When Issues Arise in Estate Planning

Financial security is a goal for us all, but with wealth comes complexity. An increase in wealth not only typically causes an increase in annual income taxes, but it may also beget estate and gift taxes. Current federal law allows each citizen to transfer a certain amount of assets free of federal estate and gift taxes, named the "applicable exclusion amount."

In 2021, every citizen may, at death, transfer assets valued in the aggregate of $11.7 million ($23.4 million for married couples), free from federal estate tax. For gifts made during one's lifetime, the applicable exclusion amount is the same. Therefore, every person is allowed to transfer a total of $11.7 million during their life or at death, without any federal estate and gift tax. (This does not include the annual gift exclusion, which applies as long as each annual gift to each recipient is less than $15,000.)

Therefore, generally, only estates worth more than these amounts at the time of death will be subject to federal estate taxes. But this wasn't always so. From 2001 to 2009, the applicable exclusion rose steadily, from $675,000 to $3.5 million. 2010 was a unique year, in that there was no estate tax, but it was brought back in 2011 and then made permanent (unless there is further legislation) by the American Tax Relief Act of 2012 at an exclusion amount of $5 million, indexed for inflation. The Tax Cuts and Jobs Act passed in December of 2017 doubled the exclusion amount to $10 million, indexed for inflation ($11.7 million for 2021). However, the new exclusion amount is temporary and is scheduled to revert back to the previous exclusion levels in 2026.

Outdated estate documents may include planning that was appropriate for estates at much lower exemption values. Many documents have formulas that force a trust to be funded up to this applicable exclusion amount, which may now be too large or unnecessary altogether, given an individual’s or family’s asset level.

Be mindful of Income tax rates vs estate tax rates

Your prior estate planning may have emphasized federal estate tax savings because of the much lower applicable exclusion amount and traditionally higher federal estate tax rates. Changes in the federal tax law make it increasingly important to focus on the income tax consequences of estate planning in addition to the estate tax consequences. For estates still subject to federal estate tax, the federal estate tax rate is 40%. These rates must be compared with the top federal income tax rates of 37% on ordinary income and 20% on long-term capital gains and qualified dividends, plus a 3.8% Medicare net investment income tax.

Furthermore, trust income tax rates must be taken into consideration. Trusts are taxed at the highest federal income tax bracket starting at $13,250 in annual trust income. Therefore, when transferring assets to a trust for estate planning purposes, consideration should be given to the potentially negative consequences of higher income taxes. Outdated estate plans may not provide the flexibility required to shift the income tax burden from the trust to individuals in potentially lower tax brackets.

Revisit your estate planning documents and gifting strategies with your attorney and tax professional to determine whether they are still appropriate, considering the Medicare net investment income tax, the current federal estate tax rate, and the increased applicable exclusion amount.

Talk with the next generation

Do your loved ones know what you plan to leave to them when you die? Do they know who to contact when something happens? Fewer surprises will make estate administration much easier when the time comes.

Consider drafting and regularly updating a letter of instruction to your children and fiduciaries. This letter should include an inventory of assets, and a list containing names, addresses, and phone numbers of your estate planning team. Easy access to this information may save your family from headaches down the road. Furthermore, having a discussion regarding your assets, your intentions, and your reasoning (especially when creating trusts rather than leaving assets outright) will help build relationships and avoid family discord, and may even reduce the likelihood of litigation down the road.

Additionally, make sure to give your fiduciaries the appropriate power to handle your assets. There has been a lot of change in recent years to laws regarding the administration of digital assets, such as email accounts, social media accounts, and song and picture libraries. You may want to create a list of your digital assets and name a successor to handle them. Proper documentation of succession planning for your digital assets is necessary because state and federal laws may prohibit others from accessing or using your digital assets without written consent.

Outdated Estate Planning - Children Grown Up

Many trusts are designed to distribute assets to children at certain ages, e.g., one-third at age 25, one-half of the remaining assets at age 30, and the remaining balance at age 35. If a child is now above one or more of these ages, they will receive distribution of part or all of the trust assets outright and free of trust upon the last to die between you and your spouse. Now that your child is older, you may feel differently about their ability to handle a large inheritance; for example, you may feel that large sums might not be spent in the most prudent manner if they are free of restrictions. Further, if the child is married, an inheritance can easily be commingled with the spouse's assets, possibly subjecting the distributed trust assets to equitable distribution upon a divorce. An inheritance free of trust will also be subject to any existing or future creditor claims. These are some of the factors you may wish to consider when reviewing your estate plan to determine if it still meets your needs.

Furthermore, in many cases, outdated estate plans are simply not consistent with current wishes or circumstances. For example, it is possible that one child within a family has been financially successful while another has not. When an estate plan is initially created, an equal amount of inheritance among children may have been the goal, but that may have changed over time. Also, in some cases, beneficiaries named on retirement accounts and life insurance policies may not be in line with the trusts created for children under a will or revocable trust. It is vital to revisit all the ways assets are being left to children, given their current age and maturity, to make sure the plan still matches the current intent.