New Federal Tax Laws
Affecting Estate Planning
New Federal Tax Laws
Affecting Estate Planning
• Nothing, Nada, Zip!
Since January 1, 2011, the Federal Estate
Tax law provides for an estate tax rate of 35
percent with an exclusion amount of $5.12
million (the extra $120,000 is an inflation
adjustment for 2012).
The current law expires (“sunsets”) on December
31, 2012!
As of January 1, 2013, in the absence of further
action by Congress, the estate tax goes back to the
$1M exemption and a 55% tax bracket (if you
don’t think that will happen, then you have
already forgotten 2010!); in addition, the
Democrats have stated that lowering the
exemption to the 2009 levels of $3.5M and 45% is
a “top priority” for any new law.
In fact, President Obama’s proposed
2013 federal budget proposal is based
on a return to the $3.5M exemption
and a 45% tax rate.
When will we know?
It’s an election year!!
There is every likelihood that nothing
will be done until December IF then!
There is every likelihood that nothing
will be done until December IF then
AND, even if Congress acts, the odds
are good that it will be another shortterm “fix”!
WHAT DOES THIS ALL MEAN?
Every estate plan (RLT or Wills) for
a married couple with an estate
above $1M needs to have a
contingency plan.
THE ANSWER
THE ANSWER:
A “Disclaimer Trust” OR an “Intentionally
Defective Marital Deduction Trust”
The “Disclaimer Trust”:
The “Disclaimer Trust”:
Everything goes to the survivor but the
survivor can, within 9 months, disclaim
any or all of the deceased spouse’s
interest into an irrevocable trust (i.e., an
“exemption” or “by-pass” trust).
The “Disclaimer Trust”:
Not recommended for an estate over
$3.5M.
The “Disclaimer Trust”:
Better to use a “QTIP Trust” with “Clayton
Election”
The “QTIP Trust” with “Clayton Election”:
• 15 months to make election
• Permits survivor to have a LPOA
• Avoids issues with “Portability”
The “Disclaimer Trust”:
Do not use if there is an issue with
“control”
The “Intentionally Defective Marital
Deduction Trust”
What about an “A/B Trust”?
The “A/B Trust”:
The “A/B Trust”:
• “A” Trust is the survivor’s revocable trust
The “A/B Trust”:
• “A” Trust is the survivor’s revocable trust
• “B” Trust is the irrevocable trust
The “A/B Trust”:
• “A” Trust is the survivor’s revocable trust
• “B” Trust is the irrevocable trust
 Must be funded with decedent’s
estate up to the exemption amount
The “A/B Trust”:
• “A” Trust is the survivor’s revocable trust
• “B” Trust is the irrevocable trust
 Funded with decedent’s estate up to
the exemption amount
 Purpose is to keep “B” Trust out of the
survivor’s taxable estate
Problems with the “A/B Trust”:
Problems with the “A/B Trust”:
• “B” Trust is the irrevocable trust
 Funded with decedent’s estate up to
the exemption amount
Problems with the “A/B Trust”:
•“B” Trust is the irrevocable trust
 Funded with decedent’s estate up to
the exemption amount
If control is an issue and the
decedent’s estate exceeds the
exemption, the balance goes to the
survivor
Problems with the “A/B Trust”:
•“B” Trust is the irrevocable trust
 Purpose is to keep “B” Trust out of the
survivor’s taxable estate
Problems with the “A/B Trust”:
•“B” Trust is the irrevocable trust
 Purpose is to keep “B” Trust out of the
survivor’s taxable estate
This will lose the “stepped-up basis”
on the assets in the “B” Trust at the
survivor’s death
The “step-up” means that inherited
property receives a new cost basis equal to
the property's fair market value on the date
of the decedent's death. In other words,
the heirs can sell the inherited assets and
pay no capital gains tax.
Problems with the “A/B Trust”:
•“B” Trust is the irrevocable trust
 Purpose is to keep “B” Trust out of the
survivor’s taxable estate
ONLY ASSETS INCLUDED IN THE TAXABLE
ESTATE ARE ELIGIBLE FOR THE STEPUP
The “Intentionally Defective Marital
Deduction Trust”:
The “Intentionally Defective Marital
Deduction Trust”:
• Creates an irrevocable trust for all of
the decedent’s assets
The “Intentionally Defective Marital
Deduction Trust”:
• Creates an irrevocable trust for all of
the decedent’s assets
SOLVES THE CONTROL ISSUE
The “Intentionally Defective Marital
Deduction Trust”:
• Creates an irrevocable trust for all of
the decedent’s assets
• “Intentionally” designed to be included
in the survivor’s taxable estate
The “Intentionally Defective Marital
Deduction Trust”:
•“Intentionally” designed to be included
in the survivor’s taxable estate
SOLVES THE STEPPED-UP BASIS ISSUE -NOW THE ENTIRE ESTATE RECEIVES A
STEP-UP AT THE SECOND DEATH
The “Intentionally Defective Marital
Deduction Trust”:
• Creates an irrevocable trust for all of
the decedent’s assets
• “Intentionally” designed to be included
in the survivor’s taxable estate
• Has “disclaimer” option to fund
“Exemption Trust” if needed.
The “Intentionally Defective Marital
Deduction Trust”:
•Has “disclaimer” option to fund
“Exemption Trust” if needed.
PROTECTS IF THE EXEMPTION DOES
COME BACK TO $1M (OR IF CLIENTS HIT
THE LOTTERY!).
Besides “control”, there are other
advantages to creating an Irrevocable
Trust at the first death:
Besides “control”, there are other
advantages to creating an Irrevocable
Trust at the first death:
• Creditor Protection
Besides “control”, there are other
advantages to creating an Irrevocable
Trust at the first death:
• Creditor Protection
• Medicaid Planning
“Portability”
“Portability”
Current law provides for "portability" between spouses
of the maximum exclusion. Generally, portability allows
a surviving spouse to elect to take advantage of the
unused portion of the estate tax exclusion of his or her
predeceased spouse, thereby providing the surviving
spouse with a larger exclusion amount.
“Portability”
NOTE: The “deceased spousal exclusion amount” is
available to the surviving spouse only if an election
is made on a timely filed estate tax return for the
deceased spouse (even if an estate tax return would
otherwise not be required).
Example #1
Assume that Husband dies in 2012, leaving $1M to his
daughter and the balance of his estate of $3M to Wife
(no tax is due). An election is made on Husband’s estate
tax return to permit Wife to use Husband’s unused
exemption. Thereafter, Wife’s exemption is now $9M
(her $5M basic exemption plus the $4M of Husband’s
unused exemption), which she may use for lifetime gifts
or for transfers at death.
Example #2
Assume that Husband dies in 2013 and the exemption
has been reduced to $3.5M, Husband leaves $1M to his
daughter and the balance of his estate of $3M to Wife
(no tax is due). An election is made on Husband’s estate
tax return to permit Wife to use Husband’s unused
exemption. Thereafter, Wife’s exemption is now $6M
(her $3.5M basic exemption plus the $2.5M of
Husband’s unused exemption), which she may use for
lifetime gifts or for transfers at death.
The biggest argument in support of portability
is that it will prevent married couples from
having to create "costly" estate plans that
contain "complex" trusts.
But not so fast! There are still plenty of reasons why
married couples should consider Trust planning and
why unwed couples may need it too; portability is
really a “get out of jail card” for those who don't do
anything or if the totally unexpected should occur.
There are a number of reasons for married clients to
still create an estate plan which creates a trust or
trusts after the first death:
PLANNING
• Planning to “lock-in” the full exemption
Planning to “lock-in” the full exemption
Given the uncertainty surrounding the estate
tax, having an exemption trust will protect the
full $5M amount if one spouse dies and the
Democrats are later successful in "rolling-back"
the exemption to $3.5 (or if the exemption
should “sunset” back to the $1M. Portability
may also be lost if the surviving spouse
remarries and is later widowed again.
• Planning to “lock-in” the full exemption
• Planning for appreciation
Planning for appreciation
Funding an “exemption trust” also protects
appreciating assets from estate tax at the
survivor’s death.
