They say the only things in life that are certain are death and taxes. Good news: After some recent changes in estate and gift tax law, they may only be half right. Today, many can die in peace and face no adverse tax consequences.
The current Estate Tax Exemption is $5,430,000 per person and $10,860,000 per married couple. This means that 99.8 percent of estates will not have to pay the current estate tax, according to the Tax Policy Center. Estate tax, which is currently 40%, is no longer the main concern for estate planners and taxpayers alike. The focus should now shift to the minimizing income tax.
The maximum capital gain tax in California comes out to be 20% (Federal Tax) + 3.8% (Net Income Investment Tax or Obama Care Tax) + 13.3% (California Income Tax) = 37.1%. This is not significantly less than the 40% estate tax rate. Pre-2012 trusts were formed with the goal of reducing estate tax by funding a Bypass Trust or Credit Shelter Trust on the death of the first spouse. The estate tax exemption amounts were much lower and they worked under a “use it or lose it” regime. This meant that if the survivor did not fund a Bypass Trust then any of the deceased spouse’s unused exemption amount would be lost forever. The Bypass Trust would remove assets from the surviving spouse’s estate, use up all the deceased spouse’s exemption amount, and keep the surviving spouse under the Estate Tax Exemption amount.
There certainly are times when a good ol’ Bypass Trust is effective and should be the structure of choice. However, recent law changes have made the Bypass trust more hurtful than helpful in certain situations.
The 2010 Tax Relief, Unemployment Insurance Reauthorization, and Jobs creation Act (Let’s just call it “the Act”) introduced “Portability” into the estate planning mix. Portability allows the unused portion of the deceased spouse’s estate tax exclusion amount to be preserved and used by the surviving spouse. An election must be made on the deceased spouse’s 706 Estate Tax Return. The Act also increased the estate, gift, and generation skipping tax exemptions to above 5 million per spouse and set the amounts to annually increase with inflation. The American Tax Payer Relief Act of 2012 made all these changes permanent.
With these recent law changes made permanent, it may be better to keep all the marital assets (up to $10.86 million) in the surviving spouse’s estate. This means that on the first spouse’s death, instead of having that spouse’s assets first go to the “bypass” trust, which skips the surviving spouse’s estate, those assets should go to a marital (QTIP) trust. (QTIP Blog post to follow). This way the assets will be “included” in the surviving spouse’s estate and therefore will “step up” to the date of death fair market value at the survivor’s death. If the estate turns out to be “too large,” (above the 10.86 million) the survivor will have the option to disclaim any remaining portion of the first spouse’s assets into a “bypass trust.”
IRC 1014 states that any property acquired from a decedent (a deceased parent, for example) shall receive a step up in basis to the fair market value at the date of the death of the decedent. This means that a child can receive a house in lower Burlingame, purchased for $35,000 in 1975 by his parents, with a basis of $1.7 million and sell it the next day owing 0 capital gains tax. All those potential capital gains are erased and at 0 cost in estate tax. Obtaining the IRC 1014 Step Up is specifically important for any Bay Area family that owns real property.
Does all of this sound a bit complicated? There are people who can help. Review your Trust with a trusted advisor and make sure that an old Bypass Trust isn’t going to keep your family from saving income tax. Most estate planning attorneys should be willing to review your existing trust for free to see if changes need to be made.
In order to comply with U.S. Treasury Department and IRS regulations, we are required to advise you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, by any person for the purpose of (i) avoiding penalties under the U.S. Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this e-mail or attachment.