Post-Election Income and Estate Tax Planning: Important Considerations for High Net Worth Individuals

With the recent re-election of President Obama and the potential continuing gridlock between the House of Representatives and the Senate, many taxpayers are wondering what this may mean for them with respect to their income and estate tax planning. In this article, Leech Tishman will help you examine several important considerations on both the income tax and estate tax sides.

Potential Income Tax Rate Increases Beginning January 1, 2013

On the income tax side, the significant increases in rates already programmed into the law for January 1, 2013 may actually occur. This could result in a significant burden upon single individuals who earn more than $200,000 per year and married couples who earn more than $250,000 per year.

The scheduled income tax increases include a highest bracket of 39.6% instead of the present 35%, and a 3.8% tax on interest, dividend, net rent, and other passive income to the extent that the taxpayer has total earnings exceeding the $200,000 and $250,000 thresholds.

Potential Changes in Estate Tax Exemptions Starting January 1, 2013

As far as estate tax, come January 1, 2013, the present $5,120,000 gifting and estate tax exemptions would drop to $1,000,000. Several clients have been working with Leech Tishman lawyers to make gifts exceeding $1,000,000 in value to make use of all or part of the $5,120,000 temporary gifting allowance, an opportunity which may never exist again during our lifetimes. In addition to this, the estate tax rate, which is now only 35%, would go up to 55%.

Many clients do have a concern that if they give away too much money, they could run out of assets. Popular solutions to this include:

1) Naming a spouse as a beneficiary of the trust and assuming that as long as the spouse is alive, the donor can derive indirect benefit by being supported by the spouse while the spouse is being supported by the trust; and

2) Forming the trust in an asset protection jurisdiction, since the IRS has ruled privately in at least one case that the contributor can be a discretionary beneficiary and actually receive the benefit of trust assets if and when they are needed.

Hopefully, there will be a political compromise with respect to both income and estate taxes between now and year-end. Many experts, however, feel that these issues will probably not be sorted out until 2013, with the compromise to be retroactive to January 1, 2013.

The Importance of Irrevocable Trusts

High net worth individuals should consider putting an irrevocable trust into place that can hold assets that would not be subject to federal estate tax, but would be considered as owned by the grantor for income tax purposes.

This is because two very important estate and gift tax provisions that presently exist for these trusts would be eliminated if President Obama’s February 2012 budget suggestions are adopted, which are as follows:

1) Presently, the grantor can pay the tax on dividends, interest and other income earned by such a trust, so that the trust can grow faster to increase the assets that would pass free of estate tax.

Under President Obama’s proposal, this type of trust would be subject to estate tax on the death of the grantor. It is likely that trusts of this type existing before the end of this year will be grandfathered. The effect of being able to pay the income tax on behalf of this type of trust, and be able to sell assets or discounted family interests to this type of trust in exchange for a low interest note has an incredible mathematical value.

2) Presently, under Pennsylvania law, this type of Pennsylvania trust can be used indefinitely to avoid estate tax not only at the grantor’s level, but also for generations of descendants. President Obama’s proposal would limit this “generation skipping dynasty” trust effect to 90 years.

Several clients are making sure that they make their sales of family company interests to these types of trusts before year-end because we can presently value non-voting or minority interests in family entities using discounts. President Obama’s 2012 budget proposal would eliminate discounts.

Implications for the Gift Tax Exemption

The Republican House of Representatives may be able to resist having some of these new restrictive estate tax provisions enacted, but what will the trade-off be for raising the estate tax exemption above $1,000,000 per taxpayer? President Obama’s February 2012 budget called for a $3,500,000 per taxpayer estate tax exclusion and did not make mention of what the gifting exclusion would be. Since the majority of high net worth individuals have probably used their $5,120,000 gifting exemption in 2011 and 2012, we may not see significant resistance to allowing the gift tax exemption to go down to $1,000,000.

Individuals with a net worth of well over $1,000,000 are scrambling to avoid additional estate taxes that may be levied on their assets after December 31, 2012. Many clients with a net worth in the $2,000,000 to $4,000,000 range have stopped annual gifting in the hopes that the $5,120,000 exemption will continue. Since that now seems highly unlikely, it may be a good idea to complete year end gifting to make maximum use of the $5,125,000 lifetime gift tax exemption plus the $13,000 per donee annual exclusion that will be available through the end of 2012. [NOTE: The $13,000 annual exclusion is scheduled to rise to $14,000 per donee in 2013.]

Please contact Leech Tishman if you have any questions regarding these income and estate tax issues and if we can be of assistance between now and year-end. For more information on the Estates & Trusts Practice Group, please click here.

Leech Tishman is a firm dedicated to providing full-service commercial legal services to individuals, businesses, and institutions. We combine a deep understanding of our clients and their businesses with skilled legal counsel to find solutions. We offer legal services in alternative dispute resolution, bankruptcy & creditors’ rights, construction, corporate, employment, energy, environmental, safety & toxic torts, estates & trusts, government relations, insurance coverage & corporate risk mitigation, litigation, real estate, and taxation. For more information call 412.261.1600 or visit www.leechtishman.com.

Adapted From: LISI Estate Planning Newsletter #2024 (November 7, 2012) at http://www.leimbergservices.com.