• Planning to “lock-in” the full exemption
• Planning for appreciation
• Planning for blended families and/or
“control”
Planning for blended families and/or “control”
For a second/third marriage (or even for a first
marriage), if one or both of the clients is
concerned with the survivor being able to
change the beneficiaries (e.g., remarriage,
separate children, etc.), the irrevocable trust is
still necessary (as previously mentioned, even
when there are no tax issues -- as when the total
estate is under $3.5M or even $1M).
• Planning to “lock-in” the full exemption
• Planning for appreciation
• Planning for blended families and/or
“control”
• Providing creditor protection for the
surviving spouse
Providing creditor protection for the surviving
spouse
As previously mentioned, creating an
irrevocable trust at the first death provides asset
protection from creditors, lawsuits and/or
Medicaid “spend-down”. In addition, any assets
owned by an irrevocable trust will be protected
from a divorce settlement if the surviving
spouse remarries and then later divorces.
• Planning to “lock-in” the full exemption
• Planning for appreciation
• Planning for blended families and/or
“control”
• Providing creditor protection for the
surviving spouse
• Planning for state estate taxes
Planning for state estate taxes
Currently, there are 16 states plus the DC that impose a
separate state estate tax, so trust planning may be
necessary in order to “double” the state exemption and
defer payment of state estate taxes until the death of the
surviving spouse (so far, no state with an estate tax has
adopted the concept of “portability” for the unused
exemption of the first to die). Even if the client resides in a
state currently without a separate estate tax, that state may
subsequently elect to impose a tax or the survivor may,
after the first death, indicate that there is a possibility of
moving to a state which does have a separate state estate
tax (e.g., move to be closer to children/grandchildren).
• Planning to “lock-in” the full exemption
• Planning for appreciation
• Planning for blended families and/or
“control”
• Providing creditor protection for the
surviving spouse
• Planning for state estate taxes
• Planning for the “generation-skipping tax”
Planning for the “generation-skipping tax”
Portability does not apply to the GST tax, so in
order to fully leverage the GST exemptions of
both spouses for GST trust planning, it will still
be necessary to create a trust at the first
spouse’s death. The so-called “Dynasty Trusts”
are becoming increasingly popular.
• Planning to “lock-in” the full exemption
• Planning for appreciation
• Planning for blended families and/or
“control”
• Providing creditor protection for the
surviving spouse
• Planning for state estate taxes
• Planning for the “generation-skipping tax”
• Planning for same sex or unwed couples
Planning for same sex or unwed couples
Until same sex marriage is recognized by the
federal government, same sex couples will need
to use trust planning in order to be able to take
full advantage of the exemption (state and
federal) at both deaths (and the same goes for
unwed couples).
Problems with “Portability”
•
•
•
•
•
•
•
No planning to “lock-in” the full exemption
No planning for appreciation
No planning for blended families and/or “control”
No creditor protection for the surviving spouse
No planning for state estate taxes
No planning for the “generation-skipping tax”
No planning for same sex or unwed couples
Trust Planning under Current Law
Trust Planning under Current Law
Considerations:
Trust Planning under Current Law
Considerations:
– “Roll back” to $1M in 2013 is somewhat unlikely
Trust Planning under Current Law
Considerations:
– “Roll back” to $1M in 2013 is unlikely
– “Roll back” to $3.5M by 2014 is quite likely
Trust Planning under Current Law
Considerations:
– “Roll back” to $1M in 2013 is unlikely
– “Roll back” to $3.5M by 2013 is quite likely
– “Portability” will most likely be extended
Trust Planning under Current Law
Considerations:
– “Roll back” to $1M in 2013 is unlikely
– “Roll back” to $3.5M by 2013 is quite likely
– “Portability” will most likely be extended
– Any new law will probably not be permanant
Trust Planning under Current Law
Planning Techniques:
– “Probate Avoidance Trust”
Trust Planning under Current Law
“Probate Avoidance Trust”:
All assets remain in the original trust – no irrevocable trust is
created with the deceased spouse’s assets
Best for estates under $1M
Simple! No separate accounting or tax return.
However, no protection for:
 Children
 Creditors
 Medicaid
Trust Planning under Current Law
New Planning Techniques:
– “Probate Avoidance Trust”
– “Disclaimer Trust”
Trust Planning under Current Law
“Disclaimer Trust”:
All assets initially remain in the original trust – but survivor has 9
months to create an irrevocable trust with some or all of the
deceased spouse’s assets
More tax planning than the Probate Avoidance Trust
Lets the survivor decide if an irrevocable trust is needed.
