As Jan. 1, 2013, approaches, attention is turning once again to the estate tax and the form it should take. The current estate tax regime is set to expire at the end of the year, with the 35 percent top rate and $5 million exclusion level slated to return to the pre-2001 scheme of a $1 million applicable exclusion and a 55 percent maximum rate.
Whether the rules revert to the former rates, or something in between, the unpredictability itself lends to increased costs. "It's tough planning because the law changes every two years," said Palmer Schoening, director of federal affairs at the American Family Business Institute. "It costs more money to plan for and creates uncertainty, which is almost an added tax."
The American Bar Association Tax Section has come up with a set of goals, starting with the need for predictability and stability in the federal transfer tax system. "When the transfer tax laws are unstable and unpredictable, as they have been for the past decade, responsibly planning one's affairs is a project fraught with frustration," according to its statement.
Thomas Duerr, CPA, managing partner and co-founder of Buffalo, N.Y.-based WNY Asset Management LLC, agreed: "It's difficult to forecast the tax impacts on planning, because you're dealing with this ever-flowing tax system," he said. "What the rates are today may not be what they will be on your client's death bed, so in all cases you're guessing."
"We're hoping that any reform brings some sort of long-term stability to the rates," he said. "The answer is to come up with a fair representation of what should be taxed, and leave it alone for long periods of time."
Larry Peck, a New York-based estate planning attorney, noted that the unpredictability of the rules often leads to inaction on the part of clients. "They want to wait until they can figure out what needs to be done," he said.
"But even under the Bush tax cuts, the changes were predictable," he observed. "There wasn't the political uncertainty then that there is today. Now, we don't know if the estate tax will be abolished altogether or go back to the way it was in 2001."
The current unified estate and gift tax exclusion amount is a good thing, according to the ABA Tax Section, and should be continued in any reform.
The reason for de-unification was that the Republicans thought that the estate tax was going to eventually be eliminated, Peck noted. "They wanted to eliminate the estate tax, but not the income tax," he explained. "If there were no gift tax, then parents could transfer assets to children in lower income tax brackets, reducing their income tax liability, and the assets could be transferred back whenever they wanted. That's why they kept the gift tax exemption at a million, because without it there would be the possibility of too much income-tax shifting."
The ABA Tax Section proposal would make permanent the estate, generation-skipping, and gift tax parameters as they applied during 2009. The top tax rate would be 45 percent and the exclusion amount would be $3.5 million for estate and GST taxes, and $1 million for gift taxes. The portability of the unused estate and gift tax exclusion between spouses would be made permanent.
PORTABILITY PROBLEMS
The portability provision currently in place provides, in general terms, that if one spouse does not fully utilize their entire $5 million applicable exclusion amount, the unused portion can be used by the surviving spouse's estate, observed Peck. "Its goal is noble," he said. "The idea is to protect the clients who don't have wills, or who go to lawyers who are general practitioners and end up with no wills or simple wills, and where a sizeable estate can lead to wasting of the exemption of the first-to-die."
"Just because you have portability doesn't mean you end up ahead," he cautioned. "With portability, there's no inflation adjustment to account for the time value of money between the first and the second death. The answer to that issue is a credit shelter trust. It's established at the death of the first spouse to die. It can be set up in a will or as a revocable trust."
"As an example, assume there are 10 years between the first and second death," Peck said. "With a 5 percent return on assets, if you put $5 million into a credit shelter trust and re-invest, at the second death the trust would be worth $8 million. If you relied simply on portability, you would only have been able to transfer the $5 million exemption amount to the surviving spouse."
Moreover, the portability provision applies only to the federal estate tax, but not to states with separate estate tax regimes, Peck noted. "No state that has an estate tax applies portability," he said. "The best way to minimize state estate tax is to use a credit shelter trust of at least the amount of the state estate tax exemption."
LOOKING FORWARD
What is likely to happen, hopefully before the end of the year, is a one- or two-year extension of the current policy, according to the American Family Business Institute's Schoening. "One year is more likely," he said. "At the same time, the general consensus that the estate tax is unwise is growing. After the elections there's a better chance to pass a more friendly law."
By "friendly," Schoening includes no estate tax at all, such as was the case for the entire year during 2010.
"There's a growing consensus that [the estate tax] is unwise," he said. "States typically act faster than the federal government, and a number have put their state inheritance tax on the path to repeal. Ohio repealed its estate tax last year, and both Tennessee and Indiana will phase out their tax over the next few years."
"Whatever deal passes will likely be done in a lame-duck session of Congress," he said. "In terms of what actually passes, it will be contingent on what happens in the November elections."
