The new federal tax law, which contains changes to estate, gift and income tax rules, should keep estate-planning attorneys busy advising clients on retirement planning for at least the next two years.
The changes packed into the tax law signed by President Barack Obama on Dec. 17 present lawyers with an opportunity to reach out to clients to review their estate plans.
If change is good, big change is better, and the new rules make major alterations.
“Every client’s estate plan has to be looked at. There’s a ton of work for good estate-planning attorneys,” said Ed Slott, a CPA in Rockville Centre, N.Y.
The biggest change is to the estate tax, a moving target that has confounded advisors but has finally been resolved, if only for the next two years. The law is in effect for 2011 and 2012.
Other changes will affect — or at least justify a discussion about — how much money a client puts in an IRA, when to pay taxes on a 2010 Roth conversion, how much passes to future generations, and whether to change beneficiary designations.
Jumbo exclusion, and a new twist
Under the new law, the estate tax exemption is $5 million per spouse and $10 million per couple. The maximum estate tax rate is 35 percent.
This is the largest exclusion in history except for last year’s, when the estate tax didn’t exist, thanks to congressional inaction.
What it means is that the estate tax has essentially been eliminated for the vast majority of people, who will be able to use an IRA or Roth IRA to pass monies to a beneficiary estate tax-free.
But this doesn’t mean lawyers won’t have work, especially with a new twist that makes the exemption portable between spouses.
Now, if the first spouse to die does not use up his or her $5 million exemption, whatever has not been used carries over and gets added to the surviving spouse’s exemption, making the estate tax exemption no longer a “use it or lose it” proposition.
Given this, lawyers should advise clients to review their beneficiary forms and consider making a spouse the sole beneficiary if he or she has a large IRA.
This may not always be the best option, however. State estate taxes may factor into the equation, and clients must file a federal estate tax return to take advantage of the portability rule, a requirement some may see as too much of a hassle.
Another downside: portability only applies to the last deceased spouse. That means if a surviving spouse gets her husband’s unused exemption, and then she remarries and her new husband dies and uses up the exemption, she will lose the carry-over from the first husband.
“I just had a conversation with a client a couple of hours ago who will leave everything to his wife. I had to explain that if his wife remarries, his daughters are going to get hit with an extra $1.5 million in estate tax,” said Barry Picker, a CPA whose firm Picker & Auerbach is in Brooklyn, N.Y.
Such conversations may continue to take place beyond the two-year limit of the law. Although the exemption amount may change, Obama has said that he wants to make portability a permanent feature.
“If so, it will have a significant impact on how people plan,” said Martin Shenkman, an estate-planning attorney in Paramus, N.J. “You will no longer need a by-pass trust to leave everything to your spouse.”
Deferring taxes on a 2010 Roth
The tax law also clarifies a choice about paying income taxes on a 2010 Roth conversion.
Under special rules, people who converted to a Roth IRA in 2010 could choose between paying all the income tax on the conversion in connection with their 2010 tax return, or splitting the tax payment evenly between 2011 and 2012.
The top tax bracket was expected to go up after 2010 from 35 percent to 39.6 percent, said Picker. But in a better-than-expected change, the new tax law freezes the 2010 income tax rates for another two years, making the choice a no-brainer.
“You might as well defer the taxes and pay it over two years,” said Slott.
Only in rare cases where a taxpayer has unusually low income in 2010 and knows he or she will be in a higher bracket in 2011 or 2012 would forking over all the taxes now be a better choice.
People who converted to a Roth for the purpose of removing assets from their estate may want to recharacterize to a traditional IRA now that the estate tax exemption has been raised, said Shenkman.
Gift tax and GST exclusions
The gift tax exclusion has been bumped up from $1 million in 2010 to $5 million to equal the estate tax exclusion for the next two years. The $5 million is one exclusion for combined gift and estate tax.
The unification of the gift and estate tax means that clients can give away as much during life as after death without incurring any transfer taxes. The portability rule applies to any unused gift tax exclusion that will pass to a surviving spouse.
The generation-skipping tax exclusion has also been raised to $5 million, making it even more attractive to name grandchildren or even younger heirs as beneficiaries of an IRA or Roth IRA. However, unlike the estate and gift tax exclusion, an unused GST exclusion is not portable and cannot be carried over to a surviving spouse.
Unless Congress acts, the $5 million estate tax and gift tax exemptions will go back to $1 million when the tax law expires after 2012.
All of this means estate planning lawyers may have new work come 2013.
“A lot of lawyers are crying that ‘There’s no estate tax anymore, so who needs estate planning anymore?’ It’s just the opposite: whenever the tax laws change, plans have to be updated,” said Slott. If lawyers aren’t calling their existing clients, their clients are probably talking to another lawyer, he cautioned.
“We’ll all be back in two years to go over it again,” said Picker.
“You have to plan for these two years. After that, you have to plan again. So that’s why I say it’s a great time to be an estate-planning attorney,” said Slott.