The Uncertain Certainty!

The estate tax applicable exclusion amount has been a constant uncertainty the last few years.  First, the estate tax was entirely repealed in 2010.  At the end of the year, Congress retroactively created a $5 million applicable exclusion, set to expire at the beginning of this year.  Then, on the brink of returning the applicable exclusion amount to $1 million and amid a fervor of last-minute gifting and planning, Congress acted to index the $5 million amount to inflation permanently.  However, it appears that “permanently” may only mean for the next five years.  With President Obama’s proposed budget, it appears that at least he believes the estate tax issue was not taken off the table during the fiscal cliff negotiations.

The constant change in estate tax amounts and rates affects the ability to make long-term plans.  As a result, it is important to consider how effective irrevocable trusts can be in your estate planning toolbox.  Among estate planners and tax professionals, there is a saying: “Don’t let the (tax) tail wag the dog.”  In other words, while estate tax avoidance may be among your goals when creating certain types of plans, considering whether you will be happy with the plan even when estate tax is not an issue is vital to creating an effective plan.

An irrevocable trust may be created in order to prevent the beneficiaries from wasting assets or to protect certain assets from beneficiary creditors.  Irrevocable trusts may also be used to ensure that your intended beneficiaries actually receive their inheritance, particularly in cases where children from prior relationships are present.  One of the more popular irrevocable trusts, the Irrevocable Life Insurance Trust (ILIT), may continue to be useful.  ILITs are irrevocable during your life because, although life insurance benefits are free from income tax, they are not free from estate tax.  Although they have historically been used to satisfy estate tax obligations, they may also be used to pay off mortgages on real property or pay income tax on “Income in Respect of a Decedent” (IRD), including retirement plans and annuities.

If you are thinking of creating a revocable trust that becomes irrevocable on your death, you are able to retain a lot of flexibility to alter it during your life as personal and legal circumstances change.  If you are thinking of creating an irrevocable trust during life, or if you have already created one, it can be maddening to discover how little flexibility you have to make changes.  It is essential to obtain quality, capable advice while carefully considering your goals, possible changes in circumstances, and methods of adding some limited flexibility to the trust.  If you have already created an irrevocable trust that you wish to alter, a careful review of your existing trust may reveal some options.

As the last few years have made clear, creating plans purely for estate tax purposes may be too short-sighted.  If President Obama has his way, the applicable exclusion amount would return to the 2009 level of $3.5 million in 2018.  Although the success of this measure is unlikely, what is clear is that the estate tax amounts and rates remain on the table and are sure to fluctuate in coming years despite the “permanent” solution already made.  Ensure that your plan can change with the political tides!

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