What the Return of the Federal Estate Tax Will Mean To You

Unless Congress enacts new estate tax legislation before December 31, the federal estate tax – which under the Bush 2001 tax laws was repealed for 2010 – will return with a vengeance in 2011.   Beginning January 1, estates for deceased individuals will be taxed at a rate of 55% for assets in excess of $1 million that pass to anyone other than a spouse.  Assets that pass to a spouse – either outright or in a qualified “marital deduction trust” – will qualify for the same “unlimited marital deduction” that existed under prior law.

The impact of a $1 million estate tax exemption will be dramatic for many estates.  For example, assume a widow residing in New York dies on December 31, 2010 with a $5 million taxable estate.  Her estate would be subject to payment of New York state estate tax of $391,600, leaving $4,608,400 to go to the widow’s heirs.  If she were to die on January 1, 2011, however, the total federal and New York state estate tax obligation would jump to $2,045,000, leaving $2,955,000 for the heirs.   

If the $1 million estate tax exemption in fact returns in 2011, here are a few key planning ideas for consideration:

• For married couples, your wills and/or living trusts should include estate tax planning clauses that allocate the maximum exemption amount to a “credit shelter trust” after the first spouse’s death.  This relatively simple strategy will ensure that each spouse will be able to use their respective $1 million exemption – thereby sheltering a full $2 million from federal and New York state estate tax.  One caveat is that each spouse (or their respective living trust) must individually own assets that will be made available for funding into the credit shelter trust after the first spouse’s death. If assets are owned jointly between spouses, the tax planning clauses will be rendered useless, since the jointly owned assets will pass automatically to the surviving spouse.
• For larger estates, life insurance held in an “irrevocable life insurance trust” will, in most cases, pass to the heirs exempt from both estate taxes and income taxes.   Life insurance held in this type of trust is especially helpful if a majority of your assets are illiquid, such as real estate or business interests.
• Couples (both married and unmarried) can use “spousal gifting trusts” that allow for the transfer of assets to each other that will be exempt from estate taxation in either partner’s estate. 
• Consider making annual gifts up to the exemption amount (currently $13,000 per year) to children, grandchildren or other desired beneficiaries.  Note that neither qualified medical expenses nor educational expenses (e.g., college or private school tuition) are subject to the $13,000 annual cap.

 Rarely in our nation’s history have we faced such a dramatic change in our estate tax law.  Given the ever-changing landscape, you’re well advised to seek competent professional advice to update your estate plan to ensure that both your tax and non-tax planning objectives are satisfied.

Estate Tax Planning With Spousal Gifting Trusts

On January 1, 2011, estates in excess of $1 million will be subject to payment of federal estate tax.  With the federal exemption reverting to $1 million, far more Americans will be impacted by the estate tax.  For example, in 2008 the federal estate tax exemption was $2 million per person.  The estate of a New Yorker dying in 2008 with a total taxable estate of $2 million would only have paid a New York State estate tax in the amount of $99,600.  In contrast, a New York resident with a $2 million estate dying in 2011 will be subject to a combined federal and New York State estate tax of $435,000.

Given the huge sums at stake, planning to minimize estate taxes will take on greater importance. One powerful and relatively straightforward planning technique for couples with a moderate to high net worth is the Spousal Gifting Trust (“SGT”).

In very basic terms, the SGT works like this: each spouse establishes an irrevocable trust, with the wife typically serving as a Trustee of husband’s trust, and the husband typically serving as a Trustee of wife’s trust.  Depending upon the client objectives, a co-Trustee may be named as well. 

Once the SGT’s have been established, both spouses will make gifts to their respective trusts in an initial amount not to exceed $5,000 per year.  As the value of the trust grows over the years, the amount that can be gifted to the SGT annually can be increased.  Ultimately, the maximum amount that can be gifted to the SGT annually without utilizing any portion of the donor’s annual $1 million gift tax exemption is a sum equal to the annual gift exemption (currently $13,000 per year).  The beneficiary spouse will have a temporary right to withdrawal the gifted sum, typically for a period of thirty days.  If the gifted amount is not withdrawn from the SGT, it can remain in the trust and invested in whatever financial vehicles the Trustee chooses.  Once funded into the trust, the assets in the trust can be used for the beneficiary spouse’s needs at any time.

How does funding an SGT provide any estate tax benefits?  The magic here is that the amounts gifted by each spouse to their respective SGT’s will not be included in the taxable estate of either spouse!   The key is that in making the gifts to each SGT, the couple is intentionally not utilizing the “unlimited marital deduction” that would ordinarily apply to spousal gifts.  While using the unlimited marital deduction will ensure that a gift made by the donor spouse would not be taxable in his estate, the spouse receiving the gifted assets will ultimately have those assets included in her estate.  By instead gifting some of the couple’s assets to SGT’s, the assets in each spouse’s SGT will grow over time completely exempt from estate tax inclusion.

To demonstrate the cumulative power of an SGT, imagine that a husband and wife, each 45 years old, contribute $5,000 to their respective SGT’s each year for 30 years.  If the assets in each SGT were to grow annually at an average of 6%, the value of the assets in each SGT would be $395,291 – or a combined value of $790,582 – none of which would be subject to federal or New York estate tax.

A final point: despite its name, the SGT can be used by same-sex and unmarried couples to provide an estate tax-exempt repository of assets.

The WSJ Weighs-in On the Estate Tax Debate

The Wall Street Journal recently ran a special report on the future of the federal estate tax.  Among the articles are recommendations from various estate planning experts providing advice for how people should be planning given the uncertainty surrounding the estate tax. The most common suggestion is for those with larger estates to take advantage of the temporary "estate tax free" and low interest rate environment to shift wealth between generations this year.  Some common techniques would include selling assets to Intentionally Defective Grantor Trusts (IDGTs) or transferring assets via short-term Grantor Retained Annuity Trusts (GRATs).  Using short-term GRATs may be a limited opportunity, as Congress is considering limiting or eliminating this strategy.

