The tax act signed into law by President Obama last week provided some very good estate planning provisions. Surprisingly, I have already read and heard complaints from other estate planning attorneys that this new tax act renders the 2012 year end gifting a “waste of time.” This is absurd; quit your whining! These are the same folks who complain that their clients would not make any significant gifts in spite the significant benefits that go with it, tax and otherwise. The one good thing about the “fiscal cliff threat” is that it convinced some to implement plans that should have been implemented already.

He also adds his top 10 estate tax and gift tax benefits of the new law:

1. Predictability: Taxpayers now have some reasonable estate tax expectations for the foreseeable future so they won’t be paralyzed by “what Congress might do in the future.”

2. Unified Gift and Estate Tax: Since the exemption amount for an estate is now permanent there was no need to split the gift tax exemption and the estate tax exemption like it was in the 2001 law. This structure is easier to understand and planning can be more straight-forward.

3. Generation-Skipping Transfer Tax: Having the same levels makes planning for multiple generations simpler (but still not without traps for the unwary).

4. Indexing: The exemption amounts are indexed for inflation, providing even longer term clarity in planning that is aligned with real economic effect.

5. Rate: The current maximum estate tax rate for estates with more than $5,250,000 in 2013 is 40%. Yes, I see this as beneficial. Perhaps it’s my age but is seems like it was only yesterday that the maximum estate tax rate was 55% (actually 60% for estate between approximately $10 and $20 million).

6. Portability: Portability permits a surviving spouse to use a deceased spouse’s unused exemption amount. Caution! To take advantage of this benefit, an estate tax return must be filed for the deceased spouse. This is a simple concept but tedious to complete. In other words, easier said than done.

7. Grantor Trusts: Plans can be designed that require the grantor to pay income tax on a trust that is not included in their estate upon death. In effect, each year that the Grantor pays taxes for the trust, the trust is growing tax-free for the beneficiaries. Over the long run this is an enormous benefit. Note: President Obama has proposed that this strategy be eliminated.

8. Perpetual Trusts: Many states like New Hampshire provide ways to create a trust that will last as long as the assets survive. In the days of olde, all trusts were required to terminate at a specific time in the future, most often measured by “lives in being.” If this notion intrigues you I encourage you to pick up a copy of Loring and Rounds, A Trustee’s Handbook (2013). No, I do not get paid for the product placement! Note: President Obama has proposed that perpetual trusts be eliminated.

9. Tax Leveraging Trusts: Without getting into a technical explanation, we can still use two year rolling GRATs (Grantor Retained Annuity Trusts – call us if you would like to learn about GRATs). In the right situation these are very powerful wealth transfer tools. Note: President Obama has proposed that a minimum term for GRATs be 10 years which eliminates much of the benefit from them.

10. Predictability: Not because I have run out of things to say but because it’s worth stating twice. OK, if you want something new: we still have the step-up in basis – that’s a huge benefit from a capital gain tax standpoint and from an administrative standpoint.

Overall, the new law is much better than the experts expected. It extends the estate tax and gift tax exclusions of 2012 and even indexes them for inflation. In 2013, you can gift $5,250,000 with no gift tax. In 2013, you can die with $5,250,000 with no estate tax. A married couple can double this amount. The tax rate for gifts or estates greater than $5,250,000 rose to 40% from 35%. But so long as your estate is less than $5,250,000, or $10,500,000 for a married couple, there won’t be a tax.

So what does this mean for you?

We will be telling our clients through our newsletter (you can sign up below) that the planning environment is very similar to what it was in 2012.

Consider gifting now.

Real Property. For most people, property values are still low from the long recession. Now is a great time to gift. By gifting now, you will remove assets from your estate at the low value. When the assets appreciate in value again, it will be outside your taxable estate. For example, gift a $1M property now and use only $1M of your gift exclusion. In 10 years, the property may be worth $2M, and it will be outside your taxable estate, and you only burned $1M of your gift exclusion.

Your Business. Gifting now is also a great strategy if you own a business. If you have a business that was hit by the recession, it might be a good time to gift all or some of the business while the value is low. Then the share gifted and all future appreciation will be outside your estate.

Investment Accounts. The same principle holds for investment accounts. If you believe the economy will rebound soon, your stock values may be lower now than in a few years from now. Why not consider gifting now at the low value?

How to Gift and Still Control and Use the Assets?

Ok, so you get the concept of gifting now at low values, but you can’t afford to gift because you need your assets. What can you do? Why not gift assets in a trust to your spouse? This type of gift trust is called a Spousal Lifetime Access Trust (SLAT) or a lifetime bypass or exemption trust.

