This article is a follow up to our previous article which posed the dilemma of peering out over the cliff into the depths of a $1M estate tax credit and a 55% top estate tax rate. Miraculously, Congress was able to take action to avert this potentially disastrous outcome by passing the American Taxpayer Relief Act. The Act preserved many of the key provisions of the laws in effect in 2012. First, and probably most important for many, the estate tax and gift tax credit remains at $5M (adjusted with inflation). Second, the estate tax and gift tax regimes remain unified, meaning that the federal estate tax and gift tax are integrated into one unified tax system. The unified credit allows you to give away $5M during your lifetime without paying a gift tax. However, by using the unified credit during your lifetime you will reduce the amount available to you upon your death (estate tax credit). The top tax rate did take a bump up from 35% to 40% however that is a lot better than the rate of 55% that we would have realized if no action was taken.
The Act did preserve a very significant provision: portability. Portability is a provision applicable to married couples that allows for the surviving spouse to utilize any unused portion of their deceased spouse’s unified credit. This means that if the deceased spouse did not utilize any of their unified credit during their lifetime or at death the surviving spouse will have a full $10M unified credit at their disposal. It is important to remember that there is no transfer tax between spouses. So upon the death of a spouse, all of the property transferring to the surviving spouse did and still does transfer tax free. Prior to the implementation of portability, the deceased spouse’s unified credit would have gone to waste because the transfer of all of the assets to the surviving spouse was not a taxable event. As a result, the deceased spouse did not utilize their credit and the taxable estate of the surviving spouse was increased by the amount that transferred from the deceased spouse. This increase, in some cases, creates an estate tax problem for the surviving spouse who also does not have the benefit of the deceased spouse’s unused credit.
In order to address this issue, many revocable living trusts were set up to establish a bypass trust. A bypass trust facilitates utilizing the deceased spouse’s unified credit and at the same time helps to prevent increasing the surviving spouse’s taxable estate. However, the inclusion of portability in the Act potentially removes the necessity of having a bypass trust for most couples. A bypass trust can have several drawbacks so the possibility of removing it from your estate plan might be very beneficial.
The most significant provision of the Act is that it makes the law permanent — well, as permanent as we are going to get. There are no automatic sunset dates that created uncertainty and injected some (educated) guesswork into planning like in previous estate tax laws. This permanency will greatly help with providing couples and individuals with some continuity and confidence that their estate plans will no longer be subject to ever changing laws. However, you should always review your estate plan with your attorney periodically. Given this new law, now would be the perfect time.