2012: A Golden Opportunity for Estate Planning

2012: A Golden Opportunity for Estate Planning

By Jarod A. Cauzza

The current state of our economy has left thousands reeling to find that next dollar and maybe more importantly how to keep what we already own. Estate planning is one of the best ways to accomplish this goal and there is no better to time create or revise your estate plans. The laws in effect for 2012 are some of the most favorable for estate planners in the past 80 years. For that reason, 2012 presents a golden opportunity to reduce your future estate tax liability, capitalize on your lifetime taxable gift tax exemptions, and take advantage of current portability options.
 

Beneficial Estate Planning Laws in 2012

In 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Tax Relief Act”). The Tax Relief Act made a number of significant changes to the laws related to estate planning. However, these changes are only guaranteed to be in effect through 2012 as the Tax Relief Act is currently set to expire on December 31, 2012. Therefore, this year may be your last opportunity to cash-in on the current benefits of the Tax Relief Act. 
 
These benefits include:
 
  • Introducing the concept of portability to estate tax exemptions for spouses;
  • Increasing the estate tax and GST tax exemption amounts to $5 million ($5,120,000 in 2012 – adjusted for inflation); and,
  • Increasing the lifetime gift tax exemption for 2011 and 2012.
First, portability allows for the preservation of the unused potion of a deceased spouse’s estate tax exemption in 2011 and 2012, regardless of the total value of their estate. Second, increasing the estate and generation-skipping transfer (“GST”) tax exemptions ensure that even more assets will be distributed to a decedent’s beneficiaries without incurring estate taxes. Third, raising the lifetime gift tax exemption amount to $5 million creates a number of planning possibilities for those wishing to decrease the size of their taxable estate while they are still alive. Consulting with an estate planner on the best ways to capitalize on these benefits over the course of the year may greatly enhance your estate planning goals.
 

Spousal Portability – A Preservation of Wealth

Under the current federal estate tax scheme, a person may transfer an unlimited amount to their surviving spouse tax-free upon their death. This is known as the unlimited marital deduction. The unlimited marital deduction reduces the deceased’s taxable estate (the amount of a deceased’s estate subject to estate tax). Any assets not transferred to the deceased’s surviving spouse upon their death will remain in the deceased’s taxable estate and may be subject to estate tax. 
 
For example, say John dies in 2012 with a taxable estate worth $3 million dollars. He leaves $2 million to his wife, Jane (who’s own estate is worth $4 million) and the rest he leaves to his kids. The value of his estate subject to estate tax would be $1 million dollars. 
 
In addition to the unlimited marital deduction, when someone dies they are given a “tax credit”. This credit, which is the sole property of the deceased, eliminates any estate tax on the deceased’s taxable estate up to a certain amount. This amount, known as the federal estate tax exemption, changes annually. In 2012, the value of the federal estate tax exemption is $5 million dollars. Therefore, someone dying in 2012 is given a credit allowing them to transfer up to $5 million dollars to the heirs of tax-free. In the example above, the use of this credit would wipe out any estate tax owed on the $1 million dollars left to John’s kids. 
 
There is no requirement a person apply their credit to their taxable estate upon their death. For instance, in the example above had John left his entire $3 million to Jane there would be need to use the credit as the unlimited marital deduction would have reduced his taxable estate to zero. However, now Jane has a $7 million dollar estate with no surviving spouse, so she cannot use the unlimited marital deduction. If she were to die in 2012, $2 million dollars of her estate would be subject to estate tax and John’s estate tax credit would have been wasted. Many spouses have failed to take full advantage of their federal estate tax credit by solely relying on their unlimited marital deduction to avoid estate taxes.
 
Prior to the passage of the Tax Relief Act, a person’s estate tax credit could not be assigned or transferred. It was either used or lost at that person’s death. However, the new portability provisions of the Tax Relief Act permit the unused portion of the deceased spouse’s estate tax credit to be transferred to their surviving spouse. This allows spouses to take full advantage of their estate tax credits. 
 
