The Estate Tax is Permanent… Right?

The concerns regarding any decrease in the federal estate and gift tax exemptions were 

alleviated with the passage of the Taxpayer Relief Act of 2012 (ATRA) which was signed into law on January 2nd of this year.  Although the tax rates for those whose estates are higher for those with estates greater than five million dollars, the estate tax is now permanent, right?  If so, why are estate planning attorneys still urging their wealthy clients, including those with estates of less than five million dollars, to estate plan without further procrastination.  What are their concerns and is it important enough to heed their advice?

Although ATRA appears to make the estate tax and gift law permanent, it may be prudent not to rely too heavily on permanency since Congress is currently facing some serious budget shortfall concerns in its requirement to submit a balanced budget and Congress must also address the ever increasing national debt ceiling in a month. As these issues are debated on Capitol Hill the concern of estate planning attorneys stems from President Obama’s budget proposal for 2013.  This proposal has several aspects that could greatly impact the future of estate planning.

South Dakota, like several other states, repealed the rule that restricted the duration of a trust to approximately 90 years.  Currently, by placing asset in a trust that has an unlimited duration, the assets will pass from generation to generation without the imposition of any further gift, estate or generation-skipping transfer taxes.  The President’s proposal would trigger an additional accumulation tax on all of the assets in the trust every 90 years.

Another significant proposal is a change in the way an intentionally defective grantor trust is taxed.  By including certain language in a trust, it is considered ‘defective’ by the IRS which means the Settlor of the trust pays the federal income tax on the assets in the irrevocable trust even though the trust assets are not includable in the Settlors estate for estate tax purposes at death.  This favorable tax interpretation has been used for years to allow the trust assets to grow without being diluted by taxes and has the effect of further diluting that part of the Settlor’s assets subject to tax at death.  It is also desirable because the tax rate for an individual is often much less than the rate of tax applied to a trust.  Many wealthy clients have used this strategy to avoid the 39% tax rate on income generated within trusts.

Valuation Discounts for the transfer of a minority interest is another tax strategy used by people with family businesses that the Obama proposal seeks to end.  For families who want to leverage their gift and shift wealth to a lower generation, the use of discounts has been a valuable tool.  Under the President’s proposal, family controlled entities would no longer be eligible for discounts.  If passed, this change would increase the gift tax value on a transfer of a closely held business and thereby reduce the current benefits associated with this plan.  It may also mean that families are less willing to structure succession plans because there is no tax saving to do so.  The idea of saving taxes has worked as a wonderful motivator.

The bottom line is that estate planning professionals continue to urge their clients to be proactive in estate planning because any legislative change will most likely happen fairly quickly and will apply to all plans on a prospective basis.  Only those plans put into place before any law is passed would be exempt from the new rules. By taking actions now, the wealthy client can preserve their wealth for future generations.  Betting that the current tax is permanent is a risk you can ill afford.

Alice Rokahr, JD, is the Wealth Planning Officer at Bankers Trust Company of South Dakota.