Happy Not-so-New Year!

For many of us in the estate planning world, we look at the first of January as the deadline for making the highest and best use of the tax laws before they revert to some draconian scheme to scrape the life savings out of the hands of the small business owner or widow at death. Let’s look at a couple key legislative acts and their impact on taxpayers.

Economic Growth and Tax Relief Reconciliation Act of 2001

Since the Economic Growth and Tax Relief Reconciliation Act of 2001 (known as EGTRA) was passed, January First has signaled the annual change in the estate tax laws concerning the amount of assets a decedent may leave to his or her loved ones. The two numbers Congress has to work with are the Exclusion Amount and the Tax Rate.

•  The Exclusion Amount represents that maximum dollar amount that a taxpayer can pass to his or her heirs without incurring an estate tax.

•  The Tax Rate is that percentage confiscated by the Federal government above the Exclusion amount.

While the Exclusion amount has increased steadily since 2001, the Tax Rate has increased, as well which means taxpayers can leave larger amounts to their heirs, but the government gets a bigger cut over and above that amount.

From 2001 to 2009, the Exclusion Amount and the Tax Rate were in flux. However, we knew where they were headed, as the changes already were drafted into the Act. The concern was the looming “sunset” of 2009 to 2010. Estate planners could only guess what would occur in 2010 and thereafter.

As it turned out (with the benefit of hindsight) Congress did not act in time to fill the void left by the sun setting EGTRA. In 2010 there was an unlimited estate tax exclusion, meaning those who died in 2010 could pass their entire estates to their loved one’s estate tax free. While anecdotal evidence suggests a few people may have traveled overseas seeking assisted suicide before midnight, the best story came from the passing of George Steinbrenner, owner of the New York Yankees, who died on July 13, 2010 (see full article here)

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American Taxpayer Relief Act of 2012

During the years of EGTRA the estate tax, the gift tax and the generation skipping tax were considered three different buckets from which taxpayers could draw various exclusions or exemptions. That changed in 2011, with the passing of the American Taxpayer Relief Act of 2012 (known as ATRA). ATRA combined the three buckets into a single unified bucket, regardless of what the taxpayer planned to do with the funds – whether gift during life or transfer at death. This was intended to simplify the tax regimes. Rather than keeping track of assets used for gifting purposes, generation-skipping purposes, or held and later applied against the estate tax, taxpayers only need to keep up with a single number. Whether they use the amount during life or at death, it all comes from the same bucket now.

Since 2011 the exclusion amount has remained relatively steady. The law identifies the exclusion amount as $5 million per taxpayer and allows for adjustment of this number for inflation. Over the life of the Act, the exclusion amount has increased with inflation from $5 million to its current $5.49 million on January 1, 2017. As the clocks struck midnight on December 31st to January 1st 2017, while the world celebrated the new year, estate planners breathed a sigh of relief that the laws would remain relatively constant for another year.

What does this mean for the taxpayer?

When comparing the traditional income tax rates to the historic estate tax rates, the estate tax rate was substantially more concerning since at times it reached as high as fifty-five percent. The focus has been on reducing the estate tax liability, because the risk was to lose more than half of the estate to taxes at death.

With the estate exclusion amount at a record high, the need to remove assets from the estate prior to death has been reduced. Now that we can turn our attention away from the estate tax momentarily, we can spend more time minimizing the income tax liability. Traditionally, as we age, our income tax liability increases since our earnings increase with experience and longevity. Upon retirement, our earnings decrease, as does our income tax bracket.

How can we take advantage of these seemingly constant movements? It is important to consider the multi-generational effect of taxes. Usually we think of estate planning as the transfer of assets from an older generation to a younger generation. In the new high exemption regime, we often consider the benefit of transferring from the younger generation to the older generation. The reason we do this is to realize the step-up in basis at the death of the older generation. Stepup in basis is the readjustment of the value of an appreciated asset for tax purposes upon inheritance, determined to be the higher market value of the asset at the time of inheritance. When an asset is passed on to a beneficiary, its value is typically more than what it was when the original owner acquired it.

If the younger generation sells a highly-appreciated asset, the risk is a high income tax liability. However, if the older generation owns the asset at death, the younger generation can inherit the asset back with the date-of-death value as the new basis. This is a very basic explanation of the technique, and there are many factors to consider, such as the three-year look-back, the affect on government benefits to the older generation and many others.

The take-away is that it is important for all of the generations involved to communicate with each other and make sure that their plans coincide. What one generation may perceive as beneficial may be detrimental to the previous or successive generations.


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