a much harsher result. Many of the key planning techniques have been subject of harsh legislative proposals that might eliminate them. GRATs were to be restricted to have a minimum of a ten-year term. Discounts were to be restricted and in many cases eliminated. So clients in this wealth range should plan aggressively while these planning techniques remain available. After 2012, they may not be. There is also a window of opportunity because interest rates remain at historic lows. Waiting may jeopardize the valuable leverage that low interest rates provide.
