The sweeping changes to the gift and estate tax laws resulting from the Tax Relief, Unemployment Insurance Authorization and Job Creation Act of 2010 (the “Act”) create some new opportunities and new considerations for gift and estate tax planning. Clients are asking “What do I do now?” Discussed below are some thoughts about estate and gift planning after 2010.
Lifetime Use of Gift Tax Exemption
The Act increased the estate tax exemption, the gift tax exemption and the generation-skipping transfer (“GST”) tax exemption to $5 million. As a result, clients can now make lifetime gifts of up to $5 million without incurring gift tax. Clients also have a $5 million GST exemption to apply to GST gifts. Married couples can double those amounts.
Because the Act applies only until 2012, clients may wish to consider using their lifetime gift exemptions within the next two years. Using the lifetime gift exemption now may preserve the benefit of the current exemption if it is later reduced by future tax laws. There are several advantages to lifetime gifts:
- Lifetime gifting removes future appreciation on the gifted assets from the donor’s estate.
- Lifetime gifts can be combined with leveraging strategies, such as irrevocable life insurance trusts (“ILIT”) and generation-skipping trusts, to produce significant transfers of wealth.
- Educational and support trusts can be established for children, grandchildren, etc.
Example: Donor makes a gift of $5 million to an ILIT and applies his $5 million lifetime gift exemption. The ILIT funds are used to purchase a life insurance policy on the donor’s life with a death benefit of $35 million. The result is $35 million transferred to the family for the cost of a $5 million gift. And if the donor applies his or her GST exemption, the benefits can be multiplied over a number of generations.
Of course, clients who live in states that still have state gift and estate taxes must carefully weigh the advantages and disadvantages of any lifetime gift strategy.
Using Credit Shelter Trusts Despite Portability
Prior to the Act, a married decedent’s estate tax exemption was lost if not used at the decedent’s death. To prevent that result, estate planning documents usually provided for the establishment of a “credit shelter trust” at the decedent’s death designed to capture and hold the decedent’s estate tax exemption.
The new Act introduces “portability” of the estate tax exemption, which was discussed in greater detail in an earlier article in this newsletter. In short, if a decedent does not use all of his or her estate tax exemption at death, his or her surviving spouse may be able to utilize the decedent’s unused exemption at the surviving spouse’s later death. Given “portability,” is there any reason to continue using credit shelter trusts? The answer is a resounding “Yes!”
The advantages of using a credit shelter trust reach beyond preservation of the estate tax exemption, especially in large estates. Advantages include the following:
- The deceased spouse’s unused exemption will not be indexed for inflation, so if the surviving spouse’s assets appreciate to the extent they exceed the value of the estate tax exemption, estate tax may result. That tax may have been avoided by use of a credit shelter trust.
- The decedent’s unused exemption will be lost if the surviving spouse remarries and survives his or her next spouse. A credit shelter trust would “lock-in” the decedent’s exemption amount.
- Appreciation in the value of assets allocated to a credit shelter trust will escape estate taxation in the surviving spouse’s estate.
- Since the GST tax exemption is not portable, a credit shelter trust can also ensure that the decedent’s GST exemption is fully utilized.
- A credit shelter trust can provide all the usual benefits of trusts: protection from claims of a beneficiary’s spouse and creditors; management of assets; and control over the disposition of assets at the surviving spouse’s death, especially in blended family and second marriage situations.
Planning Still Important
More planning ideas are likely to surface as the Act is studied and discussed. But even in the weeks since passage of the Act, it is clear that planning for one’s estate continues to be important. Engaging in the appropriate planning during life gives a client the best opportunity to ensure that his or her estate planning goals will be achieved. And keep in mind that the new estate and gift tax laws expire on December 31, 2012. Will 2012 bring a repeat of the tax legislation circus we saw in 2010? Stay tuned — there is more to come.