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US Estate Planning Remains a Moving Target Under the New Tax Law

Estate Planning Remains a Moving Target Under the New Tax Law


WITH the federal tax on estates now kicking in at $5.25 million — or $10.5 million for a couple — it may seem that only the very wealthy need to worry about paying the tax. But that doesn’t mean that everyone else can forget about an estate plan.

Consider the people who fill out forms designating who inherits assets like an insurance policy and then never go back and revise the forms when, for instance, they divorce and remarry. And then, there are the parents who have not determined who will serve as guardians for their children.

“Even though you have less than $10 million or even if you have more, you really want to guide the family as best you can,” said Stuart Kessler, a certified public accountant and director at the accounting firm CohnReznick.

Having just filed tax returns, many people may not want to think about how the changes to the tax code under the American Taxpayer Relief Act, passed in early January, could affect them.  But if they don’t, they may be shocked come next year’s tax season. Or worse they may end up making financial plans based on a cursory understanding of what the changes mean for them and regret it later.

Over the next couple of weeks, I am going to look at how the tax changes could sway people’s thinking on estate planning, investments and insurance and why people need to think clearly about how they are responding.

This week, I’m looking at estate planning, where the focus over the last decade has been on the exemption amount and the tax rate above it. The exemption rose steadily and the tax rate fell from 2001 until 2010, when the estate tax disappeared for most of that year. When the tax returned in 2011 and 2012, the exemption was set at a historically generous $5 million indexed for inflation and a 35 percent rate above that.

The American Taxpayer Relief Act made the exemption permanent at the 2011 level, indexed for inflation, and set the tax for anything exceeding that amount at 40%.  It also also kept the exemptions and taxes the same for gifts made in a person’s lifetime.

Here is a look at why people at different income levels need to pay attention to their estate plans.

THE NECESSITY OF FEAR When his nephew was about to marry in March, Mr. Kessler took the young man to lunch and offered advice: draft a will. While not exactly a romantic thought, it was a practical one. And Mr. Kessler said he often pressed clients with far less than $10 million to do the same — and to revisit it often.

“They feel they’ve set this in motion and don’t have to deal with this for 10 years,” he said. “I’m not crazy about that idea. I usually bug them in three years.”  It is easy to imagine a family with a modest amount of money having a child with a spending or substance abuse problem or a checkered marital history who would benefit from having an inheritance put into trust.

But there are simpler issues that could be overlooked if people figured there was no longer a need to think about an estate plan.

One is the beneficiary designation form, which determines who gets assets like a retirement account or an insurance policy. Many times, people fill out these forms when accounts are opened and then forget about them, even as the account or insurance policy grows or people’s life situations change. That form overrides a will.

People with dependent children also need an estate plan to make sure they have life insurance and guardians for their children. “That’s one of the major issues here,” Mr. Kessler said. “Forget about when the kids get the money. It’s, Who’s going to take care of them?”

Some states intervene when a person dies without a will — and charge fees to sort things out. In California, a will alone is not enough to avoid the state’s getting involved in the probate process, said Andy Katzenstein, a partner in the personal planning department at Proskauer, a law firm.

A better plan, he said, would be to set up a revocable, or living, trust that holds the assets. It has the added advantage of keeping prying eyes out of someone’s affairs.

“Michael Jackson’s will is being probated,” Mr. Katzenstein said. “He actually had a living trust, but he didn’t put his assets in it.”  He added, “Maybe your estate is less than $10 million and you’re not going to pay federal estate taxes, but if you don’t put it in a living trust, it’s public and everyone can see what you have.”

SPRING CLEANUP Many wealthy people made decisions last year about their estates that they may now regret because they expected that both the exemptions for the estate tax and the related gift tax would be reduced. In some cases, people gave away various types assets to beat the deadline.

Instead, both exemptions were actually raised. The gift tax exemption is $130,000 higher this year, and many of those who tried to beat the change at the end of last year now have to clean up what they did. Some people who rushed to make the gift put cash up to the $5.12 million limit, or $10.24 million for couples, into a trust, planning to substitute a less liquid asset — say real estate or part of a company — when they had time to get it valued. Yet since the trusts were written to give them plenty of time to do this, the risk now is that without pressure to get it done, they may forget about it.

“There isn’t a time limit, but if you think assets are going up in value, the sooner you swap the noncash assets, the sooner you’re moving the appreciation over to the other side,” Mr. Katzenstein said.

There are worse situations to be in. Faith Xenos, chief investment officer of Singer Xenos Wealth Management, had a client who put shares of a building on elegant Lincoln Road in Miami Beach into a trust for his children. The building was valued at $50 million for the trust, a huge discount on what it was really worth but great for estate planning purposes.

“One quarter later, they were offered $100 million for it,” she said. There was no way they could sell it without running afoul of the Internal Revenue Service because the building obviously didn’t appreciate in value by that much in a few months. “It wouldn’t pass the smell test,” she said. “It was the tax tail wagging the dog.”

NEW UNCERTAINTY The new estate tax amounts have been called permanent, but tax planners fear elected officials could change them at some point.  President Obama’s budget proposal last week seeks to bring the exemption level — “permanent” for a mere three months — back to $3.5 million and increase the tax rate on assets exceeding that to 45 percent from 40 percent. This would not happen until 2018, if at all, but it has made people jittery about what else could change.

But a more immediate issue is an estate plan that has a credit shelter trust written into it. These trusts were used to make sure both spouses got their full exemptions. But the new law includes a provision called portability that allows the surviving spouse to use any leftover exemption amount, even if it was not put in trust.

If the estate tax exemption were to be reduced in the future, the portability of the leftover exemption might be lost. The more immediate concern is moving assets into a marital trust now may incur a state estate tax bill.

In New York, for example, the state exemption is $1 million. If a credit shelter trust were funded for $5 million, the estate could owe $400,000 to New York but nothing to the federal government. If the assets just passed to the spouse, the bill would be zero.

Jennifer Immel, senior wealth planner at PNC Wealth, said the wealthy could put provisions in their estate plans to use a credit shelter trust if the laws had changed again by the time the first spouse died. In other words, Ms. Immel said, “they can take the money outright or let it fund the trust.”

And this shows why the world of estate planning remains complicated.

This article has been revised to reflect the following correction:

Correction: May 3, 2013

The Wealth Matters column on Saturday, about the intricacies of estate planning under new federal laws, misidentified a type of trust that is at issue under the new rules. It is a credit shelter trust, not a marital trust. (The two are treated differently under estate tax law, and the terms are not interchangeable as used in the column.)



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