We are quickly approaching what many are calling the “Cliff,” which is a series of tax hikes and spending cuts slated to take effect on January 1, 2013. Although it may seem like a ways away, consider how little has been accomplished this year to date on these issues that are just around the corner. Payroll taxes and income taxes, including the capital gains rate, will increase. Military spending will be slashed, along with other government spending. We will also hit the debt ceiling again. The effect of all these sudden changes could be instantly catastrophic to the U.S. economy and, according to the Congressional Budget Office (CBO), will almost certainly cause the much-feared “double dip” recession to occur next year.
With all of these issues affecting nearly every American in some way or another, although some more than others, it is hard to imagine that the estate tax is likely to be a top priority. Oh yea, did I forget to mention it? The estate tax applicable exclusion amount (the amount you may pass to your heirs tax-free) will drop to $1 million (compared to $5.12 million today) and the top marginal rate will skyrocket to 55% (up from 35%). This means that roughly 10x the number of people currently effected by the estate tax will have to pay up on death to Uncle Sam. At $1 million, many Southern Californians will use their entire exclusion amount on a first and second home or their small business. Even if President Obama has his way (exclusion of $3.5 million and top rate of 45%), many more individuals will almost certainly be effected by the tax.
Although many expect that the estate tax cliff will be its own political football to be used as a bargaining chip in other deals, no estate planner should bet their practice on it, which they could be doing if they fail to properly advise their clients about this possibility. After the debacle on Congressional inaction, causing the repeal of the estate tax in 2010 only to reinstate it in December of that year, the uncertainty about the future of the estate tax is our only certainty.
The turning point in the estate planning world is for people with estates between $1 and $5 million. Depending on your age, health status, and other factors there are a number of possibilities to potentially take advantage of before the end of this year. An A-B Trust is always a possibility. It splits the estate into two shares at the first spouse’s death in order to preserve the first spouse’s exemption and effectively double it. However, there is expense, occasionally substantial, associated with dividing the trusts and ongoing administration. In some cases, it may be advisable to use a more flexible planning alternative, such as a disclaimer trust. A disclaimer trust marries the best of both the simple and the A-B trust, but requires action very shortly after the first spouse’s death in order to avoid losing its benefits and has less flexibility than the A-B Trust. If you own a business, it may be beneficial to do some business succession planning in order to transfer some portion out of your estate, especially if your heirs are involved as employees or managers of the business.
As we round into the second half of the year with little hope of a resolution before at least November, now is the time to take advantage of the increased exemption amount if it’s beneficial to you. Speaking to a qualified estate planning attorney to at least determine if any action is advisable should be done as soon as possible so that you and the attorney have sufficient time to review your assets, determine a strategy, and, if necessary, take action.
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.