A Historical Perspective of the Estate Tax

The conservative Heritage Foundation has posted this summary of the history of the estate tax in the United States.  A key point is that, assuming we do in fact revert to a $1 million per person federal estate tax exemption next January, the relative exemption in 2011 will be about one-tenth of the exemption amount as was in effect when the "modern" estate tax was first implemented in 1916 

Will Geroge Steinbrenner Get The Last Laugh Over the Tax Man?

It appears that George Steinbrenner has outsmarted everyone again. While many people thought his fleecing of CBS in 1973 when he purchased the Yankees for the paltry sum of $10,000,000 could not be topped, his sudden death yesterday may save his estate from paying millions of dollars in federal estate taxes. As is widely known, the federal estate tax has been repealed in 2010 only; had Steinbrenner died in January (absent the enactment of new legislation), then his estate, which is estimated to exceed $1 billion, would have been subject to a federal estate tax of 55% for all assets in excess of $1 million.

Estate planning experts quoted here speculate that Steinbrenner likely had engaged in various estate planning techniques that would have minimized the estate tax hit had he died in a year when the federal estate tax was in force. I too would be surprised if Steinbrenner hadn't put in place GRATs, sales to Intentionally Defective Grantor Trusts, Charitable Trusts and other planning tools to lessen the estate tax hit. But unless Congress retroactively reinstates an estate tax for 2010 (which appears less likely the further into 2010 we get), then any such advanced planning may prove to have been unnecessary in this instance.

Federal Estate Tax Legislation? Not So Fast!

Just last week it appeared that a deal had been reached in the Senate Finance Committee to submit new Estate Tax legislation for a Senate vote. The proposal would have brought back the $3.5 million per person exemption that was in effect in 2009, but indexed for inflation. The proposal would have also allowed for the "prepayment" of estate tax at a lower rate (the highest rate would be 45%).

But The Hill is reporting that the agreement between the parties has collapsed. Apparently Senate Democrats on the Committee are refusing to submit the proposal for a vote unless they know that they have a majority of party members in support -- which apparently is not the case.

Interesting, Senator Kyle is quoted as discussing Estate Tax "reform" rather than "repeal"; clearly, repeal is a dead issue unless the Republicans take bake the White House and both Houses of Congress, with a filibuster proof majority in the Senate. Recognizing that is unlikely, Republicans are willing to accept as large an exemption amount as they can get under the present political and economic realities.

So, the dance continues ...

Finally Some Movement on Federal Estate Tax Legislation?

Bloomberg Businessweek reported today that as part of the Senate Budget Panel's $3.7 trillion spending plan, it is proposed that the Federal Estate Tax be reinstated at the 2009 exemption amount of $3.5 million per person, with a top rate of 45%. One difference between this proposal and the estate tax rules contained in the existing EGTRRA law is that, if approved, the new Estate Tax exemption would be indexed for inflation.

I think this is a reasonable exemption amount that provides certainty and protection for the vast majority of Americans; I hope it passes quickly.

Federal Estate Tax Repeal -- It Really Happened!

From the moment in June 2001 that President Bush signed into law the legislation that provided for the repeal of the Federal estate tax in 2010, “experts” have been convinced that Congress would by now have acted to “fix” what is widely acknowledged to be preposterous tax policy. Not only does the repeal exist for this year only, but the Federal estate will return with a vengeance in 2011, as the exemption returns to its 2000 level of $1,000,000 per person. Compared with the 2009 exemption of $3,500,000, 2011 will see many more “middle class” estates subject to the imposition of federal estate tax.

But just because there’s no federal estate tax in 2010 doesn’t mean that Congress has necessarily done taxpayers a huge favor. That’s because 2010 also brings the elimination of the unlimited “step-up” in basis for inherited assets. In 2010, only the first 1.3 million assets ($4.3 million if there’s a surviving spouse) will be valued at their “date of death” value for capital gains purposes. All other assets will be passed to the heirs at a “carryover” tax basis, and will result in the imposition of a capital gains tax if appreciated assets are later sold by the heirs. Trying to determine the original tax basis of many assets – especially stocks that may have been owned by a decedent for many years – will be a record-keeping nightmare.

We’re already seeing the impact of this irrational tax policy. A recent article in the New York Post described how 87 year-old Fritz Lohman died at 11:00 a.m. on New Years’ Eve. Since Lohman died in 2009, his $10 million estate will be subject to a total estate tax in excess of $3,500,000. Had Lohman survived thirteen hours, his estate would have been subject to a New York estate tax of about $1,000,000.

Why this tax roller coaster? When estate tax repeal was passed in 2001, the Senate’s budget rules required that the legislation had to “sunset” in 2011. The Republicans were then able to claim that they had lived up to their 2000 election promise to repeal the estate tax, leaving it to future Congresses and Presidential administrations to come up with a more permanent resolution. The Republicans came close to passing a permanent repeal of the estate tax during the latter years of the Bush administration, but fell a few votes short. Now, with the nation fighting wars on multiple fronts, with the need to fund health care on the horizon, and with the country’s economy stagnant, it seems unlikely that Congress will be willing to forego the revenue that would be generated by the estate tax beginning next year. At best, we may see legislation enacted that will return the tax to the 2009 per person exemption of $3,500,000.

What’s the average person to do? Married couples with total assets (including the value of the death benefit of life insurance) in excess of $2 million need to review their wills or living trusts to ensure that the estate tax planning language takes into account the possibility of a death in a year without a Federal estate tax. The absence of such a “savings clause” might result in unforeseen consequences that might be contrary to your intent.