The Good News: Beneficial Changes to Federal Law for 2011 and 2012After months of negotiations following the lapse of the Federal estate tax for 2010, Congress finally got around to enacting new estate tax rules at the end of last year. On December 17, 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 was enacted which dramatically increased the number of estates exempt from Federal estate and gift taxes. Specifically, the following features were included in the new law regarding estate and gift taxes:• The amount exempt from estate tax was increased to $5 million (from $3.5 million in 2009) for those who die in 2011 and 2012.
• The lifetime gift tax exemption was increased from $1 million to $5 million and “unified” to the full extent with the estate exemption – meaning a person can make a combined total of lifetime gifts and bequests at their death of $5 million or less and avoid paying any Federal taxes. The federal generation-skipping transfer tax exemption was similarly increased to $5 million (from $3.5 million in 2009)
• The maximum estate tax rate was reduced to 35% (from 45% in 2009).
• The new law also introduced the concept of “portability” into a married couples’ estate tax exemptions – “portability” allows the surviving spouse to utilize any unused portion of the $5 million exemption from the estate of their spouse who dies in 2011 or 2012.The Bad News: No Guidance For 2013 and BeyondFor whatever reason, Congress decided to sunset the new rules at the end of 2012 which will result in estate, gift and generation-skipping transfer tax exemptions all reverting to $1 million starting in 2013. The future of spousal exemption “portability” also remains unknown. Additionally, the highest tax rate will increase from 35% to 55%. While we can hope that Congress will at least extend these provisions, it is impossible to tell what the political landscape will look like in 2012 and 2013 when Congress will once again decide what the Federal estate and gift tax scheme will be. Therefore, it is imperative that current Estate Plans have built-in flexibility regarding disclaimer and trust provisions to allow beneficiaries to take full advantage of whatever the tax laws may be in the future.The Ugly: Washington State Estate Taxes Remain UnchangedWhile it may seem like the changes now exempt nearly all estates from estate and gift taxes (at least until 2013), Washington State has its own estate tax on estates valued over $2 million which is unaffected by the changes at the federal level. Furthermore, the “portability” provision of the Federal estate tax does not apply for Washington State estate tax purposes. While direct transfers to a surviving spouse are completely exempt from both Federal and state estate taxes at the death of the first spouse (the amount of gifts to a surviving spouse are deducted from the gross estate of the deceased), this deduction only defers Washington State tax on the estate until the death of the surviving spouse. Simply put, this means that the combined estate of a Washington State couple will be subject to Washington estate taxes to the extent it is worth more than $2 million upon the death of the second spouse, unless appropriate tax planning measures are including in the Estate Plan. Furthermore, because the taxable estate includes both probate and non-probate assets (including life insurance and retirement accounts) it is clear that many should be concerned about state taxes when discussing their Estate Plan.It is possible that the Washington legislature may enact changes to our estate tax laws, but if anything it is more likely they will raise, not lower, the tax given past history and the current economic situation of our state budget. In fact, in early 2010 a bill was introduced to double the current Washington State estate tax rates to 20% to 38%.I cannot stress how important it is to discuss state tax implications on your estate
with your attorney when reviewing your Estate Plan.ExamplesI have prepared the following hypotheticals to illustrate the importance of an Estate Plan incorporating specific provisions regarding Washington State taxes. My hypotheticals assume the following:
• All state and federal exemptions and tax rates stay the same.
• All of the couples have simple wills giving the entire estate outright to the surviving spouse and the surviving spouse bequests their estate to their children.
• All property is owned as community property.1. A moderately wealthy retired couple living in Washington State have the following assets:1. Primary residence (worth $800,000; mortgage of $300,000) $500,000
2. Vacation/rental property (worth $400,000, mortgage $200,000) $200,000
3. Bank accounts/CD’s/Money markets $200,000
4. Stocks/Bonds/Investments $250,000
5. IRA’s/401k/Retirement Accounts $600,000
6. Life insurance death benefits (for husband) $600,000
7. Cars/Boats/RV $100,000
8. Misc. Personal Property (art, jewelry, clothes, etc.) $50,000
Total $2,500,000If Husband dies in 2011, his taxable estate in Washington includes all separate property and of the community property. Since the total Community Property is $2,500,000 the taxable estate is of that ($1,250,000). Since all of his assets pass to his surviving spouse, there is no estate tax.Now suppose the surviving Wife lives off the income generated from the assets and the size of her estate at her death is $2.5 million. Since there is no “portability” of the husband’s unused state exemption of $2 million, there will be Washington estate tax due on $500,000 of the $2.5 million estate (the amount in excess of Wife’s $2 million exemption). At current rates this equals $50,000 due to Washington State. While this amount is not a huge amount and only represents 2% of the estate, it could have been avoided entirely for a fraction of the cost through successful Estate Planning.A simple way to avoid all taxes on both estates: While there are numerous Estate Planning techniques that could have avoided all state taxes, the simplest would be that the Husband’s will should have passed on a portion of the estate to beneficiaries other than his wife in a trust which could still provide Wife with the income generated from those assets during her life. Suppose Husband’s will had given at least $500,000 to his children in a credit shelter trust (or given his Wife the ability to disclaim a portion of the estate into a disclaimer trust with the children as ultimate beneficiaries) which provided that the income be used to support his wife during her life. His wife would be no worse off since she could live off the income generated from both her assets and the trust assets. Then when she dies, her estate consists of no more than $2,000,000, the credit shelter trust assets pass automatically to the children and are not part of Wife’s estate, and everything is completely exempt from Washington State estate tax.More assets = Happier Washington State Department of Revenue.2. A working professional couple living in Washington State with the following:1. Primary residence (worth $500,000; mortgage of $300,000) $200,000
2. Bank accounts/CD’s/Money markets $50,000
3. Stocks/Bonds/Investments $100,000
4. IRA’s/401k/Retirement Accounts $250,000
5. Term life insurance death benefits (for husband) $1,000,000
6. Cars $40,000
7. Misc. Personal Property (art, jewelry, clothes, etc.) $10,000
Total $1,650,000Husband and Wife have thought about Estate Planning only briefly and have established very simple wills each giving everything to the surviving spouse. They have forgotten to account for the large term-life policy in the husband’s name and think that their moderate assets of $650,000 (without the life insurance benefits) shouldn’t really cause any tax problems for their children. This hypothetical is slightly different from the first in that we will assume that the assets will appreciate between the death of the Husband in 2011 and the death of the Wife.Upon the untimely death of the Husband, his estate is worth $825,000 ( of the total community property). Assume that the Wife amasses more wealth and upon her death the $1,650,000 assets have grown to $2,000,000 and she also has a term life policy of $500,000. The taxable portion of her estate will be $500,000 (after the $2 million exemption) resulting in a tax bill of $50,000. If her estate were to be larger, even more tax would be due. This tax could have been avoided if the Husband’s will had provided Wife with the ability to disclaim some of the property into a disclaimer trust naming the children as ultimate beneficiaries (or establishing a credit shelter trust) paying Wife all income and even principal as necessary for her support.