In our first example, John left $2 million to Jane (leaving her with $6 million total) and left $1 million to his kids. John used his tax credit to eliminate estate taxes on the $1 million he left to his children. However, John’s credit is worth $5 million dollars because he died in 2012. Without portability the remaining $4 million of John’s credit would be lost. But, under the rules of portability, Jane could make an election to receive the remainder of John’s credit to be used upon her death. Now, if Jane were to die in 2012 she would have a total of $9 million in estate tax credits. She could use these to eliminate the estate tax on her $6 million dollars; thus, savings approximately $500,000 in estate tax.
 
Unfortunately, portability is not automatic. The election must be made on the deceased’s Federal Estate Tax Return, which typically must be filed within nine months of the deceased’s death. Portability elections only apply to those dying after December 31, 2010 and are unique to surviving spouses. In addition, if a surviving spouse gets remarried they lose their right to portability even if they properly elected to receive it. 
 
Whether or not to elect to take advantage of portability in 2012 is an important decision that must be carefully considered. The cost of preparing an Estate Tax Return can vary. In addition, there is no guarantee the deceased’s estate tax credit will be completely preserved. Tax Relief Act is set to expire at the end of the year and future tax laws may eliminate portability altogether. However, regardless of the future changes in estate and gift tax law the only way to guarantee you will be able to possibly take advantage of the current benefits of portability is to act today.
 

Gifting Plans for 2012

From 2002 to 2010, the lifetime gift tax exemption was valued at $1 million. The Tax Relief Act raised the amount to $5 million dollars for gifts made in 2011 and 2012. This sharp increase allows individuals to gift away up to $5 million dollars of their taxable assets without incurring any gift tax in 2012. The primary benefit of making gifts during one’s lifetime is to reduce the size of one’s taxable estate. However, gifting away $5 million dollars in 2012 may not be the best way to achieve this goal and more reasonable gifting plans should be utilized. 
 
The reason individuals should be hesitate to go all-in in 2012 is because there is a possibility the gifts made in 2012 may be recaptured as estate taxes in the future. Estate and gift taxes go hand in hand, in that, any amount of gift tax exemption used during one’s lifetime will reduce that person’s estate tax exemption. For example, if something had made a gift of $1 million dollars in 2008 and died in 2012 their estate tax exemption amount would be $4 million instead of $5 million. 
 
Traditionally, this was not a problem because gift tax exemptions were lower than estate tax exemptions. But, the Tax Relief Act’s increase to $5 million may result in gifts made in 2012 creating estate tax liability in the future should exemptions levels drop. That being said, individuals should still consider gifting highly appreciable assets or real estate in 2012. One of the main benefits of making lifetime gifts is that it prevents the inclusion of appreciation in their taxable estate. This can be exceptionally beneficial in today’s real estate market with property levels at or near the bottom of the barrel. People can gift more real estate tax-free then they can once the market rebounds.
 
However, before deciding to gift away everything you own tomorrow you should know there are a number of gifts that can be made without affecting one’s lifetime gift tax exemption amount or incurring any gift tax. Individuals are allowed to gift up to $13,000 to as many people as they want tax-free. Spouses can gift as much as they want to each other.  Also, gifts made directly to pay someone’s educational and medical expenses are tax-free. These excluded gifts can be more beneficial that large donative transfers and are much less complicated. 
 

If Congress lets the Tax Relief Act expire at the end of the year, the applicable estate and gift tax exemptions will be each reduced to $1 million and the estate tax rate will increase to 55%. This could result in a lot of estates having to pay estate tax in the coming year. And with the economy continuing to struggle and both the Democrats and Republicans focused on the 2014 elections we cannot so easily expect there to be an extension of the Tax Relief Act. Portability and gifting are but two of the many options people should consider in this watershed year for estate planning. Estate and gift taxes can be complicated, so the only way to figure out what options are best suited for you and your loved ones is to talk to an accountant and/or qualified estate planning attorney. No one can predict the future, but that does not mean you cannot plan for it and there is no better time than the present.


Jarod A. Cauzza is an associate at Neil Dymott. His areas of practice include estate planning, trust administration and probate. For further information, Mr. Cauzza can be reached at (619) 238-1712 or jcauzza@neildymott.com

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