Blogging from Heckerling – Estate Planning Post ATRA

Continuing with our reports from the Heckerling Institute on Estate Planning, January 2015

Marriage, divorce, birth, death have always been reasons clients want to revise previously set estate planning transactions that no longer accomplish their original goals. Now ATRA may be one of the biggest reasons that current estate plans need to be revised.

Only 15 years ago, the estate tax exemption was $675,000 ($1,030,000 for GST); the top estate tax rate was 55% and any unused exemption amount was lost by the surviving spouse.  Fast forward to 2015 and as a result of ATRA, the current estate tax exemption is $5,430,000 (same for GST), the top estate tax rate is 40% and we have portability. While the estate tax burden has decreased, the income tax burden for individuals and trusts has significantly increased.  The top income tax rate on ordinary income has gone from 35% to 39.6%, long-term gains from 15% to 20% and we have a new 3.8% Medicare tax on net investment income. A New York City resident is looking at a top effective rate on income of 52.26%!

John F. Bergner of Winstead P.C. suggested several new estate planning strategies post ATRA.  One of the concepts discussed was to think about avoiding valuation discounts on assets.  While in past years estate planners put much effort into setting up ownership structures that would permit a valuation discount due to (1) fractional interest, (2) lack of control or (3) restrictions on outright sale, the post ATRA world could make these structures detrimental to the overall tax burden of a family. 

Remember: The estate tax value of an asset is what determines basis for income tax purposes of the inherited property.  If the decedent’s total assets do not exceed the current estate tax exemption ($5.34M); a reduced fair market value will produce no federal estate tax savings AND will increase the gain that will have to be recognized on the eventual sale of the property by the beneficiary. 

Example: The client owns a 25% interest in a family limited partnership (“FLP”) that has been discounted down to a value of $3M.  If he owned these assets outright, the value would be $4.5M.  His only other assets are valued at $750,000.  If the client dies with these asset values, there would be no estate tax either with or without the discount.  The discount provided no estate tax benefit.   However, assuming that the client holds this discounted FLP interest at death, the beneficiary has a built in gain of $1.5 million that will cause additional capital gains tax on the eventual sale.