On January 1, 2013, both the Senate and House passed the American Taxpayer Relief Act of 2012 (ATRA). For estate taxes (death taxes), ATRA included a five million dollar (with indexed increases) exclusion amount for gift and estate taxes, and they’re permanent.
Well, permanent until they change them, which they obviously can do. For 2013, the applicable exclusion amount was set at $5.25 million. The federal estate tax exclusion is the amount any one person can transfer at their death without tax.
ATRA was the first law in 10 years to set a permanent estate tax exemption. Previously, Congress instituted a series of “sunset,” or automatically reverting, laws if no further legislative action was taken. For the last decade, we have known what the short-term future held, but nothing past that. Needless to say, these “sunset” laws created uncertainty and made estate planning more art than science. With the passage of ATRA, some of the science has returned.
If you are married and have a family trust, the permanency of these estate tax laws creates some welcomed certainty when trying to plan for the future. You should look at how these changes impact your current trust terms. Unfortunately, if you are single your planning options remain the same.
Many family trusts were created before the federal estate tax exemption was increased to just one million dollars in 2002. A very common provision required your family trust to be split into two parts. This was part of a typical “A/B” trust scheme. Most clients don’t know what their trusts require when the first spouse dies. After the death of a spouse, many of my clients are less than happy with the consequences of this required split because there can be negative tax consequences and administrative headaches.
The original trust drafter didn’t do anything wrong, it’s just that times — and laws — have changed. This means that the provisions in your trust that control what happens after the first spouse dies may be out of date, but there is a very good chance you may be able to improve them. This requires a proactive approach.
These new laws have the most profound impact on couples whose net assets total less than $5,250,000. Why? Because if you have less than $5,250,000 there’s a good chance that the required “A/B” funding isn’t necessary. If the funding isn’t necessary, why should you deal with the downsides associated with saving estate taxes if estate taxes aren’t an issue?
No plan is perfect. If the provisions to avoid mandatory funding are written into your trust, there are side effects to consider. The most significant is that the surviving spouse may have complete control over the final distribution of the marital assets. Once the first spouse dies, there is nothing preventing him or her from changing the entire plan regarding who gets what. If you have a blended family where tension exists between your spouse and the stepchildren, perhaps this isn’t the best plan for you. However, I’ve met with many clients in blended families that have a strong level of trust. When they know the potential hazards, they proceed based on the positive attributes of such a plan, such as flexibility and reduced costs.
You should review your trusts from time to time. How frequently? I suggest at least once a decade, and more frequently if the family undergoes big changes. Make sure your trust is right for your current situation… Before it’s too late!
Eric S. Gullotta, JD, CPA, MS (Tax) specialies in estate planning and taxation law. His office is located at 232 West Napa Street, Suite A, in Sonoma. Contact him at 938.7234 or visit Gullottalaw.com.