Dear Mr. Premack: I am widowed with three responsible adult children. My husband and I worked hard and he left me the entire estate, which is now around $2.6 million. My son has been asking if I have my own estate planning in order, and I think that I do. I have a Will that leaves my estate to the children in equal shares. What I’m most concerned about is the estate tax, which I hear is very high. Can I do anything to reduce the estate tax my kids will have to pay when I die? – E.B.
We are in a very odd moment for estate taxes. Historically, Congress tries to set tax policy in a way that motivates certain behaviors (like charitable giving), that raises tax revenues, and that allows people to know what exposure they may have in the future. However, since year 2001 Congress has let the estate tax fluctuate in a manner that makes long term planning very difficult.
The trend has been positive, in the sense that fewer estates have been forced to pay estate taxes since the law changed in 2001. The exemption from the tax has been expanded from just $670,000 in 1999, up to $3.5 million in 2009, up to an unlimited amount in 2010, and then back to $5 million in 2011-2012. The problem is that all these exemptions are temporary.
When the “Bush Tax Cuts” were set to expire at the end of 2010, Congress had two choices: 1) let them expire, or 2) pass a new law.
If they were allowed to expire, the law that existed in 1999 would be reinstated, and it said that the exemption for year 2011 would be just $1 million. In other words, we would have gone from an unlimited exemption in 2010 to a $1 million exemption in 2011 and forward. In your case, if you had died in 2010 there would be zero tax, but if you died in 2011-12 your estate would owe about $800,000 in estate tax.
If they were to pass a new law, the Republicans and Democrats would have to find a compromise. In fact, this is the option they chose, agreeing on the new $5 million exemption for years 2011-2012. In your case, that means if you die in 2012 there will be zero tax.
We have just entered 2012, so there are exactly 12 months of life remaining in the $5 million exemption. What happens next? You guessed right. Congress has two choices: 1) let the exemption expire, or 2) pass a new law. But this time, it is a presidential election year and the two parties are not likely to be eager to make any deals, at least until after the election. Thus, the President and a lame duck Congress will be setting tax policy for 2013 and beyond.
What will they do? We cannot know. Many analysts think they will extend the $5 million exemption for a few more years. Some think they may reduce the exemption to its $3.5 million level set in 2009. What we know for certain is that if they fail to pass a new law, the 1999 law is reinstated with its mere $1 million exemption.
Thus, you face a period of tax uncertainty. People are, of course, understandably reluctant to die in 2012 just to take advantage of the $5 million exemption. Yet you would like some certainty about what tax your children will pay, so that you can begin to plan (either to investigate ways to reduce the tax, or ways to pay the tax like the purchase of additional life insurance). Sadly, Congress is not likely to let us know until after the election.
The conundrum, then, is that if you do nothing your estate may owe a huge tax, but if you do something it may turn out to be unnecessary if they decide to pass a new law. One option is to take advantage of the gift tax exemption. In 2012 you can gift up to $5 million to anyone without paying gift taxes. You could transfer about $1.6 million of your wealth to your children in 2012, leaving yourself with a $1 million estate that is within the limits of the worst case scenario. But if you give away your wealth and then Congress passes a new extension, the gift was unnecessary after all (and you can’t get your wealth back from your children). But if you don’t give away your wealth and then Congress allows the exemption to expire, you’ve left your estate exposed to a huge tax that could have been avoided! This is not an easy decision, and is one that should likely be deferred until after the election, when it may be easier to see in which direction Congress may turn.
Paul Premack is a Certified Elder Law Attorney practicing estate planning and probate law in San Antonio.
Original Publication: San Antonio Express News, January 2, 2012