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Winter 2013

Estate Planning and Administration Bulletin

 

Federal Estate and Gift Tax Rules are Now “Permanent”!

By William E. Hart, Esq.

Click here for a printable copy of the bulletin.

 

Introduction

As we all peered over the “fiscal cliff,” the American Taxpayer Relief Act of 2012 was passed by both houses of Congress and signed by President Obama in early 2013.

This act does, indeed, bring relief:  For the first time in 12 years there is no automatic sunset built into the federal estate tax, gift tax, and generation-skipping transfer tax law.  The law now makes “permanent” the very generous provisions of the December 2010 political compromise about these taxes, and the law’s structure is unchanged.  Definitions of a “taxable gift,” the gift tax exclusions, a decedent’s “gross estate” and estate and gift tax deductions are all unchanged.  This is a great relief for those of us trying to plan into the future.

Federal Estate and Gift Tax are Unified

The gift tax and estate tax share the same exemption, pegged at $5,000,000 in 2011 and adjusted for inflation.  Accordingly, the exemption is $5,250,000 for 2013 gifts and estates.  This unification means that the gift tax exemption used to offset “taxable gifts” made during life reduces the taxpayer’s estate tax exemption dollar-for-dollar.  Unification also means that the estate tax and gift tax have the same effective rate:  Amounts in excess of the exemption are taxed at a flat 40%.

 

 

Portability of the Estate Tax Exemption to a Surviving Spouse is Here to Stay

“Portability” is now a permanent feature of the federal estate and gift tax.  If a decedent’s federal estate tax return is completed and filed, all of the unused exemption is transferred to the surviving spouse.  Thus, a surviving spouse can use the dollar amount of the deceased spouse’s unused exemption in addition to his or her own exemption, the latter increasing with inflation adjustments, to offset taxable gifts made during life and his or her taxable estate at death.  For married couples portability may remove the need to set aside assets in trust at the first death in order not to waste the first decedent’s federal estate tax exemption.  This will allow many couples to simplify their estate plans.  More on this below.

 

 

Generation-Skipping Transfer Tax Exemption Runs in Parallel

The generation-skipping transfer tax (“GST”), set at the highest estate tax rate (now 40%), applies to gifts as they are paid out (from a trust or otherwise) to a beneficiary who is more than one generation younger than the donor or decedent unless the GST exemption is allocated to the gifts.  The law now sets the GST tax exemption at the same dollar figure as the estate and gift tax exemption:  $5,000,000 in 2011 dollars, which is $5,250,000 this year.  It is, however, a separate exemption not diminished by using the gift tax or estate tax exemption.

 

Basis Step-up at Death Maintained

As in the past, every asset included in a decedent’s gross estate for federal estate tax purposes will receive a step-up in basis to the value reported on the estate tax return.

 

 

Massachusetts Estate Tax is Still a Concern

 

For residents of Massachusetts and others who own real estate or tangible personal property located in Massachusetts, our state’s estate tax will remain an important planning consideration.  The Massachusetts estate tax (there is no Massachusetts gift tax) uses the same definitions of a decedent’s gross estate and deductions as federal law.  So, a decedent’s real estate, furniture and furnishings, bank accounts, securities, life insurance proceeds, retirement accounts, annuities, and small business ownerships will all be part of the gross estate for both federal and Massachusetts purposes.  Similarly, the decedent’s debts, cost of estate administration, gifts to charity and gifts to a surviving spouse will be deductions for both Massachusetts and federal purposes.

Two important differences, however, are that Massachusetts does not have “portability” or an estate tax exemption.  Rather it has an estate tax “threshold” of $1,000,000.  If the value of the decedent’s gross estate minus deductions plus lifetime “taxable gifts” (defined under federal gift tax law) exceeds $1,000,000, the whole of the taxable estate will be subject to Massachusetts estate tax.  If that value is $1,000,000 or less, there will be no Massachusetts estate tax.

