How the New Tax Law Affects Your Estate Planning
July 22, 2011
For much of 2010 there was no federal estate tax in place, and there was considerable uncertainty as to what Congress would do about the issue. In the post-election session of Congress in December, Congress included a new structure for the federal estate tax that will be effective for the next two years, and potentially longer if Congress finds it easier to extend the current law rather than re-visit the issue. While the federal exemptions have increased significantly, the Minnesota estate tax exemption remains $1,000,000. As described below, the difference between the federal and state exemptions will have an unexpected and undesirable impact on many estates in Minnesota.
Following are the most important provisions of the new federal estate tax law:
- The estate tax exemption amount has been increased to $5 million per person, which means that with proper planning, a married couple can pass assets up to $10 million without incurring federal estate tax;
- The new federal estate tax rate for amounts over the exemption amount is 35%;
- For the first time, any exemption amount that goes unused at the death of the first spouse to die can be transferred to the surviving spouse. This could potentially allow the surviving spouse to transfer more than $5 million free of federal tax at his or her death. In order to make use of this new allowance, an estate tax return must be filed at the first spouse’s death, even if that return would not otherwise be required (this new concept is referred to as “portability” of the exemption).
- The new lifetime gift tax exemption is also $5,000,000 per individual (although a gift tax return should be filed for any gifts exceeding $13,000 in any year in order to claim this exemption). This new larger gift tax exemption provides a good, and possibly temporary, opportunity for individuals to move large amounts of assets out of their estate during their lifetime without incurring tax. There are also techniques available to allow a person to leverage this exemption to move even more assets out of his or her estate.
While the new federal estate tax legislation will lower the federal tax burden for individuals with estates over the prior exemption amount ($3.5 million), in Minnesota, it will result in some individuals paying more Minnesota estate tax when their spouse passes away than would have been the case under the former law. Prior to the middle of the last decade, a common estate tax plan would place assets up to the federal exemption amount into a trust at the first spouse’s death. This planning technique would allow the assets placed into the trust to pass free of tax. However, now, because the federal exemption has increased so dramatically while the Minnesota exemption has remained at $1,000,000, that type of plan can result in an unexpected Minnesota estate tax burden for the surviving spouse. The reason is that Minnesota will tax any assets placed in that trust that exceed $1,000,000. The rate at which these assets are taxed varies, but is approximately 8.5%. If the full $5,000,000 federal exemption amount is placed into this trust, it would mean a Minnesota tax of approximately $390,000 to be paid by the surviving spouse.
As a general rule, we recommend that you review your estate plan approximately every five years, not only for changes in the law, but also to determine if the personal situations of either the person making the plan or the beneficiaries have changed. However, regardless of when you last reviewed your plan, because of the recent changes in the federal tax law, we recommend that you review your estate plan now.
We would be happy to discuss any issues you may have regarding your estate planning documents.