The new law that averted the “fiscal cliff” contains major changes for estate and gift tax rules that will affect not only the advice lawyers give to their clients, but the future landscape of estate planning law for years to come.
In an unexpected turn of events, the deal made permanent the lifetime tax-free exemption of $5 million (adjusted for inflation) — which began in 2011 — as well as portability of the spousal exemption. Almost everyone expected that the amount would be reduced to as little as $1 million and not made permanent.
In the short term, the rules provide a welcome certainty for attorneys who, for the past several years, have faced a moving target in the estate tax realm.
“It has been up in the air for the last couple of years,” said Adam Wiensch, a partner at Foley & Lardner LLP, Milwaukee.
But in the long term, some see the newly permanent rules as nothing less than a tectonic plate shift in estate planning law.
“For the vast majority of attorneys, this is a game-changer,” said Martin Shenkman, an estate planning attorney in Paramus, N.J.
Shenkman predicts the changes will make most potential clients less likely to hire an estate planning lawyer, thereby forcing attorneys to rethink whom they serve and how to serve them.
“This is the first time in history,” he said, “that most clients now have no fear of the federal estate tax.”
New certainty for clients
After scrambling to advise clients about uncertain estate and gift tax rules for the past few years, estate planning lawyers breathed a collective sigh of relief that the new law sets the amount of the combined estate and gift exemption at $5 million and does not contain a sunset provision.
“This is a huge relief just to know what the future holds and to be able to advise our clients with confidence,” said Amiel Weinstock, an attorney at Nixon Peabody in Boston.
Under the bill that President Barack Obama signed into law Jan. 3, the $5 million exemption, which began in 2011, is adjusted for inflation. The exemption for 2012 was $5.12 million and in 2013 likely will be about $5.25 million (although the IRS has not provided an exact figure).
The measure also raises the top estate and gift tax rate from 35 percent to 40 percent.
Because old rules were set to expire at the end of 2012 and automatically reset the exemption to $1 million and the tax rate to 55 percent, lawyers had been advising clients about possibly missing out on an extra $4 million gifting opportunity.
“There was a lot of gifting activity at the end of 2012 to get in before the deadline. People were in a rush to make the maximum gift, thinking it would go down. Now the urgency is removed and people can reflect with cooler heads,” said Matthew Karr, an estate planning attorney at the Heritage Law Center in Woburn, Mass.
The new law also makes permanent the portability rules for the spousal exemption, and therefore any part of the exemption that is not used by a spouse who dies can be used by the surviving spouse. However, the exemption must be claimed within 90 days of the spouse’s death on a special form the IRS plans to create.
The change will simplify the advice attorneys can give.
“For most clients, if they want to give money to their children, they can write a check without more complicated strategies. A lot of clients will say they don’t need to set up a trust. They can leave everything to the surviving spouse now that they can have two exemptions,” said Wiensch, who noted that there are still reasons to set up a trust, such as protecting assets from creditors.
‘Jump on it’ before next cliff
The law leaves open several other estate planning techniques that affect high net-worth clients. Those techniques are likely to be affected as more fiscal cliff talks take place in the coming months.
Among the items on the chopping block are: valuation discounts in grantor trusts and other techniques that freeze the value of assets, such as short-term GRATs (Grantor Retained Annuity Trusts) and sales to defective grantor trusts.
Lawyers have an opportunity to advise affected clients of these near-certain changes coming soon.
“Attorneys should view this as a grace period and should be jumping all over this before Obama gets another bite at the apple,” Shenkman said. “If they don’t, they will have wasted this grace period given from Washington heaven.”
Shenkman said he is sending out letters to every one of his high net-worth clients warning them of these eventualities.
Given that the new exemption is much higher than expected and appears to be a certainty for years to come, estate planning attorneys may see less work from clients, except for ultra-wealthy ones.
“I was hoping to have the exemption move down to $3 million,” Karr said. “That would have provided more business.”
And with the now-permanent portability rules, the exemption is more like a combined $10 million.
“What number of families has more than a $10 million net worth? It’s a minuscule percentage,” Shenkman said.
For clients who are on the edge of the $5 million range or whose state estate tax does not mirror the federal estate tax, there still will be opportunities to provide tax-driven planning advice.
But now that the high exemption eliminates much of the need for esoteric tax strategies, Shenkman predicts that estate planning attorneys, most of whom are small-firm practitioners, will have to reassess their client base and think creatively to serve the majority of clients, who no longer fear having to pay the estate tax.
“The smarter practitioner will focus on where the real bread and butter is,” such as educating clients on divorce, asset protection and succession planning for businesses, he said.
“It’s a new world,” Shenkman added. “Attorneys need to reevaluate how they manage their practice and will have to do it more cost-efficiently and with less complexity, because clients won’t pay anymore, because the fear is gone.”