The tax changes that Congress passed in the first days of 2013 raised taxes on most American households. While the new higher rates for upper income earners and the end of the FICA tax cuts got the attention of most Americans, Congress also made several changes to the estate tax.
The good news is that Congress chose to keep the $5.25 million estate tax exemption. With the expiration of the Bush administration the automatic estate tax exemption was supposed to decrease to just $one million, which would have exposed far more Americans to estate taxes. Estates that fall below $5.25 million will owe NO federal estate taxes. Also $5.25 million is the 2013 estate tax number. That amount will adjust annually with inflation. That number can double when a surviving spouse assumes the exemption of the deceased spouse. This concept is called portability and means that for many people their bypass trusts are an unneeded expense.
The trust could actually cost heirs money through higher capital gains rates because the trust is not allowed to deduct the inherited value of an asset from the sales price of that asset, unlike an individual. Anything over the estate tax threshold is taxed at a 40% tax rate.
To get the doubling exemption you have to leave your assets to your spouse rather than to a trust. While there is a tax saving benefit to doing this, you are giving your survivor an enormous amount of power. Can you trust them to leave your assets to your heir upon his or her death?
Especially in blended families there can be falling outs between the surviving spouse and the next generation. Are they competent to invest the money? Will they give the money to charity rather than to the children or grandchildren? Is their certain assets (like a family business or home) that you want to leave to a certain heir? If so are you sure that your surviving spouse agrees with that judgement?
There are also state estate taxes to deal with. 17 states have estate taxes in addition to the federal estate tax and seven have inheritance taxes. Estate taxes are charged to the estate, while inheritance taxes are charged to each heir individually. In some states with high state tax rates, the bypass trust could be more than justified to protect the estate from the state estate tax rate, even when they fall well below the federal exemption rate.
For more information or to discuss your personal situation, make an appointment to discuss the pros and cons of your old estate plan. You may need to re-purpose or even close existing trusts. You may need to update your will or other estate documents.