When Does Permanent Mean Temporary?

The American Taxpayer Relief Act of 2012 (ATRA) made the estate tax exempt amount permanent at 5.25 million, indexed for inflation. However, the Obama administration has proposed to make the exempt amount 3.5 million starting in 2018. See, http://www.treasury.gov/resource-center/tax-policy/Documents/General-Explanations-FY2014.pdf

Is this absurd? Yes.
Does it create uncertainty? Yes.
Is it in keeping with this administrations agenda? Yes.
What’s the take away?

If you thought estate tax was entirely off the table in terms of concerns because the exemption amount was so high, then it is time to think twice.

ATRA also made portability permanent. What is “portability”? It is a new concept that allows one spouse to use another spouse’s exemption. So, if it goes to 3.5 million, then a married couple can avoid taxes on 7 million. But wait….portability is not indexed for inflation. So, if one were to rely open the portability feature to be at ease re: the estate tax, please be aware that the income and growth that may accrue in a tax sheltered trust (a credit shelter trust or a family trust for the benefit of the survivor) is also protected from being exposed to the state tax. So, conversely, if one were to rely on portability as the strategy to avoid estate taxes, then be aware that the “income and growth” on the assets that the survivor inherits will also be subject to the estate tax.

For example, let’s say a husband and wife (Jack and Jill) have 6 million in assets (including the proceeds in life insurance). They feel as if ATRA makes it so they DO NOT need to leave assets to the survivor in a tax sheltered and asset protected trust. So, let’s see how this plays out. Assume Jill survives Jack and inherits all the assets free of trust. So, now Jill has 6 million. She and her family feel safe because 5.25 plus 5.25 is 10.5 million and they are almost certain there will be no estate tax exposure. But, let’s assume that the exemption amount goes to 3.5 million. Now, there is 7 million that can be protected. Jill’s family is still safe from the estate tax when Jill passes, right? Not if Jill lives many more years, we have more inflation and her assets appreciate. Let’s say that the 6 million turns into 8 million over the course of twenty years (Jill’s surviving years). If that happens and the estate tax exemption is at 3.5 million, then the amount that is exempt under portability is 7 million. Well, 8 million is 1 million more than 7 million. Result: Estate taxes due on 1 million. That’s not good planning.

Furthermore, the free of trust to spouse distribution does nothing to ensure assets will stay in the family. Why? The survivor could re-marry, could meet someone else, could be taken advantage of by someone else. Many things could happen. Leaving assets in a tax sheltered trust can protect the assets from creditors and lawsuits and guarantee remainder stays in the blood family.

Contributed by: Mark F. Winn, Master of Laws (LL.M.) in Estate Planning, a local asset protection, estate planning and elder law attorney.