Rethinking planning for couples with estates under $5 millionArticle added by Julius Giarmarco on March 21, 2013
Julius Giarmarco

Julius Giarmarco

Troy, MI

Joined: July 07, 2008

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The American Taxpayer Relief Act of 2012 gives us 1) transfer tax certainty; 2) a large indexed transfer tax exemption ($5.25 million for 2013); and 3) portability of the first deceased spouse's unused estate tax exemption. As a result, estimates are that 99.8 percent of Americans will no longer be subject to federal estate taxes. But income tax changes may significantly impact trusts, because the top income tax rate (39.6 percent) and the 3.8 percent Medicare tax (on net investment income) apply to trusts with undistributed income of only $11,950 in 2013.

In light of these changes, planners need to rethink traditional planning concepts — particularly credit shelter trusts (CSTs). Using a CST to hold the deceased spouse's estate tax exemption poses two major problems. First, the undistributed net investment income of the CST will be taxed at 43.4 percent (39.6 percent + 3.8 percent) on amounts over $11,950 for 2013. Second, there is no stepped-up basis for the appreciation on the assets in the CST from the date of the first spouse's death until the death of the surviving spouse.

In contrast, a revocable living trust leaving all of the assets outright to the surviving spouse will achieve a basis adjustment at the death of both spouses. Moreover, any income will be taxed at the spouse's tax bracket, which does not reach the 39.6 percent rate until $400,000 of income. Further, exposure to the 3.8 percent Medicare tax does not occur until income exceeds $200,000.

Of course, a CST may still be advisable for other reasons, including protecting a spouse who is not capable of managing assets, protecting children from a prior marriage in blended families, removing the appreciation on the assets in the CST from the surviving spouse's estate, and asset/divorce protection.

If a CST is desired for preservation, management or asset protection purposes, giving the surviving spouse a testamentary general power of appointment may be helpful to allow a basis adjustment at the surviving spouse's death. And, by having the CST distribute its income to the surviving spouse (or other beneficiaries), the income tax burden (and rate) shifts to the spouse (or the other beneficiaries receiving the income).

Many couples with nontaxable estates, particularly those with children all from the same marriage, will prefer to simply leave their estate to the surviving spouse. But, for the reasons mentioned above, they may want the ability to utilize a CST. The solution may be a disclaimer trust. With a disclaimer trust, a married couple’s revocable living trusts leave the deceased spouse’s entire estate to the surviving spouse. The CST is then funded only if the surviving spouse disclaims (refuses) part of the deceased spouse’s estate. This enables the surviving spouse to decide how much to keep outright (to be taxed at the second death) and the amount to be allocated to the CST (which is shielded from estate tax at the second death).
For married couples who live in states that have their own estate tax, postponing the federal estate tax until the death of the surviving spouse by using a CST could result in a state death tax at the first spouse’s death. This can occur if the state’s estate tax exemption is less than the federal estate tax exemption.

Another factor is whether state law provides for an unlimited marital deduction against the state death tax. By using a disclaimer trust, the surviving spouse, upon the advice of counsel, will be able to determine whether it is more or less advantageous to fully fund the CST and pay any state death tax. In making an informed decision to disclaim and how much to disclaim, one must examine the size of the combined estate, the surviving spouse’s age and health (which impacts the spouse’s need for funds), whether minor children will be beneficiaries of the CST, the potential for appreciation in the assets not disclaimed, the status of the estate tax exemption, and the applicability of a state death tax. The actual disclaimer must meet certain legal requirements and the surviving spouse must not accept any benefits from the assets to be disclaimed before making the disclaimer.

Accordingly, couples with estates of $5 million or less who have living trusts utilizing the popular reduced-to-zero marital - credit shelter trust formula are well advised to have their estate plans reviewed.

THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS
BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT
INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL
AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.
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