Posted On: January 1st 2013
When planning for retirement and drafting an estate plan there are many thing to consider. The basis of estate planning has two primary considerations: what will happen to your estate after you die and what will happen to your estate if you are disabled or incapacitated require long term healthcare. With laws changing every year, it is important to choose an estate planning lawyer that can help you plan for the future and develop a strategy so that your needs are met.
On January 1, 2013, the federal estate and gift tax exemption climbed to $5,250,000. In addition, the estate and gift tax rate of increased to 40%. The Federal estate and gift threshold is due to increase to $5,340,000 as of January 1, 2014. This translates to $431,600 of New York State Estate Tax with the current $1,000,000 New York State Estate Tax threshold.
Although these Federal figures were referred to as “permanent”, the President’s proposals for the federal fiscal year 2014, submitted in April 2013, include proposed changes to the tax structure of estates and gifts. Beginning in 2018, he recommended a return to the estate, generation-skipping transfer (GST) and gift tax exemption and rates as existed in 2009. This would mean a top rate of 45% and the exclusion would decrease to $3,500,000 for estate and GST taxes and $1,000,000 for gift taxes.
Today many clients are understandably concerned about liquidity and losing control over their assets. There are several estate planning techniques that can mitigate clients’ fears and anxiety and maximize the use of the current exemption amount. The best practice in 2013 and moving into 2014 is to utilize the maximum $5,250,000 lifetime estate and gift tax exemption ($10,500,000 for married couples filing jointly) to get the assets and their appreciation out of their gross estates now. As real estate values are starting to increase, getting the appreciation of these assets outside of one’s estate becomes more meaningful and significant tax savings can be measured.
The Qualified Personal Residence Trust (QPRT) and Spousal Limited Access Trust (SLAT) are two prudent strategies. Both trusts are treated as gifts and can be funded using the exemption. Each is designed to maintain liquidity, simplify one’s estate plan, and minimize the impact of any estate tax that might be imposed on larger estates. With these strategies, a family may place approximately $10 million in trust, transferring assets that would otherwise be taxed to the estate while maintaining use and enjoyment of the transferred property without causing estate tax inclusion under IRC § 2036.
A QPRT is an irrevocable trust that is funded with one’s personal residence and/or vacation residence. During the QPRT’s trust term, the homeowner may continue to live at the residence rent-free and may take all available income tax deductions on the home. At the end of the trust term, the grantor may continue to reside in the residence by paying a fair market rent to the beneficiaries, further reducing the size of the grantor’s taxable estate. By utilizing part of one’s lifetime gift tax exemption, this type of trust provides one’s heirs with an early inheritance without future gift tax on any appreciation in the value of the home. Furthermore, if the home is sold, the trustees can purchase a new home with the proceeds of the sale. Assuming the client survives the trust term, the residence will pass to beneficiaries outside of the estate and gift tax system.
Although the legislative vagaries of the estate and gift system cannot be predicted with any degree of certainty over the next few years, clients need not worry about the inclusion of their home in their gross estate when they die after the trust term. This strategy provides invaluable peace of mind and asset protection during a time of depressed real estate values that are sure to yield favorable valuations. At the end of the trust term, the QPRT’s trustee transfers ownership by deed from the trust to the beneficiaries. Nevertheless, beneficiaries should know that if they choose to sell the home will likely not escape capital gains tax – the income tax basis in the home will have remained the same. However, capital gains treatment is still preferable to a 40%-55% estate tax rate. The QPRT is an especially attractive option for clients who do not intend to sell their home and instead prefer to keep the home in the family for generations to come. If the grantor were to die during the trust term, the QPRT is terminated and the fair market value of the home would be included in the gross estate at date of death. This is an important consideration for older grantors.
Another strategy for maximizing the current exemption levels is the Spousal Lifetime Access Trust (SLAT), which offers a married grantor the opportunity to fund an irrevocable trust with marketable securities or income producing real estate for his or her spouse and their children’s benefit, using the current lifetime gift tax exemption amounts. In this arrangement, the spouse may serve as a trustee with an independent trustee such as another family member or advisor. During the spouse’s lifetime, he or she is entitled to the income of the trust. Upon the grantor’s death, the assets of the SLAT will pass outside the estate, avoiding estate and gift taxes. The SLAT is an attractive option because it affords flexibility in allowing a spouse access to income and principle from trust assets subject to an ascertainable standard for health, education, maintenance and support, without subjecting the property to estate tax upon the spouse’s death. However, clients should be advised that if the distributions are used for the grantor’s benefit, they may be deemed a retained interest and for this reason, trust distributions from a SLAT should be used for the exclusive benefit of the spouse. Another possible drawback arises should the spouse beneficiary predecease the grantor spouse, in which case the grantor would lose access to the trust. To protect the grantor-spouse from this result, he or she can purchase a life insurance policy on his or her spouse’s life in an Irrevocable Life Insurance Trust (ILIT) that would pay proceeds equal to, or exceeding, if so desired, the value of the SLAT. Furthermore, if a divorce takes place, the grantor may also lose access. Nonetheless, the SLAT can be drafted such that, in the event of a divorce, the trust can immediately vest in the name of their children instead of the former spouse.
Regardless of the outcome of Congress’s legislative battle, there is no reliable guarantee that Congress will extend the current estate and gift tax exclusion in future legislation. Nonetheless, the QPRT and the SLAT are among the best planning strategies at our disposal.