Historically, many lawyers have taken somewhat of a "one-size-fits-all" approach to estate planning, focusing primarily on reducing future estate tax and only tangentially considering federal income taxes, state estate and income taxes, international issues, asset protection (including protection from divorce), charitable planning, and other nontax objectives (i.e., keeping assets in the bloodline). Over the past 15 years, the combination of significant federal and state legislative changes, an increasingly litigious society, and a globalizing economy have forced practitioners to rethink the manner in which estate plans have been structured and introduce a myriad of additional factors that must be considered. What was once a one-size-fits-all approach has morphed into a Pandora's box, requiring practitioners to take a much more thoughtful and calculated approach to planning and to consider the interplay among federal and state estate and income taxes, and many nontax considerations. This article discusses some of the recent legislative changes affecting estate planning and the manner in which estate planning has changed to adapt to such changes.
Historical Approach to Estate Planning
The complexity of today's planning cannot be fully appreciated without first understanding the relative simplicity of planning in years past. In 2000, prior to the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), (1) the estate and gift tax applicable exclusion amount (commonly referred to as the estate and gift tax exemption) was only $675,000; the top federal estate and gift tax rate was 55 percent (with an additional 5 percent surtax for higher estates intended to phase out the estate and gift tax exemption); the federal capital gains tax rate was 20 percent; and "portability" and the net investment income tax (NUT) did not exist. In this tax environment, little variation existed in the estate plans that practitioners implemented for clients, at least from a tax perspective. The primary objectives were to take full advantage of the client's estate and gift tax exemption and, for clients owning assets in excess of the estate and gift tax exemption (or the combined exemptions for a married couple), to remove assets with high appreciation potential from the taxable estate so that growth on the value of the assets could occur outside of the taxable estate.
For married couples, the first objective generally was achieved by utilizing a bypass trust/marital trust or A/B plan (traditional plan), whereby upon the death of the first-to-die spouse (DS), assets having a fair market value (FMV) equal to the DS's remaining federal estate and gift tax exemption would fund a bypass trust, which would be exempt from federal estate tax upon the surviving spouse's (SS) death. The balance of the DS's assets would pass to the SS (outright or in trust), which would utilize the federal estate tax marital deduction so that no federal estate taxes would be imposed upon the DS's death. To ensure that the DS held assets sufficient in value to fully fund the bypass trust (thereby fully utilizing the estate and gift tax exemption of the DS), couples were often forced to divide and retitle their assets so that each spouse owned assets having a FMV at least equal to the estate and gift tax exemption. Any portion of a DS's estate and gift tax exemption not used upon his or her death was forever lost.
The second objective was typically achieved through the implementation of lifetime gifting techniques. When a client makes a lifetime gift, the donee takes a carryover basis in the gifted asset equal to the donor's basis in the gifted asset immediately prior to the transfer. (2) As a result, although the donor has effectively removed any post-gift appreciation from his or her estate, if the donee subsequently sells the gifted asset, the donee would have to pay capital gains tax on all of the appreciation, even that appreciation occurring prior to the gift. (3) At a time when the estate tax rate was sufficiently higher than the capital gains tax rate (and no NUT existed), the estate tax saved by making a lifetime gift almost invariably exceeded the future capital gains tax associated with the gift. (4)
Legislative Changes and Their Impact on Planning
* Recent Legislative Changes--Even through the 2000s, as the estate and gift tax exemption increased, estate plans generally remained the same. However, the American Taxpayer Relief Act of 2012 (ATRA) (5) drastically altered the way in which practitioners approach estate planning. Significantly, ATRA permanently 1) increased the estate, gift, and generation-skipping transfer (GST) tax exemptions to $5 million indexed annually for inflation ($5.43 million in 2015); 2) increased the estate, gift, and GST tax rates to 40 percent (from 35 percent); 3) increased the capital gains tax rate to 20 percent; and 4) extended portability of the estate and gift tax exemption between spouses. In addition to these changes, the 3.8 percent NUT, which generally applies to passive income, such as gross income from interest, dividends, rents, royalties, annuities, and gains from the disposition of property, became effective in 2013.
In addition to changes in the law, society is changing. The increasing rate at which lawsuits are filed and the prevalence of divorce has led many clients and practitioners to place a greater emphasis on integrating asset protection strategies into estate plans. This has led a number of states to enact legislation permitting the use of domestic asset protection trusts or DAPTs as a way to protect asset from future creditors while allowing the settlor of the DAPT to retain a beneficial interest in the assets transferred to the trust. (6)
Moreover, as society and the economy become increasingly global, a greater number of individuals are deciding to live and/or invest abroad, thus, requiring practitioners to consider additional complex issues, such as compliance with the various reporting requirements of the Foreign Account Tax Compliance Act (FATCA), which generally requires U.S. taxpayers to report their ownership interest in certain foreign accounts, and wealth transfer tax and cross-border income tax planning issues related to planning for non-U.S. citizens with U.S...