The Impact of the New Laws on Your Existing Estate Plan

3/10/2011 Articles

After the passage of the Tax Relief Act of 2010, you may want to consider whether the new laws have an impact on your existing estate plan. 

Gifts Measured by Reference to a Tax Exemption Amount

Under the Tax Relief Act, each person may shield up to $5 million of assets from the federal estate tax.  That's good news.  However, the increased exemption amount may cause a change in the distribution of your assets at death that you are not expecting.  Many estate plans are drafted to automatically take advantage of changes in the tax law by measuring gifts by reference to an estate tax exemption amount.  For instance, the amount that passes into a Bypass Trust or Exempt Trust is measured by reference to the estate tax exemption amount available at the time of death, rather than a reference to a dollar amount such as "$5 million."  This way, as the tax laws change, there is no need to amend your trust document to take the changes into account.

The concern here is that an estate plan may measure amounts that pass to certain parties by referring to a tax exemption amount, such as the estate tax exemption amount (or the generation-skipping tax exemption amount).  For example, an estate plan for a married person may provide that, upon the first death, an amount equal to the federal estate tax exemption amount will pass to the deceased spouse's children from a first marriage, with the balance passing to the surviving spouse.  As a result of the gift to the children being based on the estate tax exemption amount and the increased estate tax exemption amount, the gift to the children could be substantially larger than anticipated, leaving much less for the surviving spouse.  This may not be the result contemplated when the initial estate plan was drafted. 

If your current estate plan contains gifts measured by reference to tax exemption amounts, you may want to contact your estate planning attorney to discuss the impact of the increased exemptions and any modifications you may wish to make to your plan.

Portability of Unused Exemption Amount to a Surviving Spouse

In addition to an increased estate tax exemption amount, the Tax Relief Act includes a new provision for the portability, or transfer, of a deceased spouse's unused exemption amount.  This provision has limited application, so please keep reading.

What is Portability?
With portability, a surviving spouse can take advantage of a deceased spouse's unused estate tax exemption amount available at the time of the first spouse's death.  For example, if a husband dies with an estate of $3 million, and if the estate only used $3 million of his $5 million dollar estate tax exemption amount, then the $2 million unused portion may be transferred to his  wife and added to her $5 million exemption amount.  The result would be that the surviving spouse would have an $8 million exemption amount to apply to lifetime gifts or to her own estate at death. 

Portability may also be used to simplify an estate plan for a married couple, which will be discussed just below.

For portability to be an option, however, the following criteria must be satisfied:

  • You must be married.
  • Your spouse must die on or before December 31, 2012.
  • The executor of your spouse's estate must file an estate tax return and elect to transfer the remaining unused exemption amount to you.

Then, Why Have a Bypass Trust?
A typical estate plan for a married couple establishes a Bypass Trust or Exempt Trust at the death of the first spouse for the purpose of setting aside assets equal to the deceased spouse's estate tax exemption amount.  This separate trust must be maintained and managed by the trustee, who is often the spouse.  Often, the primary purpose of the trust is to capture the estate tax benefit of the first spouse to die.   But what if a married couple could simply forego the creation of the Bypass Trust at the first death, and pass the deceased spouse's estate tax exemption to the surviving spouse for later use?  Wouldn't that be simpler? 

While portability has the advantage of seemingly simplifying estate planning (i.e., no trust is needed), there are several aspects of portability that you should consider before you forego your Bypass Trust:

  • Will you and your spouse outlive portability? The law allowing portability is part of the Tax Relief Act which is effective for the years 2011 and 2012 only. 
  • Do you want to decide who receives your assets at your death? A Bypass Trust ensures that you decide who will be the recipient of your assets, rather than leaving that decision to your surviving spouse.  The establishment of a Bypass Trust may relieve the stress placed on a surviving spouse who may be "bullied" by kids or other relatives to make gifts.
  • Is creditor protection a concern? A Bypass Trust provides protection from creditors of beneficiaries of the Bypass Trust, as creditors of a beneficiary cannot access the assets of the trust.

These are some of the questions you should discuss with your estate planning attorney before relying on portability as your estate planning tool.

Generation-Skipping Transfer Tax Allocation for 2010 Transfers

The Tax Relief Act retroactively reinstated the generation-skipping transfer ("GST") tax, a secondary tax on gifts to persons two or more generations younger.  In 2011 and 2012, a person may transfer up to $5 million of assets to persons younger than their children without the imposition of the GST tax, and if the transfer exceeds $5 million, the tax rate for the excess amount has been lowered from 45% to 35%.

In 2010, transfers to persons younger than children could be made without the imposition of any GST tax.  However, if those transfers were made to a trust for younger persons, rather than as outright gifts to them, then the future distributions from the trust may be subject to the GST tax after all.  To avoid having future distributions from a trust subject to the GST tax you should proactively apply your available GST tax exemption amount to the trust by declaring so on a federal gift tax return.  If this allocation of your GST tax exemption is made, you can insure that future distributions from the trust while it is in existence or when the trust terminates, will be free of this additional tax. 

Consider contacting your estate planning attorney or CPA to discuss whether you should allocate your GST tax exemption amount to any gift you made in trust in 2010.

To discuss whether the new laws impact your existing estate plan, please call your Farella Family Wealth attorney.

George Argyris / [email protected] / 415-954-4992
Fred Caspersen / [email protected] / 415-954-4427
Lara Gilman / [email protected] / 415-954-4913
Michael Korbholz / [email protected] / 415-954-4956
Barbara Murphy / [email protected] / 415-954-4933
Kate Ohlandt / [email protected] / 707-967-4156                              
Evan Abrams / [email protected] / 415-954-4421
Genevieve Larson / [email protected] / 415-954-4931
Kristine Waggener / [email protected] / 415-954-4972
Mark Weaver / [email protected] / 415-954-4473