For example, if a married couple own their assets jointly, name each other as beneficiaries of retirement plans and life insurance, and have simple wills passing probate assets to the surviving spouse (who is a U.S. citizen), there will be a marital deduction covering the whole estate at the first death and hence no Massachusetts estate tax.  The combined estates of both spouses will be owned by the survivor when he or she dies, and if the second estate crosses the $1,000,000 threshold there will be some Massachusetts estate tax.

Traditional estate plans using a “bypass” trust (in the form of a “family trust,” “credit-shelter trust” or “QTIP marital trust”) will still help:  Without incurring any tax at the first death, up to $1,000,000 can be set aside to bypass the second estate, thereby reducing the taxable estate of the second spouse to die by the value of the bypassing assets.

This may create a dilemma for many couples.  Because using a trust introduces complexity, extra income tax filings, and a need to scrupulously separate the trust’s assets from the surviving spouse’s assets, the question for many married couples will become, “Are the Massachusetts estate tax savings worth the complexity of using trusts to hold assets to bypass the second estate?”  Below is a chart that can help people think through this issue.  It assumes that there is no change in value between the first and second deaths and that the survivor dies a Massachusetts resident.

Married Couple’s Massachusetts Estate Tax Burden at Second Death

 

Total of both spouses’ taxable estates Estate tax with all assets passing tosurviving spouse Estate tax using bypass trust for            $1,000,000 at first death Bypass trust savings
$ 1,000,000 $             0 $          0 $          0
1,500,000 64,400 0 64,400
2,000,000 99,600 0 99,600
3,000,000 182,000 99,600 82,400
4,000,000 280,400 182,000 98,400
5,000,000 391,600 280,400 111,200
7,500,000 705,200 574,000 131,200
10,000,000 1,067,600 916,400 151,200

 

 

For those married couples with a burning desire to have a simple estate plan the chart shows the cost on doing so.  In addition, there are numerous other good reasons to continue to use trusts in estate planning, such as:  (1) to hold assets away from the claims of a beneficiary’s creditors or spendthrift tenancies; (2) to hold assets for beneficiaries who are too young to manage them, e.g., under 25 or 30; (3) to hold assets for a disabled beneficiary of any age, including those who desire to maintain eligibility for Medicaid, SSI, and other programs with an assets test for eligibility; (4) to allow appreciation on bypassing assets after the first spouse’s death to go untaxed by the Massachusetts and federal estate tax; (5) to ensure that assets of the first spouse to die will pass to his or her children when the surviving spouse has children from a prior or later marriage or other intended beneficiaries; (6) to take advantage of the generation-skipping transfer tax exemption of the first spouse to die; and (7) to establish a “qualified domestic trust” in order to get an estate tax marital deduction for gifts to a surviving spouse who is not a U.S. citizen.

Trust and Estate Income Tax Rates are Very High

The new legislation reestablished the top federal income tax bracket of 39.6%.  Although this bracket applies in 2013 only to taxable income in excess of $450,000 (adjusted for inflation after 2013) for married individuals filing jointly, it applies to the taxable income of trusts and estates in excess of $11,950 in 2013 (also adjusted for inflation).  In addition, there is a new 3.8% federal income tax on investment income as part of the health care law.  Accordingly, a trust or estate that accumulates income in 2013 may reach a top federal income tax rate of 43.4% on income in excess of $11,950.  This high rate of federal income taxation will motivate trustees and personal representatives of estates to distribute income to beneficiaries rather than to accumulate it, and it may cause some people to shy away from using trusts in their estate plans.

We will be happy to review your plan and discuss options with you.  You may contact any member of our Estate Planning and Administration Department.

Kathleen L. Bernardo kbernardo@bulkley.com 413-272-6295
William E. Hart whart@bulkley.com
Elizabeth H. Sillin esillin@bulkley.com 413-272-6296
Ronald P. Weiss rweiss@bulkley.com 413-272-6259

 

 

To comply with U.S. Treasury regulations, we inform you that any tax advice contained in this bulletin is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.