A single taxpayer and, for these purposes, a non-married couple will not have the benefit of two $5 million exclusions. Portability will provide no tax savings if there is no spouse who can make their unused exemption available. There is also no spouse to join in making gifts (“gift splitting”) to maximize the use of the annual gift exclusions. These are the amounts which you can give each year to any donee without gift tax consequences.
There is no marital deduction on the first death, so the opportunity to defer an estate tax that a married couple can choose, does not exist.
If the single or non-married taxpayer has a partner that he or she wishes to benefit, it has always been advisable to fund a trust for that partner to avoid having the assets of the first-to-die partner added to and growing in the estate of the surviving partner. Many non-married couples, looking at the large $5 million exclusion, might view the cost and formality of establishing a trust as not worthwhile. This could prove a significant mistake. Consider:
Single Taxpayers with Net Worth under $3 to $5 Million
- The trust will protect the assets from claims and mismanagement, including challenges by family and others who might have disapproved of the relationship and who view themselves as appropriate heirs.
- State estate tax could be an important factor. New York as an example, will tax all assets above $1 million.
- Growth in the assets after the death of the first partner are removed from the estate of the surviving partner.
- In 2013, if Congress doesn’t act, there will be a $1 million exclusion.
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. These are discussed next. Don’t let the tax tail wag the estate dog.
Single taxpayers in this approximate asset range may view themselves as safe from the estate tax. The issues are 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 assess the risk of a 2013 return of a lower exclusion and higher rate with significant worry. But this worry should be assessed in terms of a host of other factors.
For example, if the taxpayer is in her 80s with a nearly $5 million net worth, she might reasonably assume, based on her budget and financial projections, that her estate is unlikely to grow beyond the $5 million threshold. Perhaps she doesn’t view the probability of a $1 million exclusion in 2013 as very great. But, what about a $3.5 million exclusion, which is what most advisers anticipated for 2011? At a $3.5 million exclusion in two years she might not have much opportunity (considering her age) to mitigate the tax if she waits for clarification of the law.This taxpayer may be loath to incur the cost and complexity of using Grantor Retained Annuity Trusts (GRATs) explained in Chapter 6. And GRATs are no guarantee to reduce an estate. They are really designed to remove upside appreciation over a number of years. Not the right recipe.
What about this elderly taxpayer simply making a large gift? That would assuredly remove all appreciation (not just the appreciation above the 7520 rate as a GRAT would) from her estate. Gifting away perhaps even several million dollars of assets, after reconfirming she has more than adequate assets for any “what if” that may arise can be simple and inexpensive, especially if she opts for an outright gift rather than a trust. But a trust does not have to be extremely complex or costly, since there is no leveraging and perhaps no desire or need to structure the trust as a grantor trust (on which the taxpayer/grantor would pay the income tax on the income earned by the trust)—perhaps funding 529 plans for all grandchildren or great-grandchildren with the five years of frontloading would make sense. The 529 rules permit a donor to gift five years worth of annual gifts to a 529 plan in one year. Although if the taxpayer died within the following five years, some portion of those gifts might be added back to her estate, she will have removed all the earnings on those gifts from her estate from the date of gift to the date of death.
A younger taxpayer in this net worth range may view the estate tax as a distant worry, if that. However, a taxpayer who has not retired, and has an estate in this net worth range may well grow the estate to an amount in excess of the $5 million exclusion, and may exceed the value of whatever estate tax exclusion is enacted for 2013 and later years. What actions might be appropriate? Perhaps if the taxpayer is in good health, merely establishing a life insurance trust to cover possible future tax costs will suffice. The insurance might even be structured in a manner that minimizes premiums for the first two years and when the results of the 2013 law are known, the taxpayer can restructure the insurance payments or perhaps even cancel the policy, depending on the outcome. 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.
Single Taxpayers with Net Worth over $3 to $5 Million
At some range of wealth, it will become worthwhile in the taxpayer’s view to plan to reduce the estate tax. Taxpayers who are in a net worth range on the cusp of or over the $5 million threshold will likely incur an estate tax under the current generous TRA rules. If the rules enacted in 2013 are harsher, the tax cost will be even greater. This will call for some degree of planning, but the planning has to be tempered by the fact that, if in 2013 Congress extends the TRA estate tax generosity, no tax might be due. What types of techniques might warrant consideration? These will obviously depend on a myriad of factors such as age, spending, etc. Consider:
- Aggressive annual gift programs.
- Purchase of life insurance in an insurance trust.
- Inclusion of a charitable bequest in his or her will for some portion of the estate in excess of the estate tax exclusion available on death.
This mid-range net worth is difficult to plan for, in that there might be a meaningful likelihood of a very substantial tax, but an unwillingness to incur the costs and live with the complexity that a comprehensive plan might require. Creative planning options tailored to the particular client might be worthwhile. For example, if the client owns his or her home and the residential real estate market is depressed, it may be feasible to sell the home to intended heirs. This would not only freeze the value of the home at its current low rate and remove the recovery in value from the estate, but it would also require the taxpayer to rent his or her home back from the heirs. This rental payment could help reduce the estate. Further, any gain on the sale of the home, may be covered by the home sale exclusion. If the gain is greater than that amount, then perhaps a grantor trust could be considered but this might meet with resistance as too costly and complex with only a modest likelihood of paying tax.
Depending on age, anticipated growth in his or her estate, and other factors, GRATs to remove upside appreciation from the estate, a loan at the current low interest rates to freeze the value of growth in the estate to the interest rate required to be charged on the loan, etc. may be considered.
Single Taxpayers with Net Worth over $4 to $10 Million
At this net worth range, the single or non-married taxpayer will almost assuredly face an estate tax. If the taxpayer’s wealth is such that even marriage and the availability of portability won’t prevent tax, then aggressive planning should be pursued. This might entail the arsenal of planning acronyms, including: GRATs, sales to IDITs (grantor trusts), creative uses of life insurance, charitable planning, and the like. See Chapter 6 for some additional ideas. These clients should carefully evaluate several key concerns. 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 the subject of harsh legislative proposals that might eliminate them. GRATs were to be restricted to 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 while interest rates remain at historic lows. Waiting may jeopardize the valuable leverage that low interest rates provide.