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Finally, Some New Rules Without Expiration Dates. A new Playbook: Estate Planning After the American Taxpayer Relief Act of 2012 and After Repeal of the Indiana Inheritance Tax

Introduction and Background

Prior to the enactment of the American Taxpayer Relief Act of 2012 (the “Act”), the federal gift and estate tax laws (or “rules”) changed, or were scheduled to change, almost every year. Some of these changes could cause an increase, or a decrease, of millions of dollars in federal transfer taxes, from one year to the next. The frequent federal transfer tax law changes, or scheduled changes, encouraged some clients to make frequent, or immediate, planning revisions, but discouraged other clients from doing any planning at all. Furthermore, prior to 2013, Indiana inheritance taxes could pose a significant burden, warranting planning measures to reduce or eliminate the tax. With the passage of Act in early 2013, and with the repeal of the Indiana Inheritance Tax in 2013 (for decedents dying after December 31, 2012), we finally have a new set of rules without expiration dates, resulting in a new estate planning playbook.

Estate Planning Before the American Taxpayer Relief Act of 2012

As indicated above, under former law, the amount of federal estate tax that would be owed by a decedent’s estate could differ significantly, depending upon a difference of a year or two in the date of death. This variation was due solely to the year-to-year changes in the federal estate tax exemption. For example, the estate tax exemption was $2 million in 2008, $3.5 million in 2009, and $5 million in 2011. Furthermore, prior gift and estate tax laws had expiration dates. The $5 million exemption that applied in 2011 was scheduled to expire on December 31, 2012, to be replaced with only a $1 million exemption.

Before enactment of the Act, clients and their advisors were forced to consider alternative planning scenarios based on varying estate tax exemption amounts and assumptions as to the date of death and as to whether or not the then-current law would actually expire as scheduled. This uncertainty over the “rules” that would apply at death made planning very difficult.

Estate Planning After the American Taxpayer Relief Act of 2012

The Act, which was not actually enacted until January 2, 2013, sets federal gift, estate, and generation-skipping transfer tax, exemption amounts at $5 million, indexed for inflation – and with no expiration dates. With inflation adjustments, these exemptions are $5.34 million in 2014. The Act also adds something new to the estate planning playbook: the ability to make a “portability” election, which may allow a surviving spouse to utilize the unused estate tax exemption of his or her predeceased spouse.

Estate plans should be reviewed in light of these changes. An estate plan completed in 2008, for example, when the federal estate tax exemption was $2 million, may no longer make sense or properly effectuate a client’s intentions after the Act. Life insurance should be reviewed to ascertain the planning impact of the Act on the amount of the life insurance and on the ownership of such life insurance.

More on the “Portability” Provisions of the American Taxpayer Relief Act of 2012

For years, clients have been advised to keep certain assets titled in the individual names of the husband and wife (and not titled in their joint names, with rights of survivorship), in order to utilize the estate tax exemption at the first to die of the husband and wife. The failure to properly title assets could have caused significant (even millions of dollars of) estate tax. With the new portability provisions of the Act, however, the separate titling of assets (and the planning that went along with such titling) may no longer be necessary in order to avoid federal estate taxes. In fact, a client’s desires might be better achieved by titling assets jointly with his or her spouse. Keeping assets titled in the individual names of the husband and wife might cause a probate proceeding to be needed in the estate of the first to die, unless revocable trust ownership is used. A probate proceeding might easily be avoided by titling assets in joint names.

On the other hand, some clients will be better served to keep certain assets titled in individual names in order to, for example, “protect” such assets in trust for the benefit of children and grandchildren. Furthermore, having assets titled in the decedent’s individual name may allow all appreciation on such assets to escape further estate taxation. Even clients who have gifted away their entire gift tax exemption may want to keep some assets titled in their individual names in order to utilize the inflation adjustment increases to the gift/estate tax exemption that would be available.

Use of Trusts After the American Taxpayer Relief Act of 2012

Popular planning techniques in 2011 and 2012 included the creation and funding of various types of trusts – spousal lifetime access trusts, gift trusts for children and/or grandchildren, asset protection trusts, grantor retained annuity trusts and charitable annuity trusts. Such planning techniques allow appreciation to be removed from the grantor’s estate, and each technique also has its own special purposes or benefits. Such techniques should still be attractive in 2014 and beyond, and an added motivation will be to take steps to reduce income taxes. Income tax rates have increased. A gift trust for children and/or grandchildren may help reduce the overall income tax liability of a family because the income from such a trust could be sprinkled among various family members who are in different income tax brackets, reducing the overall income tax liability of the family. Grantor retained annuity trusts and charitable lead annuity trusts continue to be good planning tools in a low interest rate environment.

Repeal of the Indiana Inheritance Tax

Indiana long had an inheritance tax. The inheritance tax could be significant, and even applied to certain relatively small value transfers at death. Planning to reduce or eliminate the Indiana inheritance tax was often an important part of the overall estate planning – and such planning measures included changing the State of residence, and using trusts that were specially drafted and designed to minimize the Indiana inheritance tax. In 2012, the Indiana Legislature passed legislation to repeal the inheritance tax over a ten – year period, such that the tax would have been fully repealed in 2022. The legislature also enacted provisions increasing the amount of certain exemptions that applied for inheritance purposes, prior to complete repeal of the tax. The 2013 Indiana legislature decided to accelerate the repeal of the inheritance tax. Legislation was enacted in 2013 which fully repealed the Indiana inheritance tax, effective for decedents dying after December 31, 2012. Accordingly, for Indiana – specific estate planning purposes, there is also a new set of rules with no expiration date, and a new estate planning playbook. Clients should have their estate plan reviewed to make sure that their existing estate plan makes sense and properly effectuates their intent, after repeal of the Indiana inheritance tax.

Future Federal Tax Law Changes

Even if the new higher federal gift, estate and generation-skipping transfer tax exemptions are now in fact “permanent,” it seems likely that additional laws affecting federal death taxes will be enacted and will change from time to time. For example, there is sentiment to reduce or eliminate some of the estate planning benefits of family limited partnerships (or family limited liability companies), grantor retained annuity trusts, dynasty trusts and grantor trusts. Prompt planning may be needed in order to take advantage of these planning techniques.

By Timothy Bender, JD, CPA (Inactive), CFP®

Review and More Information

To have an estate plan prepared or reviewed, or for more information, please contact our Indianapolis office at 317.453.2000 and our Bloomington office at 812.332.5000.

NOTICE: In keeping with the applicable provisions of the Internal Revenue Service Regulations, please be advised that any statements contained in this document which may, in any way, be construed as tax advice were neither intended nor written to be used, and may not be used, for the purpose of avoiding penalties under the Internal Revenue Code