How provisions related to new federal estate tax laws will impact businesses

Jeff Consolo, Chair, Estate Planning and Probate Department, McDonald Hopkins LLC

Jeff Consolo, Chair, Estate Planning and Probate Department, McDonald Hopkins LLC

On December 17, 2010, President Barack Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. Significant components of the new law are provisions related to the federal estate or “death” tax.

There are parts of the law that were surprising to most estate planning attorneys and it was hoped that the law would provide clarification. However, there was some clarity, followed by more confusion, says Jeff Consolo, who chairs the Estate Planning and Probate Department of McDonald Hopkins LLC.

“The act does provide some clarification for the next two years, but come January 1, 2013, we could be right back to where we were prior to the signing of the act in December,” says Consolo.

Smart Business spoke with Consolo about the act and its impact on business.

What did the act do with regard to the federal estate tax law?

It did a great deal, but the highlights are the increase and reunification of the estate, gift and generation-skipping rules, including both the exemptions allowable and the tax rates imposed; the granting of portability of exemptions between spouses; and the fact that Congress did not eliminate the use of valuation discounts for estate planning purposes. The reunification and the increase of exemptions to a $5 million level surprised most estate planning attorneys.

What does that mean in layman’s terms?

At the end of 2009, the exemption for gifting purposes during life was $1 million, and the exemption for estate purposes was $3.5 million per person. In 2010, the gift tax exemption was the same but there was no federal estate tax. In 2011 and 2012, the exemption is now $5 million per person, whether used during life or at death. That is a huge difference. Simplistically, an individual can now pass up to $5 million to anyone, estate and gift tax-free.

The portability issue is also important. Previously, spouses each had a $3.5 million exemption so, in theory, they could transfer up to $7 million to their beneficiaries tax-free. From a practical standpoint, that was not always the case, because to do that, each spouse needed to have $3.5 million in their own name. Sometimes, this balancing of ownership was not possible because assets had to be held by one or the other. Now, you do not need to worry about that. If the first spouse dies and only uses $3.5 million of the $5 million exemption, the surviving spouse has $6.5 million of exemption to use.

Finally, the ability to couple valuation discounts and a larger gift exemption is an incredible benefit for purposes of transferring wealth to younger generations.

How does the coupling of valuation discounts and a larger gift exemption assist in transferring wealth?

Previously, it was only possible to transfer up to $1 million to individuals other than your spouse without paying a gift tax. Now, it is possible to transfer up to $5 million. When you couple this larger exemption with other estate planning techniques, it is possible to transfer even more than $5 million without paying a gift tax. The ability to transfer these amounts, whether $1 million or $5 million, is not relevant for many individuals, but for those individuals or families with significant wealth, these changes are almost too good to be true.

Does someone who doesn’t have a large amount of wealth need to worry about estate planning?

Yes. If you and your spouse never accumulate more than $5 million, you may not have a federal estate tax issue, but you may still have a state estate tax to be concerned about. In addition, many individuals want to avoid, or at least reduce, the necessity of having their estate pass through probate at their death.

Parents will still be concerned about how and when their children are to be given assets at the time of their deaths. If parents have a special needs child, they must plan for that child and, in certain instances, planning can be used for creditor protection. There are just as many non-tax reasons to plan now as there were before.

What are the portability issues you mentioned earlier?

The biggest issue is in the context of a second marriage. For example, a husband and wife each have been previously married, each has children from those marriages and both have $500,000. The husband dies first, does no planning and passes everything to his spouse, knowing there will not be tax and assuming she will provide for his children.

She then has $1 million. There is no tax at her death and she could pass all $1 million only to her children, which is probably not what the husband expected. So even though taxes can be avoided with minimal planning, individuals must consider their personal situations and plan accordingly.

What are some key items to be considered in estate planning?

First, if you have a will and trust, contact your attorney to see if it needs to be reviewed in light of the new law. Second, if you do not have an estate plan, do not assume that just because your estate will not exceed $5 million that you do not need to plan. Third, if you have significant wealth, review the possibility of making transfers to younger beneficiaries, and do so sooner rather than later because the law only extends for two years. So, in late 2012, the process begins all over and there is no guarantee that the rules will remain the same.

Jeff Consolo is the chair of the Estate Planning and Probate Department of McDonald Hopkins LLC. Reach him at (216) 348-5805 or [email protected]