The new federal tax law ushered in the highest estate- and lifetime gift-tax in U.S. tax law history: $5 million for individuals and $10 million for married couples. While this may appear to have taken off the pressure for careful estate planning - only 1% of U.S. estates are estimated to be larger than $5 million - the higher limits pose both opportunities and challenges for high-net-worth families.
Given the new law, here are some estate planning considerations married couples should address:
Change charitable donations? -- The single most obvious benefit of the higher estate tax exemption is that if planned properly, a couple can now leave substantially more - $10 million instead of $2 million - to heirs and relatives. This is most significant to those whose primary reason for charitable giving is to reduce taxes. Given the new law, reviewing your purposes and strategy should be your first priority.
Accelerate and increase gifting? -- For couples who have exhausted the previous unified gift-tax exemption of $2 million, the $10 million limit represents an unprecedented opportunity to move assets out of their estates without taxation. Keep in mind, however, that the annual limit on tax-free gifts is only $13,000 in 2011, $26,000 if a couple splits their gift.
Since the new tax law expires in 2013 and it's uncertain what future exemption limits will be, it may be a good idea to take full advantage of the higher limits over the next two years. Targeting appreciating assets - like stocks and real estate - should be the first priority. Even if Congress reduces the exemptions after 2012, once those assets are out of your estate, any appreciation on those assets is also out of your estate.
Trust or will? -- The higher limit may mean you can avoid establishing trusts to remove funds from your taxable estate. One disadvantage of testamentary transfers to beneficiaries is you lose control over how and when the funds are distributed. Wills must still pas through probate, which means there is the potential for considerable delay before your heirs gain access to the assets they may need to pay taxes or other bills. Wills also distribute assets without limitations as to the purposes they can be used for or when, such as reaching the age of majority or annual distribution amounts. Only trusts can establish these directions.
Understanding the new portability provisions -- One new feature of the tax law concerns "portability" of the estate tax exemption between spouses. Under this provision, any credit that has been unused by a deceased spouse can be transferred to the estate of the surviving spouse.
For example, if a spouse's estate has used only $2 million of the $5 million exemption, the remaining $3 million can be applied to the surviving spouse's estate, raising its exemption to $8 million. But there are two important caveats: 1) It's not automatic. Even if an estate won't own a penny in federal estate taxes, it must file a tax return to establish the transferred credit. 2) Portability does not apply to generation-skipping trusts whose beneficiaries are grandchildren and great-grandchildren.
If the surviving spouse is predeceased by more than one spouse, the additional exclusion amount carried over to the surviving spouse is limited to the lesser of $5 million or the unused exclusion of the last deceased spouse.
Avoiding unintended disinheritance -- Because estate laws are constantly changing, when it comes to dividing assets among different heirs, many wills and trusts rely on a "formula clause" that doesn't specify dollar amounts of percentages. For example, a document may simply say that children of the deceased are to receive the maximum amount allowed to pass to them free of federal taxes, with the remainder going to the surviving spouse. For an estate that is $5 million or less, this means the spouse is effectively disinherited. Adding further clarification in such cases is vital to ensuring that an intended beneficiary isn't left penniless.
Lower state thresholds -- Be aware that more than a dozen states also levy inheritance taxes, and the threshold of taxability may be considerably lower than the federal level.
Estate planning is an important part of your overall financial plan, no matter how large your net worth. To review your current estate plan in light of the new tax laws, please call.