The Effects of the Fiscal Cliff Avoidance on Estate Tax Planning in Washington Statecornerstonews
The Effects of the Fiscal Cliff Avoidance on Estate Tax Planning in Washington State
Estate tax planning took a marked change in 2013 when the federal estate tax became less relevant and the Washington state estate tax became the more oppressive tax for most residents of our state. To understand the shift we must first look to the past.
In 2001, then President George W. Bush enacted sweeping tax legislation under the Economic Growth and Tax Relief and Reconciliation Act of 2001 (EGTRRA). In terms of estate planning, EGTRRA ostensibly provided for the phase-out of the estate tax. However, under EGTRRA, one year after the phase-out of the estate tax, the 2001 estate tax laws were set to go back into effect. More specifically, in 2010, the law provided that there would be no federal estate tax. However, in 2011, the estate tax would revert to its 2001 levels: taxes imposed on estates valued at over $1 Million (including life insurance proceeds). For this reason, many estate planning attorneys continued to use the $1 Million mark to determine when and if estate tax planning was necessary. The tax rate was roughly 45% of anything over $1 Million. Accordingly, if a person had a gross estate of $1.5 million, for planning purposes, estate planners would often prepare for the fact that the amount over $1 Million ($.5 Million) would be subject to the 45% rate. And, if a person had less than $1 Million, then that estate would not be subject to tax.
Fast forward to 2010…there was no federal estate tax (as planned). But, before the law reverted back to 2001 levels as it was planned to do, Congress made a change which provided for a $5 Million exclusion. However, this change was only effective for two years. And, under the law at the time, the estate tax rates would again revert to 2001 levels in 2013. Again, many estate planning attorneys continued to use the $1 Million threshold for estate tax planning because of that law.
On January 1, 2013, the so-called “fiscal cliff” was avoided. As part of that avoidance, the estate tax was resolved. The current law enacted on January 1, 2013 provides that an estate will not be subject to federal estate tax unless it is valued at over $5 Million (technically $5.43 million for 2015). More importantly, the new law provided no reversion back to the 2001 levels as had been the fear for the previous decade of planning. Plus, the new law allowed for portability…allowing one spouse to use his or her deceased spouse’s unused unified credit, effectively making the unified credit over $10 Million for a couple. So, for the past decade, the federal estate tax had been the primary concern of estate planning attorneys in Washington. That all changed on January 1, 2013 and now the Washington state estate tax takes the front seat in most estate plans.
The Washington state estate tax is imposed on estates valued at over $2 million. It was always less of a concern for estate planners because the federal estate tax was pegged so low. However, now that that federal estate tax is not imposed until a couple has over $10 million, estate planners in Washington are looking to the Washington estate tax for primary planning purposes.
Washington’s estate tax is structured differently from its federal counterpart in several ways. First, Washington’s estate tax does not generally tax gifts like the feds do. Second, Washington does not allow portability like the feds do. Third, Washington allows a generally more favorable deduction for qualified farm property included in the estate. Fourth, our Washington state estate tax rate begins at just 10% of the amount over $2 million. This changes the landscape tremendously for Washington residents.
Estate planning attorneys previously relied on credit shelter trusts to allow more assets to pass to the next generation free of the estate tax or to reduce the estate tax. This technique is less important now. While it is true that the credit shelter trust is still necessary to be able to fully leverage and avoid Washington’s estate tax, another consideration is the income tax. That is, upon the death of one spouse, all of the community property gets a “step up” in tax basis (though the current Obama administration is proposing to eliminate this rule). This reduces the overall income tax which might be due upon the sale of an asset. That same step up in tax basis might also be available upon the death of the second spouse, but not for any assets held in a credit shelter trust. This means that although an individual can use the credit shelter trust to avoid the estate tax (imposed at 10%), he or she may be subjecting the same assets to income tax on any gain at a rate of generally at least 15% and maybe as high as 23.8% (with the new Medicare surtax). It appears then that a more thoughtful approach to estate tax planning is required. The standard credit shelter trust plan that has been the hallmark of estate planning attorney for years no longer fits every tax situation.
In many cases, the better approach to the credit shelter trust is to allow the use of the trust to be optional at the direction of the surviving spouse. This allows the surviving spouse and his or her planning professionals to evaluate the factors at the time of the first death, such as: (1) what is the gross value of the estate; (2) what are the current tax rates imposed by the federal and state government; (3) are there other estate tax planning techniques the surviving spouse would prefer to a trust; (4) does the surviving spouse mind the additional complexity of an irrevocable trust; (5) what are the surviving spouse’s spending habits; (6) what are the assets of the estate, etc.
The bottom line is that true estate planning is more important than ever in Washington State in light of the competing tax schemes to which an estate may be subject.