Congress provided some dramatic theatre over the New Year’s holiday, eventually passing the American Taxpayer Relief Act, more commonly known as the “fiscal cliff legislation.” The legislation made significant “permanent” changes with regard to the estate tax that fundamentally change many longstanding traditional approaches to estate planning, especially the common “A/B Trust” for married couples.
For more than a decade, the estate tax exemption (the fair market value of one’s estate that can pass free of any estate tax) was in flux. In 2002, the exemption was $1,000,000. It increased over the years to $1,500,000 in 2004, $2,000,000 in 2006, $3,500,000 in 2009, unlimited in 2010, and originally back to $1,000,000 in 2011. At the end of 2010, Congress passed temporary legislation to increase the exemption to $5,000,000 in 2011, indexed for inflation. However, the $1,000,000 exemption amount was scheduled to return in 2013.
The fiscal cliff legislation makes the $5,000,000 exemption, indexed for inflation, permanent. Of course, nothing is “permanent” with regard to the law. A new Congress may always override what a previous Congress accomplished. However, unlike any time over the past dozen years, there is no “sunset clause” that automatically drops the exemption. As a result, we finally have some certainty regarding the estate tax. With the index for inflation, the 2013 exemption is $5,250,000.
The legislation also made permanent a concept originally introduced in 2010 as a temporary idea: “portability.” The idea behind portability is to provide an opportunity for a surviving spouse to “claim” the deceased spouse’s unused exemption as his/her own. This means that a married couple is not required to have specific planning in place to maximize each spouse’s exemption. The surviving spouse may choose to file an estate tax return, IRS Form 706, within nine months of the first spouse’s death to elect portability, thus claiming the deceased spouse’s unused estate tax exemption. Although there are some exceptions and caveats to portability, it is a powerful tool that changes some traditional estate planning strategies.
For generations, the centerpiece of a married couple’s estate plan was the A/B Trust. With an A/B Trust, upon the death of the first spouse, the trust divides into two sub-trusts, an “A Trust” for the surviving spouse’s share and a “B Trust” for the deceased spouse’s share. The idea behind an A/B Trust is to capture the estate tax exemption of the first spouse to die to increase the amount of inheritance a married couple may pass free of estate tax.
Before portability was introduced for 2011, an A/B Trust was the only method for capturing the deceased spouse’s unused exemption. When portability was introduced for 2011, it was only scheduled to be available for two years. Because it was not a permanent tool, it wasn’t prudent for estate planning attorneys to rely on portability. As a result, A/B Trusts were still critical in ensuring that a couple’s estate is not required to pay unnecessary estate tax.
The fact that the fiscal cliff legislation makes the estate tax exemption permanently high and establishes permanent portability means that A/B Trusts are generally no longer necessary as an estate tax planning tool. With each individual allowed to shield at least $5,250,000 from inheritance tax, the vast majority of couples will not need to use the unused exemption of the first spouse. Furthermore, portability is always available should future circumstances dictate otherwise.
A/B Trusts are still useful for non-tax reasons. For example, if there is concern on the part of a couple that the surviving spouse will amend the estate plan to disinherit certain individuals, then an A/B Trust still makes sense for these “control issues.” This is especially relevant for blended families or if there is concern that the surviving spouse might be manipulated by an unscrupulous individual.
If you have an A/B Trust solely for estate tax purposes (i.e., you are not concerned about “control issues”) and both spouses are still living and have capacity, you might want to consider amending your trust. The fiscal cliff legislation makes A/B Trusts largely unnecessary for estate tax purposes and removing the A/B aspect of your trust could greatly simplify its administration.
Of course, there is nothing fundamentally wrong with the A/B Trust format and amending your A/B Trust is not necessary. It is simply important to be aware that, in light of the fiscal cliff legislation, your A/B Trust can be simplified if you so choose.
The fiscal cliff legislation also impacts gifting, trust administration and asset protection. A qualified attorney can help you determine how the legislation affects your estate planning needs.