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Thursday, December 23, 2010

Federal Estate Tax Reform 2011

As you may be aware, President Obama recently signed the “Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010”. In addition to keeping most of the income tax rates at their 2010 levels, this Act includes a major change to the federal estate tax.

Summary of the New Tax Law

Starting in 2011, each United States citizen and permanent resident alien will be entitled to a $5 million lifetime gift and estate tax exclusion amount. Anything over $5 million will be taxed at 35%. This means that starting January 1, 2011, you will be able to give away $5 million dollars either during your lifetime or at your death… but only for 2 years. This new tax law sunsets at the end of 2012.

Another major change in the federal estate tax law is that it allows for the transfer of a decedent’s estate tax exclusion amount to his or her surviving spouse. This is known as the portability provision. So let’s say a husband dies in 2011, leaving $3 million to his children; his widow can receive his $2 million in unused exclusion amount so that if she dies in 2012 she can pass on $7 million to her children free of the federal estate tax. This is a major boon to couples who fail to prepare a Will and for couples who have not equalized their estates.

So How Does the New Tax Law Affect You?

For 99.5% of the population, it means that you will not have to pay a federal estate tax if you pass away in 2011 or 2012, and you may or may not have to pay a huge estate tax if you die after that. Tax planning must be done to deal with state estate and inheritance taxes as well as the possibility that the federal estate tax will return in full force in 2013. Additionally, traditional estate planning documents should still be prepared to direct where assets go, set up trusts for children, nominate executors, guardians and trustees, where necessary, avoid probate.

It is also important to remember:
  1. In Florida, the benefits of setting up a revocable living trust and avoiding probate remain unchanged. Additionally, if you own real estate in another jurisdiction other than Florida, you may have to pay an inheritance tax or estate tax in that jurisdiction.
  2. New Jersey still has an estate tax that applies to anyone who dies with more than $675,000 in assets and New Jersey DOES NOT have a portability provision. Furthermore, New Jersey also has an inheritance tax, up to 16%, on transfers to certain individuals, including siblings, nieces and nephews and friends.
  3. New York still has an estate tax that applies to anyone who dies with more than $1 million in assets. Moreover, New York DOES NOT have a portability provision and it is strongly recommended that clients title their assets in a way that will avoid probate.
  4. Pennsylvania still has an inheritance tax of up to 15% that applies to everyone who plans to leave assets to anyone other than a spouse or a charity.
In most cases, the new law should not affect most of the documents that competent attorneys will have drafted over the last 5 years. However, I highly recommend estate planning documents should be reviewed if they were drafted by an attorney who does not focus on tax planning or if you have had changes in your personal life or a substantial change in your wealth.

The new tax law also provides ample opportunity for gift planning, including gifts to trusts; however, such gifting could also have negative capital gains tax implications if done incorrectly.

As always, I am available for a consultation if you have any questions.

Friday, December 17, 2010

Revised Estate Tax Appears to Be a Done Deal

As I write this post, the new tax law appears to be a done deal. We are just awaiting President Obama to sign off on it. It will probably take me a week or so to digest all of the finer points of the new tax law, but I will briefly discuss the main points that I am aware of:
  1. The new estate tax AND gift exemption amounts will be $5,000,000 per person (this is a reunification, previously the gift tax exemption amount had been $1,000,000) - This takes effect in 2011;
  2. There will only be one rate for gift and estate taxes - 35% on transfers above the exemption amount - This also takes effect in 2011;
  3. Capital Gains tax rates will continue at 15%
  4. It appears that there is a portability provision. This would allow one spouse to give the other spouse everything outright at death, and then the surviving spouse would have a $10,000,000 exemption. (NOTE: This would not be advisable in New Jersey or New York where an increase in state estate tax would result.)
Also of note:
  1. There appears to be a 0% GST tax rate for 2010, so for the super wealthy, you have another few weeks to fund generation skipping trusts. In 2011 and 2012, the GST Exemption amount will be $5 million;
  2. There appears to be an extension of a provision that would allow certain IRA owners to contribute money in their IRA to charity with favorable tax consequences;and of course
  3. There will be a continuation of almost all of the tax rates that were in place in 2010.

It looks like I owe my dad a dinner.

Tuesday, December 14, 2010

The New Jersey QDOT Trap - Revised

When a person dies, the surviving spouse can receive all of the decedent's money free of tax, but only if the surviving spouse is a citizen of America. If the surviving spouse is not a U.S. citizen, anything over the estate tax exemption amount is subject to an estate tax. One way to avoid paying a tax on money going to the benefit of a surviving non-citizen spouse is to set up a Qualified Domestic Trust (QDOT).

With the ever increasing federal estate tax exemption, and the fact that we do not have a federal estate tax in 2010, most practitioners are not giving much thought to the use of QDOTs. This is because many practitioners are trying to avoid the large federal estate tax and not the smaller NJ Estate tax. If the estate is not going to be subject to the federal estate tax, the thinking is that there is no need to set up a QDOT for the surviving spouse.

Unfortunately, New Jersey has a little known rule that subjects the estate of a decedent to the New Jersey Estate tax if assets in are being left to a non-citizen spouse. This could create a significant tax on the death of the first spouse and another tax when the surviving spouse dies as well.

To avoid the NJ Estate tax, a QDOT can be set up for the surviving non-citizen spouse to deal with assets passing to him or her. Normally, if a QDOT is set up, almost all distributions other than income distributions and distributions for hardship will be subject to the federal estate tax. However, it appears that according to Treasury Regulation 20.2056a-6, the federal estate tax would not kick in until after the original decedent's exemptions are used up.

If the surviving spouse intends on becoming a citizen shortly after the first spouse passes, the QDOT can be dissolved with no tax consequences provided no disqualifying distributions were made.

The New Jersey QDOT trap only applies to decedents who own more than $675,000 at the time of their death and who were married to non-citizen spouses. However, when calculating the size of a decedent's estate, New Jersey will look at all of the decedent's assets, including retirement accounts, life insurance homes, stocks, bonds, etc.

(Note: it does not matter if the decedent is a citizen or a permanent resident alien. What is important is the citizenship of the surviving spouse.)

REVISION NOTE: This posting was revised on October 19, 2011 to correct errors and make clarifications.