Understanding estate and tax planning in the current legislative environment and beyond

Carly Fagan Neals, J.D., Senior Trust Officer and Vice President, First Commonwealth Advisors

In recent years, federal estate and gift taxes have been in a continual state of change. As a result, estate planning documents may no longer contain the best options to get individuals, especially those with high net worth, to their goals. And this changing landscape may not be stabilized any time soon; if Congress fails to act before the end of the year, individuals will face significantly lower estate and gift tax exemption amounts and higher tax rates in 2013, says Carly Fagan Neals, J.D., senior trust officer and vice president at First Commonwealth Advisors.

“Similarly, while the extension of the 15 percent long-term capital gains rate provided ongoing windows of opportunity for those wishing to harvest gains at the lowest long-term capital gains rate in our country’s history, there seems to be no doubt that this historically low rate will be higher in 2013,” says Neals.

Smart Business spoke with Neals about how to react to potential changes in federal estate and gift tax law and capital gains rates.

What does the current landscape mean for wealthy individuals?

For estate planning, as a result of drastic changes in tax rates and exemption amounts, high-net-worth clients should talk to their legal advisers to determine what flexibility is built into the plan for these quickly changing laws. Will their current estate planning documents effectuate their wishes, and will their plans be carried out with similar results regardless of the federal estate and gift tax exemption amounts at the time of death?

The same holds true for the likely changing long-term capital gains rates. Examining assets and current and future personal tax obligations can allow individuals to be strategic and potentially take advantage of the current 15 percent long-term capital gains rate.

Individual should discuss questions and concerns with their investment advisers, accountants and possibly, legal counsel. This ensures that all possible consequences are examined before initiating a sale that would result in a long-term capital gain and avoid surprises that would negatively affect other aspects of the client’s financial picture and/or plan.

What are the federal estate and gift tax exemption amounts and rates, and how could they change?

The federal estate and gift tax exemption amount is $5.12 million per individual, with a tax rate of 35 percent for estates or gifts in excess of that amount. In the absence of new legislation, on Jan. 1, 2013, the rates will return to pre-Bush-era tax cut rates — a $1 million federal and gift tax exemption, with the excess taxed at 55 percent. This could mean the difference between an individual with a $5 million estate paying no federal estate taxes versus paying millions at the time of passing.

Another unknown is what will happen to portability, which makes a deceased spouse’s unused portion of the federal tax exemption available to the surviving spouse. In addition to the higher estate tax exemption, the increased gift tax exemptions amounts have also created a window of opportunity that could allow wealthy individuals to transfer assets to the next generation or second generation heirs without incurring transfer tax, thereby decreasing their own taxable estate.

What could happen to estate and gift taxes?

Determining where these exemptions and rates will head is speculative. While there seems to be consensus on the likelihood of higher long-term capital gains rates, the future of where estate and gift tax exemptions land is still very much unknown. The Obama administration has alluded to supporting a return to 2009 rates, with a $3.5 million federal estate tax exemption and a 45 percent tax rate on the excess, while Republican candidate Mitt Romney’s plan has suggested doing away with the death tax, while keeping the gift tax in place with a $1 million exemption and a 35 percent top gift tax rate. What takes place in the November elections will guide the direction of these tax laws and their upcoming expiration.

What planning techniques can provide flexibility for the current tax landscape and the one that lies ahead?

All individuals should consider a comprehensive review of their estate planning documents. In recent years, it was a common and appropriate planning technique for practitioners to draft estate planning documents that used formula provisions to dispose of assets at the time of a client’s death. With the roller-coaster exemption amounts, this type of formula planning could lead to unintended consequences. For example, in the case of ‘formula documents,’ high exemption amounts could allow all of an individual’s estate to be placed into a trust for their children, leaving the surviving spouse with no assets. Creating documents without formulas allows flexibility as tax laws change.

Have your advisers work together as a team. Your estate planning lawyer, accountant and investment adviser should be working toward your common goals, not giving you advice in a vacuum. This protects you from unknowns and allows you to ask questions and feel comfortable letting the advisers guide you.

How can business owners take advantage of the current rates?

For those with certain closely held assets that are likely to appreciate quickly, including ownership in a private business, certain techniques can allow the transfer of wealth with tax benefits through the use of estate planning tools. However, time constraints may limit options, as valuations and planning can take a considerable amount of time.

For investors who have over concentrated positions or are holding assets with a low cost basis,  selling this year may allow them to take advantage of the 15 percent capital gains rate. In the absence of legislative action, the long-term capital gains tax rate will increase to 20 percent at the beginning of 2013.

If you believe you may benefit from historically low rates and high exemption amounts, contact your advisers to discuss taking advantage of them before the end of the year.

Carly Fagan Neals, J.D., is a senior trust officer and vice president at First Commonwealth Advisors. Reach her at (412) 690-2131 or [email protected]

Insights Wealth Management is brought to you by First Commonwealth Bank