Monday, January 31, 2011

The Estate Tax: What You Need to Do

Even if you can't or don't want to make large gifts now that the government has expanded the gift-tax and estate-tax exemptions to $5 million, experts urge reviewing your will—especially if it has one or more trusts.

Over the past 26 months four sets of estate-tax rules have been in effect, with the individual exemption bouncing from $2 million (2008) to $3.5 million (2009) to unlimited (2010) to $5 million (2011).

Most worrisome are what is known as "formula clauses." These are provisions tying bequests to the amount of the estate-tax exemption, and in the past attorneys used them to maximize the amount a couple could pass on tax-free. Through 2009, the value of one exemption was lost if assets passed directly to a surviving spouse.

The trouble arises because this year's $5 million exemption is a far cry from, say, the $1.5 million level of 2005, and it was unexpected until this past December. So if a spouse dies this year with a $3 million estate and unchanged formula clauses, a surviving spouse might get nothing outright because all assets would go into a trust.

Another profound change in the new estate rules, called "portability," has long been sought by American Institute of CPAs, and many hope it stays in the law even if rates or exemptions change after 2012. Portability allows each partner of a married couple to use the rest of the other's estate-tax exemption. It especially eases planning when one spouse has a large, indivisible asset.

Example: David's assets include an interest in several businesses worth $3.5 million and a $2.5 million individual retirement account. His wife Kathy has assets of her own worth $1.2 million. Under that old law, planners would have had a hard time equalizing assets (IRAs have only one owner) to take advantage of the couple's current $10 million exemption. Portability means that if Kathy died this year, her unused exemption would be reserved for use at David's death. If David died this year, there is no problem, either.

Although portability eases post-death planning and may eliminate the need for trusts, especially for couples with assets well below $10 million, enough wrinkles remain on cost basis and other issues that estate planners aren't likely to starve. And tax writers did include what some are calling the "black widow provision," which prohibits a taxpayer from piling up many $5 million exemptions through serial marriages.

--Laura Saunders

No comments: