Clarifying Estate of Confusion

By Jackie Russell

Although used by Mark Twain, the quotation that, “The only two certainties in life are death and taxes,” actually originated in a 1789 letter from Benjamin Franklin to Jean-Baptiste Leroy. While thinking about either of these matters is not particularly pleasant, thinking about both at the same time can be downright painful. The Economic Growth and Tax Relief Reconciliation Act (“EGTRRA”) of 2001 (which was designed in part to repeal generation skipping (“GST”) and estate taxes) temporarily minimized this pain but, because it was subject to sunset provisions after December 31, 2010, it remains important for many of us to understand the basic tenets of estate planning (assuming, of course, that your Uncle Sam is not your favorite relative).

Current estate law is incorporated in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“2010 Tax Act”) which revised the estate, gift and generation skipping transfer (“GST”) taxes through 2012. The GST tax is a tax in addition to the regular gift or estate tax for transfers of property having a value in excess of the $13,000 annual gift tax exclusion (the amount you can give away to any individual each year tax free) to someone two or more generations below the donor (e.g. when a grandparent gives property to grandchild). The 2010 Tax Act increased the federal estate exemption to $5 million per individual and lowered the top marginal rate to 35% for estate, gift and GST taxes. The federal estate exemption is the amount that can be transferred over a person's lifetime and/or at death free of gift tax and estate tax. So, for example, if you used $2 million of the exemption on taxable lifetime gifts, then you will only be able to pass $3 million to your heirs tax free.

The 2010 Tax Act allows the $5 million exemption to be portable between spouses, which mean a married couple may be able to transfer up to $10 million tax free. However, be careful if you choose to only rely on portability when planning for your estate because portability does not apply to GST taxes and because it currently only applies if both spouses die between December 31, 2010 and January 1, 2013. Lastly, portability is not automatic, so an estate tax return should be filed when the first spouse dies, even if no tax is due, in order to transfer the unused exemption to the surviving spouse. If the executor does not file the estate tax return or misses the deadline (9 months after death or 15 months after death if a 6 month extension is filed), the surviving spouse loses the right to portability.

Now you may be thinking your spouse and you currently have only $1 million in assets and that there is no way that you will ever have combined assets over $5 million so there is no reason to spend money to file an estate tax return electing the $5 million portability. But stranger things have happened and there are a myriad of ways that one’s net worth can grow (even if you don’t win the lottery). For example, assume you made an investment in your son's start-up business a couple of years ago, which is now worth $7 million, which puts your total estate at $8 million. If you do not sell the investment before your death, then it will be included in your estate and your estate and/or heirs will have to pay estate taxes of 35% on the aforementioned $3 million (or $1,050,000). Worse, this could result in your estate and/or heirs having to sell some of the assets to pay such taxes which could cause conflict among family members because of sentimental or other concerns. This is one of the reasons life insurance is a popular tool in estate planning - because it can be used to pay some or all of the estate taxes.

So what will happen after December 31, 2012? Well, the sunset provision of the 2010 Tax Act calls for the estate exemption to return to $1 million with a top tax rate of 55%. Is it likely for Congress to allow the exemption to return to $1 million in two years, which is an election year? Will portability provisions be extended beyond December 31, 2012? Well, no one knows for sure, but it would be wise to recognize there is actually a third uncertainty in life – namely, that the only thing certain about the future is that it is uncertain. This is another reason to consider using life insurance as an estate planning tool as it helps you be prepared for potential changes. But whatever happens in the future, the old saying, "Hope for the best, but plan for the worst," applies to estate, gift, and generation-skipping transfer taxes.

About the Author
Jackie Russell is a tax accountant with Kingery & Crouse, PA in Tampa, FL. Kingery & Crouse, P.A. is a full service public accounting firm with a staff of dedicated professionals providing audit (including SEC and employee benefit plan audits), tax and accounting services. You may contact Kingery & Crouse at (813) 874-1280 or find us on the web @ www.tampacpa.com.