Tax changes that President Barack Obama and Congress hammered out in the final days of 2010 discouraged clients from seeking estate planning advice last year, even though estate lawyers insist that there are many planning opportunities that shouldn’t be missed.
It seems that the $5 million estate tax exemption for 2011 and 2012 has all but eliminated “estate tax avoidance” as a motivating factor for clients. With the $5 million exemption, a lot of people breathed a sigh of relief because they said, “I don’t have that much.” It seemed to diminish the concern for estate planning as motivated by the estate tax. It probably took until September for advisers to realize that this really is a planning opportunity for high-net-worth families.
There is so much uncertainty at this time, it’s difficult to give suggestions without saying that the benefits will vary based upon where estate and income tax rates, and estate and gift exemptions, wind up in 2013. Most of 2011 became a year for figuring out how to take advantage of the $5 million exemption before it disappears.
The very wealthy should be planning very aggressively and taking significant advantage of what may be a small window of opportunity. We don’t know what tomorrow will bring. After a temporary suspension in 2010, the estate tax rate had been poised to jump to 55% with a $1 million exemption, or $2 million for couples. Instead, the rate was set at 35% for two years and applies only to estates worth more than $5 million, or $10 million for couples. This year, the president and Congress again will have to address the estate tax issue, as these parameters expire at the end of the year.
The estate tax exemption is tied to the lifetime gift tax exemption, meaning that amounts given away as gifts will be subtracted from the estate tax exemption after death. The big key now is to develop flexible estate plans that work with formulas instead of numbers to retain the integrity of the plan even when there are law changes.
In the end, it appears that the top three reasons that clients sought estate planning last year was to avoid chaos and discord among beneficiaries, to avoid probate and to protect children from mismanaging their inheritance. Minimizing or avoiding estate tax seems to be further down on the list of people’s concerns until they realize just how much the estate may end up paying. For clients with more than $5 million, the time to act is now as 2012 is going to go by quickly.
But there is a possible problem. Even though lifetime gifts of below $5 million during 2012 escape gift tax, the way the Tax Code is now written, if the donor dies in 2013 or later, the applicable exclusion amount reverts to $1 million. As a result, lifetime gifts of over $1 million are “clawed back” into the transfer tax system without the protection of a $5 million applicable exclusion amount, and presto, there’s an estate tax on what had been free of gift tax. Congress could fix this, and even seems to want to, but ongoing legislative dysfunction will darken the chances.
This clawback doesn’t necessarily make it worse for the donor or the estate. Instead of paying a gift tax on the transfer, an estate tax is paid, so it’s pretty much a wash. One advantage is that the donor does get the asset out of his estate and any additional appreciation on the asset goes to the donee. A possible disadvantage or problem is that there may not be enough assets in the estate to pay the estate tax if it now includes taxes from past gifts. A qualified estate planning attorney or tax professional is needed figure out if it’s worth doing the gifting now or waiting until the assets pass through the estate.