Federal Estate Tax Considerations in Preparing an Estate Plan

While Ohio’s estate tax is going away in January 2013, the federal estate tax is in flux. Beginning in January 2013, the federal estate tax exemption is set to decrease from $5 million to $1 million. Also due to disappear is the 2012 “portability” feature of the $5 million exemption, whereby the unused part of the exemption in the estate of the first spouse to die can be used in the estate of the second spouse, which means a potential total of $10 million exemptions for a married couple. Thus, for the deaths in 2012 as estate worth less than $5 million does not have to even file a federal estate tax return. But that amount reduces to $1 million in 2013. Congress may ultimately change that amount or change the effective date – all of which makes tax planning extremely uncertain. 

Some common present major estate tax planning techniques are: 

1. Causing the $5 million estate tax exemption of the first spouse to die to “by-pass” the estate of the second to die;
2. Making life-time annual exclusion gifts ($13,000 in 2012 per donor per donee / $26,000 for married couples per donee);
3. Irrevocable life insurance trusts (ILITs); and
4. Valuation discounts for businesses, farms, vacation homes, and most properties including publicly traded securities. 

Correctly structured bequests to spouses can be tax-free regardless of value because of the present unlimited federal estate tax marital deduction. This means that the estate of the first spouse to die can be free of federal estate taxes regardless of size. But, without correct planning, the first spouse’s exemption will be taxed in the estate of the second spouse. “By-pass” or credit shelter trusts prevent this tax disaster. 

If the surviving spouse is not a citizen or is a non-resident alien, a “Qualified Domestic Trust” (QDOT) must be used to assure the unlimited marital deduction is permitted in the estate of the first spouse to die. 

Although life time gifts in excess of the annual exclusion can produce significant estate tax savings, under the current “Unified Gift and Estate Tax” system, such gifts are brought back to be included in the donor’s estate.

Irrevocable trusts are often used by wealthy people to avoid death taxes, especially life insurance trusts on the life of the insured grantors. These are called “ILITs”. 

Large estates commonly employ a variety of valuation discounts to reduce death taxes, such as the time-value of money technique, minority interest discounts in family limited partnerships, farms, businesses, and even personal primary and vacation residences. 

Estate tax laws are incredibly complex and in enormous flux. A qualified estate planning lawyer has a sophisticated knowledge of tax laws and can apply them to the facts of each person’s estate.