I recommend to my executive and professional readers the following topical article authored by the estate planners and tax planners of my law firm, Hoogendoorn & Talbot LLP:

The flurry of tax legislation enacted by Congress and approved by President Obama in mid-December left almost everyone a bit breathless.  Numerous news articles have already been published about the major provisions and many financial advisors have circulated e-mails on details of the legislation.  Estate tax legislation was a prominent part of the action and it is important for every client to take note of the major items from that legislation which may have an impact on a client’s personal estate and on estate planning considerations.  

Estate Tax Provisions

In 2001, the new Bush administration enacted estate tax legislation which substantially increased the federal estate tax exemption to $3,500,000 by 2009. We fully expected Congress to enact legislation extending the 2009 estate tax provisions prior to 2010. Instead, nothing was done and the federal estate tax expired for 2010, being replaced by special capital gains tax provisions.

The estate tax rules that existed prior to the 2001 act, namely an estate tax exemption of $1,000,000, was scheduled to be reinstated in 2011, barring Congressional action.

Surprisingly, in mid-December the lame duck Congress reinstated the 2009 estate tax with several revisions as follows:

1. The estate tax exemption is increased to $5,000,000 per individual (adjusted for inflation beginning in 2012).

2. Any portion of the $5,000,000 personal exemption not used at the death of the first to die of a married couple can be used by the surviving spouse (referred to as “portability”).

3. The estate and gift taxes were reunified, thus increasing the gift tax exemption from $1,000,000 to $5,000,000. In other words, the $5,000,000 exemption can be either used during life or preserved until death.

4. The generation-skipping tax exemption likewise is increased to $5,000,000.

5. The estate, gift and generation-skipping tax rate applicable in 2011 and 2012 is 35%, replacing the 45% rate applicable in 2009.

6. Unless Congress and the President take further action by December 31, 2012, the estate tax rules that existed prior to the 2001 act (namely a $1,000,000 exemption without portability between spouses and a maximum 55% tax rate for estate, gift and generation-skipping tax purposes) go back into effect.

Estate Planning Responses

While most estate planning decisions are driven by concerns for immediate family and possible charitable interests, state and federal tax concerns have provided a significant overlay for those family and community concerns.

At Hoogendoorn & Talbot, our basic estate planning advice, employing “pour over” wills, living trusts and powers of attorney for property and health care, will not be affected by this new tax legislation. Furthermore, the tax planning modification that could be envisioned for those whose estates cannot realistically be expected to ever exceed the $5,000,000 per person or $10,000,000 per couple exemption amounts, must await more permanent Congressional action by late 2012 before eliminating tax planning complexities.

We have continued to revise the tax provisions in our estate planning language to cover the ever changing federal estate tax scenarios. Furthermore, state estate tax scenarios often have been as unstable as the federal scenarios. While about half of the states have no estate tax, the other half have either an inheritance tax or an estate tax.

Those with an estate tax generally are tied closely to the federal system as it existed in 2001 before any changes were made. As an example, the Illinois estate tax with a $2,000,000 per person exemption in 2009 expired at the end of 2009, coinciding with the expiration of the federal estate tax. At the time of the December federal tax legislation, there was no Illinois estate tax. However, on January 11 the Illinois legislature in a late night session not only increased the individual Illinois income tax rates by 67% but also reintroduced the Illinois estate tax in effect in 2009 with a $2,000,000 tax exemption. This substantial difference between the state and federal exemptions is a reality in numerous states and does necessitate the inclusion of special provisions in living trusts.

While many people deferred new estate plans or reviews of existing estate plans during 2010 awaiting clear direction from Washington, additional deferral of planning or reviews would appear to be futile. Long periods of certainty on the estate and gift tax fronts appear to be a condition of the past. While our principal estate and gift tax planning advice will be based on the assumption that Congress is psychologically and politically incapable of taking back what once has been given (suggesting the permanence of the $5,000,000 per person exemption and the 35% maximum rate), our wills and trusts will continue to cover the possibility that a highly polarized Congressional situation in Washington could result in a temporary return to the $1,000,000 per person/55% maximum rate in 2013.

Those individuals who have been looking for additional gifting opportunities, having used up most or all of their $1,000,000 lifetime gift tax exemption in effect over the last ten years, may want to consider taking early advantage of the new $5,000,000 gift tax exemption in effect for 2011 and 2012.

There is no assurance that this large gift tax exemption will be maintained beyond 2012, even if the exemption available at death remains at $5,000,000. Furthermore, lifetime gifts are not taxed in most states. Accordingly, transfers during life completely avoid any transfer tax in those states which have only an inheritance or estate tax. Those tax rates generally reach 16%.

In summary, we encourage our clients to use this opportunity to revisit their estate plans and to continue periodic estate planning reviews, recognizing that personal, familial and financial changes will remain the central focus of such reviews, and that federal and state tax considerations will continue to be based on ever changing laws.

Income Tax Provisions

The December tax legislation included numerous income tax provisions that are of interest to every client. The reduced income tax rates that were scheduled to expire, especially the 15% rate on dividends and capital gains, has not escaped the attention of most people. A number of additional benefits for both middle and upper income taxpayers were included, such as a Social Security tax reduction on the employee portion of the tax from 6.2% to 4.2% for two years, no phase out of the personal exemption for higher income taxpayers, no reduction of the itemized deduction for higher income taxpayers, an increase in the alternative minimum tax exemption, and a host of other relatively minor tax benefits.

More immediately relevant to longer term estate and tax planning has been the extension through 2011 and 2012 of two provisions impacting individual retirement accounts. Anyone over age 70½ may donate up to $100,000 per year from their IRA to charity, thereby satisfying their required minimum distribution on a dollar for dollar basis. Additionally, anyone with an IRA, regardless of age and income level, may elect to withdraw the IRA, pay the tax due on the withdrawal and roll the withdrawn amount into a Roth IRA, withdrawals from which will be entirely free of federal income taxes (subject to certain early withdrawal and age limitations).

It is important to be aware that the ability to give required minimum distributions to charity is primarily beneficial to residents of states which tax retirement benefits. Residents of states such as Florida and Illinois, which either have no state income tax or do not tax qualified retirement benefits, currently realize virtually no benefit from this tax provision unless they are bumping up against the charitable deduction limitation of 50% of adjusted taxable income – a not unusual situation for retired individuals with relatively substantial assets and relatively modest income.

It is also important to be aware that the conversion of an IRA into a Roth IRA generally is recommended only for those who (1) always are likely to be in or near the highest income tax rates, (2) would prefer not to make IRA withdrawals to cover normal living expenses but would prefer to let the IRA accumulate and (3) are not considering a gift of remaining, untaxed IRAs to charity at death.

Conclusion

These comments are intended to provide a bird’s eye view of those aspects of the December tax act that are more directly applicable to estate planning clients. There may be other features of the law about which you have read and about which you have further questions. Whether your questions relate to these tax concerns or to estate planning questions apart from these tax issues, we encourage inquiries and requests for an appointment for an estate planning review, both for existing clients and for any reader who would like to consider becoming a client.  This Alert is a publication of Hoogendoorn & Talbot LLP and is intended to provide clients and friends with information on recent legal developments. This Alert should not be construed as legal advice or an opinion on specific situations. For further information, feel free to contact members of the firm.

Copyright 2011 by Hoogendoorn & Talbot LLP
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