Let’s Get Real about Death and Taxes!

Over the years of my practice I have seen the specter of death taxes weigh over my clients and drive their estate plans.  A lot of people have been confused about what estate taxes are and what they mean.  If you ask me, rightfully so!  The world of estate tax has been extremely tumultuous over the last several years.  So, the next time someone starts chatting you up about death tax at a cocktail party (I know this happens all the time!), this article will ensure that you know what it’s all really about.

It used to be that, especially in California, estate tax was a real issue for many people, particularly when there was real estate involved.  Over the last several years, estate tax has become less of a concern for most people.  The unified credit (combined amount of gifts and bequests you may make tax free) was increased to $5,000,000 in 2011 and the concept of “portability” was added.  Portability allows the surviving spouse to claim his or her deceased spouse’s unused exclusion amount without the need for special planning.  These changes left many to wonder whether their A-B Trusts had become obsolete. Unfortunately for planners, all of these estate tax provisions are scheduled to expire at the end of this year, leaving attorneys like me to guess about the possibilities.  Well, we now have some guidance.

First: What is the Estate (a.k.a. Death) Tax?
Each year you are allowed to make tax free gifts of up to $13,000 per year without being subject to gift tax.  Any gift over $13,000 requires a gift tax return, but does not require any tax payment under most circumstances in exchange for decreasing the amount you may pass to your heirs at death without tax.  Assuming no taxable gifts were made during your life, estate tax is based on the total value of your estate, less certain deductions.  Over the course of the last decade, the amount that could be passed tax-free has gone from $1 million to $5.12 million after the inflation adjustment.  Additionally, the highest marginal tax rate decreased from 50% to 35%. This means an unmarried person with a $3 million estate who created a trust in 2002 would have been worried about the tax on the remaining $2 million. But in 2012 all of it would be able to pass tax-free.

So what’s happening now?
The estate tax exemption is currently $5.12 million.  For married couples, there are two major ways to, essentially, double that exemption: an A-B Trust  and portability through filing an estate tax return.  A married couple who both die in 2011 and/or 2012 could shelter over $10 million from estate tax, but little was known about what would happen beginning in 2013.  With $10 million potentially sheltered, the estate tax did not need to be a consideration for most estate plans.  However, if the law reverted to its default in 2013, a married couple would only be able to shelter $2 million from estate tax.  Obviously, this huge difference led estate planners with varying levels of conservatism to guessing how large a clients’ estate needed to be to incur tax.  If your estate is over $2 million, the question for the last two years has been how much additional planning, if any, do you need?

To 2013 and beyond!
Finally we have received some clues for the future of the estate tax.  President Obama has proposed a permanent estate tax exemption amount of $3.5 million and lifetime gift tax exemption of $1 million.  Additionally, the President has proposed making the concept of portability a permanent addition to the estate tax code.  Clearly the debate is not over and Congress will have the final say.  But the good news is that so far it does not look like the new estate tax regime will be a huge departure from the previous rules of the game.  In fact, the rules will go back to 2009 estate tax rates with the addition of portability. This should lead to more consistency for attorneys and client estate planners.

Estate Planning: The Price of Organization, Rewards, Gifts, and Wondrous Tax Things…

FREE REPORT:  This complimentary report, focused on Estate Planning, is comprised of many of Mr. Miller’s articles from his long running column for the largest regional newspaper in San Diego County. This report will guide you through the questions surrounding getting your estate planning in order.