Orange County Bar AssociationTrusts and Estates Section Meeting

Practical Aspects of Estate Tax Changes of 2010

Presented on Wednesday, March 9, 2011 byRichard Heaton of Garrett & Heaton, LLP

Tax Relief Act of 2010

• Signed into law by the President on December 17, 2010.• Includes a comprehensive set of income tax, estate tax, and

unemployment insurance provisions.• Most of the provisions are temporary, in place for 2011 and

2012 only, effectively extending the Bush-era tax cuts.

Estate Planning Impact

• Requires review, but not necessarily modifications to existing plans

• Provides ways to increase basis, while preserving zero estate tax for modest estates

• Makes having B and C trusts for even modest estates more attractive

• Makes A-C (Optional B) plans workable in most situations

Existing Estate Plans

• The AB, ABC, and Optional AB that have been utilized for so long all still work, but they may not meet the clients’ desires.

• It is useful to classify the size of estates:

$10 Million

$50 Million

“Just a Millionaire”

Existing Estate Plans

• In large estates, the traditional ABC planning may not change• The potential change in planning is most likely for the modest

estates of $2 million to $10 million– Assets put into a B trust will not get a step-up in basis

Consider the following example…

Example: UPS Stock

• Client funded bypass trust with UPS stock when the exemption was $600,000

• UPS stock appreciated to well in excess of $20 million• IRS tried to ignore the bypass trust, but was unsuccessful due

to good planning

If a similar situation happened with today’s law…

Comparable Example (today)• Bypass trust funded with $500,000 in highly appreciating

stock that appreciates to $5 million at second death.• If stock was in the B trust, it would not get a step-up in basis.• There would be no estate tax, but there would be a lost basis

step-up of $4.5 million at an income tax cost of $1,125,000.• Alternatively the stock could be put into a traditional C trust

that was QTIPable, resulting in a step-up at second death.• This assumes the portability of the $5 million of the

exemption at the death of the first spouse.

Reliance on Portability• Simple plans relying on portability, and giving everything to the

surviving spouse in a simple A Trust, are problematic.Example:

– Estate worth $10 million at first death with no appreciation– Entire estate left to surviving spouse assuming full DSUEA– If spouse remarries, and new spouse dies, there could be

unnecessary tax at the death of the surviving spouse– DSUEA is based on the amount available to the last predeceased

spouse– Timely estate tax return must be filed

Increasing Basis• Various ways to have options to increase basis and preserve a

zero estate tax for modest estates

Examples:1. Survivor’s Trust and QTIP Trust2. A-C (Optional B) Plan

Modest Estates• A trust C (which is QTIPable) is virtually mandatory, in any

type of blended family situation.• Even in nuclear families with lengthy marriages, the B and C

trusts can offer substantial protection against subsequent gold diggers, undue influence, and creditors.

A-C (Optional B) Plan• Assets of the predeceased spouse automatically go to a C

trust, which is able to be QTIPed.• If surviving spouse elects not to QTIP part of the C Trust then

the assets go into a traditional bypass trust.• This allows the surviving spouse an extended time to make a

decision, longer than 9 month disclaimer period.• Should allow for at least 15 months to decide (assuming an

extended return)• Election valid on first 706 filed even though late

A-C (Optional B) Plan• If no estate tax return is filed in a timely manner, then the

deadline is the first estate tax return filed after the due date• Thus, an election out of QTIP treatment may be made even

after the 15 month deadline, though this is naturally not advisable.

Potential Solution• The A-C (Optional B) Plan seems to be very workable in most

modest estates.– Works well in blended families and nuclear families to

prevent gold diggers and undue influence.– Allows the surviving spouse a longer period of time to

determine whether to receive a potential step-up in basis or to fund the B Trust.

– Has the advantage of not worrying about portability or loss of portability due to remarriage.

Example: Peter’s Estate

Taxable estate of $8,155,027

Savings from not paying estate tax 2,854,259Savings from not paying income tax (due to step-up in basis) 1,181,005 Difference $1,673,254

Conclusion: Peter’s Estate should not pay estate tax

Rule of Thumb• If an estate is worth $14.25 million or more, then the step-up

in basis will not be worth the payment of the estate tax.• Example of an exception: If an estate has negative-basis

property, that is property with liabilities substantially in excess of basis, then it may be well worth paying estate tax even in a taxable estate that is over $14.25

Negative Basis ExampleGross Value

$54,000,000Adjusted basis $ 4,000,000Mortgage $44,000,000Equity $10,000,000Potential Gain $50,000,000

Estate Tax Savings $ 3,500,000Income Tax Saving $15,700,000

Conclusion: Pay the estate tax

Potential Future Effects

• Estate tax rate has gone down from 55% to 35%• Traditional planning will need to be reviewed– Consider Estate tax vs. Income tax paid on trustee fees

• Inflation factor highly significant: if COLA is a mere 1.5%, then the exclusion for a married couple next year will be increased by $150,000 to $10,150,000

Thank you!

This presentation is available on the Garret & Heaton, LLP website at:http://gh-llp.com/resources.html