Best for estates from $1M up to $3.5M
However,



No protection for children
No “Limited Power of Appointment” permitted
No “step-up” for assets in the irrevocable trust
Trust Planning under Current Law
New Planning Techniques:
– “Probate Avoidance Trust”
– “Disclaimer Trust”
– “Intentionally Defective Marital Deduction Trust”
Trust Planning under Current Law
“Intentionally Defective Marital Deduction Trust”:
Decedent’s assets go in to an irrevocable trust which qualifies for
the Marital Deduction
Any amount up to $3.5M
Safeguards the children
Survivor can have a Limited Power of Appointment
Assets are protected from the survivor’s creditors
Assets do not need to be “spent down” for Medicaid (allocate
residence to the survivor’s trust)
Assets get a new basis at survivor’s death
Contingent “disclaimer” provision
Does require planning at first death and a separate tax return
Trust Planning under Current Law
New Planning Techniques:
–
–
–
–
“Probate Avoidance Trust”
“Disclaimer Trust”
“Intentionally Defective Marital Deduction Trust”
“QTIP Trust” with “Clayton Election”
Trust Planning under Current Law
“QTIP with Clayton Election”:
 Like the Marital Deduction Trust; funds the MD portion first,
then the Exemption Trust (as an election).
 Use for larger estates where combined estate is above $7M or
either spouse’s estate will exceed $3.5M
 Assets in the MD Trust are stepped-up at 2nd death, but assets
in the Exemption Trust are not.
 Because this is an election:
 15 months to make election
 Limited Power of Appointment over entire trust
Trust Planning under Current Law
New Planning Techniques:
–
–
–
–
–
“Probate Avoidance Trust”
“Disclaimer Trust”
“Intentionally Defective Marital Deduction Trust”
“QTIP Trust” with “Clayton Election”
“QTIP Trust”
Trust Planning under Current Law
Traditional “QTIP”:
 Funds the Exemption Trust first, then the MD Trust with the
excess.
 Use for larger estates where combined estate is above $10M
or either spouse’s estate will exceed $5M
 Assets in the MD Trust are stepped-up at 2nd death, but assets
in the Exemption Trust are not.
 Limited Power of Appointment over entire trust
Trust Planning under Current Law
New Planning Techniques:
–
–
–
–
–
–
“Probate Avoidance Trust”
“Disclaimer Trust”
“Intentionally Defective Marital Deduction Trust”
“QTIP Trust” with “Clayton Election”
“QTIP Trust”
“QDOT”
Trust Planning under Current Law
“QDOT”:
 “Qualified Domestic Trust”
 Use if either spouse is a non-citizen and the other spouse’s
estate will exceed $3.5M
 Like a QTIP which funds the Exemption Trust first, then the
MD Trust with the excess.
 Must have US citizen as the trustee or co-trustee of the MD
Trust.
 Any distribution of principal from the MD Trust during
survivor’s lifetime are subject to 35% (could be 45%) estate
tax.
 Unlimited Marital Deduction is a “deferral” of tax; the QDOT
insures Uncle will get his share.
Trust Planning under Current Law
“Non-Traditional Couples”:
 Federal tax law only recognizes a “traditional” marriage between a man
and a woman; there is no Marital Deduction available.
 Use a Probate Avoidance Trust for under $1M if no issue of control and no
wish for creditor/Medicaid protection
 Use a Disclaimer Trust for estates between $1M and $5M if no issue of
control and clients want survivor to determine if irrevocable trust is
needed.
 Use the modified “A/B Trust” for any size estate when control is an issue or
if the estate is greater than $5 or to force the use of the irrevocable trust.
“Modified” means there is no “formula” for funding the irrevocable trust; all of the
deceased parties assets are held in the trust even if above the federal exemption amount.
Excess will be taxed whether held in trust or distributed outright to partner.
However, assets in the irrevocable trust are not subject to an additional tax at the
partner’s death; i.e., up to $10M can pass tax free.