Federal estate-tax law permanence and NC repeal: Time to revisit your plans

Amid a host of headlines out of Raleigh is the news that North Carolina has repealed its estate tax. The tax, which featured a top rate of 16%, was payable by individuals with taxable estates in excess of $5,250,000. The repeal is retroactive to January 1, 2013.

The changes at the federal level are more complex and many of you have asked whether your estate plan should be altered in light of The American Tax Relief Act of 2012 (ATRA). ATRA finally makes permanent the exemption amount—the sum a single taxpayer can transfer to a beneficiary other than a spouse or charity without incurring the gift/estate tax. (A person can transfer unlimited amounts to a spouse or charity, so this tax and the exemption typically apply when assets are transferred to children or grandchildren or trusts for their benefit.) Also, ATRA changes the rate that would apply to taxable transfers. The new rate is 40%, which is down from a high of 55%, but higher than the 35% rate that applied in 2012.

Today the exemption amount, which will increase with inflation, is $5,250,000. As a result, a married couple can transfer $10,500,000 to their heirs without paying a transfer/estate tax. Furthermore, a surviving spouse is able to use unutilized exemption amounts of a deceased spouse. This “portability” of the exemption eliminates the “use it or lose it” problem that so many couples faced. Do you recall fretting over which spouse would predecease the other and who should own more assets? While this “titling” question still needs attention in the estate planning conversation, portability has greatly reduced the risk of a truly bad tax result based on order of deaths and who owned what assets. This is certainly true for elderly couples with estates well under $10,000,000.

The result of this new law is that many families now have overly complex and sometimes disadvantageous estate plans. Back when the exemption amount was only $1,000,000, for example, a couple with a $5,000,000 estate could justify a complex estate plan that creates a trust at the first death. This trust, designed to provide for the surviving spouse, would restrict spousal access enough so that the trust assets would bypass the surviving spouse’s estate for estate tax purposes. This plan makes sense in a world with a $1,000,000 exemption and no portability. However, it makes less sense today when a surviving spouse might have the use of two much larger exemptions totaling $10,500,000 at their disposal.

In fact, if taxes were the only consideration, a trust like the one described above, often called a “Family Trust,” could cost the family avoidable taxes. Why? Because assets held in such a trust will not receive a stepped up cost basis at the surviving spouse’s death. Therefore, heirs would inherit trust assets that may have appreciated and could be subject to capital gains taxes upon sale. Were the spouse to inherit those assets outside of a trust (or in a “Marital Trust” instead) a new basis would be set upon the second death yielding a better net result for the children.

In short, your estate plan may create a trust at the first death that is not warranted today or perhaps should be redrawn so that it would enjoy the step-up in basis at the second death. Many lawyers are recommending replacing current documents with disclaimer-funded trusts which offer a “wait and see” approach to utilizing the first-to-die’s exemption. Others are incorporating a “Special Trustee” whose sole responsibility is to monitor the tax laws and decide whether a trust should be partially or fully distributed (“decanted”) to the surviving spouse.

In our experience, up-to-date, well-drawn documents are more flexible and responsive than documents put in place years ago. Good counsel is a must!

Lastly, remember that taxes are not the only driver for trusts. The goal of estate planning is to preserve and disburse assets in a deliberate fashion for the benefit of one’s heirs and charities whether taxes are an issue or not. Therefore, a simpler tax code does not always translate into simple estate plans.

We hope this information is useful to you as you address your estate planning with your legal advisor. Bragg Financial does not practice law and this article should not be considered legal advice. Feel free to call us for a conversation about your plan.

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.