If you set up a SLAT, your spouse can be the trustee and primary beneficiary. You would then gift assets to the trust for the benefit of your spouse. As trustee, your spouse would have control of the assets, i.e.  your spouse would be able to decide how to invest and when and how much to distribute out. If you have a solid marriage, you would have a say in those decisions and you would benefit from the distributions and growth of the trust assets.

Key Concept. If you have a solid marriage, you have amazing planning opportunities.

Key Concept 2. Jonathan Blatmachr, one of the top veteran estate planning attorneys in the country, likes to advise his clients to use tax deductions sooner rather than later because you never know when Congress will change the rules.

The 2013 American Taxpayer Relief Act has generous estate and gift exclusions. But will the generous exclusions last? We just don’t know. Historically, tax laws change. Favorable rates change to unfavorable rates and so it goes back and forth.

What we do know is that for many, asset values are lower than they will be in the future. Now may be the perfect time to remove assets from your estate to a trust for your spouse. You will continue to indirectly control and benefit from the assets while removing the assets and all future appreciation forever from your taxable estate.

For married couples, a popular strategy is for each spouse to create a trust that will ultimately provide for heirs, but that also names the other spouse as a beneficiary. The advantages are clear: Couples can move as much as $10.24 million out of their combined estate, while retaining rights to draw income if they need to. The one hurdle is that the Internal Revenue Service could void your careful planning if you and your spouse create trusts that are too similar. This poses particular problems for procrastinators, since creating the two trusts in rapid succession heightens the risk of raising IRS eyebrows. “The less time you have, the more conservative you need to be about making them very, very different,” says Diana Zeydel, national chair of the trusts and estates department of Greenberg Traurig in Miami.

 

Current estate planning rules are advantageous to protecting assets and transferring wealth with less tax. In fact, 2012 has been labeled the year of the gift tax, partly because you can gift up to $5,120,000 tax-free this year, and the estate tax exemption is also the same amount. Those exemptions will decrease to $1 million each next year, and this year’s estate tax rate of 35 percent could potentially rise to 55 percent, more in line with historical levels. So if you are in the position to do so, take advantage of the current rules.

 

The structure we are proposing is a lifetime bypass trust. The concept is the same as used with an A/B trust, or bypass trust.

When a bypass trust is created upon the death of a spouse, it is funded with the deceased spouse’s share of property up to the then death tax exclusion amount. The surviving spouse is usually the trustee and the primary beneficiary of the bypass trust.

The benefits of the bypass trust are:

1) Assets in it (and all future growth) will not be subject to the death tax at the deceased spouse’s death or at the surviving spouse’s death because the trust was funded using the deceased spouse’s death tax exclusion, and

2) Assets in it will be significantly protected from lawsuits and divorce claims against the surviving spouse.

The use of a bypass (A/B) trust is a tried and true estate planning strategy.

The Lifetime Bypass Trust is based on the same principal, except that we are creating and funding it now, to take advantage of the $5.12M gift exclusion available this year, rather than waiting until a spouse dies. One of my client’s calls it an “early bypass trust.”

Just like the at-death bypass trust, the lifetime bypass trust would name spouse as trustee and spouse and children as beneficiaries.

Just like the at-death bypass trust, the assets in the lifetime bypass trust would be exempt from estate tax when the grantor spouse dies, when the surviving spouse dies and, if generation skip exemption is used, even when their children die – two generations of no estate tax on the gifted asset and future appreciation.

Just like the at-death bypass trust , we can give the surviving spouse a limited power of appointment to change the remainder beneficiaries, limited to a certain class of people, like descendants. However, with the lifetime bypass trust, we could also include the grantor spouse as a permissible beneficiary. (Can’t do this with bypass trust created at death b/c the grantor spouse is dead.)

The grantor spouse, after the creation of the trust, can be named a remainder beneficiary if done correctly. This will not cause estate tax inclusion unless there is an implied understanding between grantor and trustee at the time the trust is created.

We recommend drafting the lifetime bypass trust to give an independent third party/trust advisor the authority to add and remove the grantor spouse as beneficiary.

The lifetime bypass trust uses the tried and true principles of a standard at-death bypass trust, but it uses the gift exemption now, while it is $5.12M, rather than at death, when the death tax exclusion is scheduled for a big drop (under current law $1M).

The downside to the lifetime bypass trust is the loss of step up in basis at death. But since the estate tax rate (35%-55%) has historically been a much higher rate than the capital gains tax rate (15%-20%) , most people would rather avoid the estate tax. In addition, the Democrats and the President have expressed their intent to do away with the step up in basis for inherited assets. So losing the step up in basis may happen anyway.

Finally, we may look back and realize 2012 was the best and easiest time in history to reduce or eliminate estate tax. If the estate and gift tax exclusions drop as scheduled on January 1, planning will get much more complicated and much more expensive.