Why Tax Planning Still Matters

TRA 2010 introduced several major changes into the Federal estate tax laws: (1) an applicable exclusion amount of $5 million; (2) a flat 35 percent tax rate; (3) reinstatement of carryover basis; and (4) the possibility of portability between spouses by operation of law.

These changes—particularly the last one—have some wondering whether traditional estate tax planning is dead.  Some wonder whether this is any continuing need for credit shelter or disclaimer trusts now that a spouse’s unused exemption can be transferred to the surviving spouse by making an election on the predeceased spouse’s estate tax return.

The waters have been further muddied by mixed motives on the part of the estate planning community.  Many who make their living by selling estate plans that incorporate credit shelter planning fear that the new law will make these plans superfluous.  But self-interest aside, there really are some compelling reasons to continue to incorporate credit shelter planning (though perhaps in an unintrusive way, such as a disclaimer trust).  Here are a few of those reasons:

1. The Temporary Nature of TRA 2010 – As discussed in our article on Planning Under the New Estate Tax Law, the new Act only postpones the expiration of the prior law.  The new Act is currently scheduled to disappear at the end of 2012.  While some would say (and I would agree) that a return to a $1 million exemption and a 55 percent tax rate is not likely, the fact remains that we don’t know what the future holds.  If portability is eventually repealed or modified, those who rely on it as an estate planning device could pay millions in unnecessary taxes.
2. No Inflation Adjustment for the Deceased Spouse’s Unused Exclusion– The deceased spouses unused applicable exclusion amount is not adjusted for inflation.  While the surviving spouse’s unused applicable exclusion amount will continue to increase in $10,000 increments over time, the predeceased spouse’s exclusion amount is fixed at death.  If we assume the historical 2.56 percent increase in CPI, the difference between a credit shelter bequest and reliance on the predeceased spouse’s exclusion amount can be substantial.  Consider:
   1. Over a 15 year term, a $5 million bequest to a credit shelter trust will be worth around $7.5 million if the CPI rises at its historical rate of 2.56 percent.  In contrast, a surviving spouse’s exclusion amount will be worth only $5 million in 15 years.
3. Possibility of Spouse’s Remarriage - The predeceased spousal exclusion can only be claimed for the most recently deceased spouse.  In other words, if the spouse remarries, she can only use the exemption amount of the new spouse.  The exemption amount of the first predeceased spouse will be lost.  This can be avoided with credit shelter planning.
4. GST Exemption – Only the estate (and possible the gift) tax exemptions are portable.  The GST tax exemption is not.  Use of a credit shelter bequest will provide a convenient way to allocate the predeceased spouse’s GST exemption, ensuring that it is used.

And those are just the economic/tax reasons.  Sometimes those of us who are involved in sophisticated tax planning forget that a majority of trust planning is not tax driven.  There will still be continued need for trusts to provide asset protection, control the timing and manner of asset distributions, and other non-tax benefits.  If anything, the new law will simply add additional tools to help us reach our clients non-tax goals in a tax-efficient manner.