Spencer Fane LLP Logo

The changing face of estate planning

Adlai Stevenson said that which seems the height of absurdity in one generation often becomes the height of wisdom in another.

While estate planning has always sought to achieve a mix of tax and nontax goals, a dominant theme historically was the reduction or elimination of state and federal estate taxes or providing funds to pay those estate taxes. Because this theme ran through most estate planning, the actual estate plans prepared for most people were very similar.

For a married couple, this generally meant a separate revocable living trust for each spouse and a division of assets between these trusts. At the death of the first spouse, a “marital trust” and a “credit,” or “bypass,” trust would be created.

The goal of this “traditional” estate planning was to assure that the estate tax exemption amount of each spouse was fully utilized, so as to reduce (or eliminate) estate taxes. If, despite the full utilization of the estate tax exemption amounts of both spouses, there was still a potential estate tax liability at the death of the surviving spouse, the traditional estate plan also would include an irrevocable life insurance trust, so as to provide funds to pay the estate tax at the death of the surviving spouse.

This traditional estate plan developed during a period when the estate tax exemption amount was very low by today’s standards. Between 1987 and 1997, the estate tax exemption amount per individual was only $600,000. By 2003, it had only increased to $1 million. By 2008 it had increased to $2 million. But for many people, even with a $2 million estate tax exemption amount, the reduction or elimination of estate tax was still the primary estate planning driver.

The landscape for estate planning changed dramatically with the enactment of the American Taxpayer Relief Act of 2012. The ATRA basically eliminated the impact of estate taxes for most people. The estate tax exemption amount per individual was set initially at $5 million, and it is adjusted annually for inflation.

In 2014, the inflation adjusted exemption amount per individual is $5.34 million, up from $5.25 million in 2013. For a married couple, that means a combined estate tax exemption amount in 2014 of $10.68 million.

In addition, the ATRA introduced into estate planning for married couples the concept of portability, which basically means the unused estate tax exemption amount of the first spouse to die can be utilized to reduce or eliminate estate taxes at the death of the surviving spouse.

Thus, estate taxes are no longer the primary estate planning driver for most people. On the other hand, nature abhors a vacuum. Thus, for most people, the primary tax driver now in estate planning is income tax planning, the management of tax basis and maximizing the step up in basis at death.

While estate taxes have generally been reduced, income taxes have gone the other way. The ATRA increased the capital gains tax. In addition, last year the 3.8 percent Medicare contribution tax on net investment income was enacted.

Estate planning today also is being driven by the desire to achieve asset protection, not only during a person’s lifetime, but also with respect to amounts left to heirs at a person’s death.

Traditional estate planning with its focus on estate tax reduction often ignored income tax planning. For example, a married couple sets up and funds separate revocable trusts. At the death of the first spouse, the assets in that spouse’s trust get a step up in basis to fair market value at the time of the first spouse’s death. However, to the extent these assets are allocated to a credit trust, or bypass trust, at the death of the first spouse, there is no further step up in basis at the death of the surviving spouse.

In addition to income tax planning, asset protection planning has become a primary driver in estate planning. Married couples are finding statutory tenancy by the entireties trusts – such as the Missouri qualified spousal joint trust -– very appealing, so as to preserve the asset protection available to married couples. The asset protection benefit of leaving inheritance to children and grandchildren in trust, as opposed to outright, also is driving estate planning, so that wealth transferred to the next generation can be protected from bad marriages, financial mistakes or poor choices.

Estate plans written pre-ATRA should now be reviewed, and in many cases, should probably be revised. Existing estate planning trusts or other entities may no longer be needed, for example, in the case of irrevocable life insurance trusts or family limited partnerships. Traditional estate planning will often need to be replaced with estate planning specifically tailored to meet the current needs and situation of each person.