Despite a deadline of Dec. 31, 2012, which would have meant the largest tax hike in U.S. history, Congress waited until Dec. 32nd (that’s an intentional typo) to pass the American Taxpayer Relief Act of 2012, or ATRA.

While many planners were leveraging the fear that the Federal Estate and Gift Tax Exemption would revert to $1 million to obtain new clients, the newly enacted "permanent" Federal Estate and Gift Tax Exemptions instead remained at $5 million, and were indexed for inflation to $5.25 million in 2013. The top estate and gift tax rates, however, increased from 35 percent to 40 percent. Also to be noted is that portability became a permanent part of the estate tax regime going forward.

Now that many planners are recovering from the fiscal cliff of 2012, we are faced with how best to advise our clients going forward. The Tax Policy Center estimates that only 3,800 estates in the entire country — which is a minuscule 0.14 percent, or 1 in every 700 people who die — will pay any estate tax in 2013. (The Tax Policy Center is a joint venture of the Urban Institute and the Brookings Institution, based in Washington, D.C., which aims to provide independent analyses of current and longer-term tax issues and to communicate its analyses to the public and to policymakers in a timely and accessible manner.)

The obvious question now posed by all but the wealthiest of clients is: "Do I need an estate plan?" However, as attorneys and life insurance brokers are well aware, there are still a multitude of reasons to advise your clients to implement estate plans.

New Jersey State-Based Estate Taxes

The New Jersey state-based estate tax exemption remains at $675,000. Therefore, an estate worth approximately $2 million, while not subject to federal estate taxes, will result in a New Jersey state estate tax liability of $99,600.

One way to avoid state-based tax liability is by employing the use of an irrevocable trust. If the client were to gift $1.5 million into an irrevocable trust, reducing the client’s net worth to $500,000, the eventual estate would be below the New Jersey State exemption and thus not be subject to New Jersey state estate taxes.

A planner must first consider how the loss of ownership and control (as to not violate sect. 2036 of the I.R.C.) of the $1.5 million will the impact the client. There are also potential capital gains issues to be wary of when attempting this strategy because when you gift, you gift cost basis. As such, there is no step-up in basis to the date of death value as there would be had the heirs inherited the property instead of receiving it during the donor’s lifetime. This strategy may then backfire on a planner who counseled their client to save $99,600 in New Jersey estate taxes, but triggered a capital gains tax liability that may outweigh the estate tax savings.

Another way to avoid or reduce state-based tax liability is to purchase life insurance. Many planners fail to realize that even the elderly can be insurable. Using the same fact pattern, if the client with a net worth of $2 million were to purchase a $200,000 life insurance policy, it could create a scenario where the life insurance proceeds could pay the estate taxes and still cover the cost of the premiums.

Of course, the planning technique that best works in conjunction with life insurance is an Irrevocable Life Insurance Trust (ILIT). An ILIT would be the owner and beneficiary of the life insurance policy. The beneficiaries of the ILIT could be the client’s children and perhaps, the spouse. Once the insured passes away, the life insurance proceeds flow into the ILIT and are not included in the insured’s estate for estate tax purposes. (The life insurance proceeds are not subject to income tax pursuant to sect. 101 of the I.R.C.)


Some high-net-worth clients feel like they are "self-insured" against estate taxes. But what if the majority of the client’s assets are illiquid? Clearly real estate is illiquid, especially in the rough markets we have seen over the past five years. Additionally, many people fail to realize that retirement accounts can also be an illiquid asset.

My firm was recently retained by a client to prepare his estate plan. As a routine part of our meeting, I asked if he stood to inherit funds that might significantly impact his net worth. He answered that his last living parent had recently died and recounted the following concerning his dad’s estate. Dad’s estate consisted of income-producing real estate and a $4 million IRA. The federal and state estate tax liability was calculated to be $2 million. He and his siblings did not want to sell the real estate, as it produced a substantial amount of yearly income and was essentially an annuity for them. However, they were advised that the real estate would have to be sold to pay the estate taxes. By the time the real estate was on the market, the crash of 2008 was upon them. Meanwhile, the nine month from date of death deadline to file an estate tax return extension and requirement to pay estimated estate taxes was rapidly approaching.

Ultimately, the client and his siblings had no choice but to liquidate Dad’s $4 million IRA. In doing so, they incurred a 50 percent income tax liability or $2 million. The remaining $2 million was used to pay the $2 million estate tax liability. Therefore, it cost this family $4 million to pay a $2 million tax liability because they did not get the proper advice from their prior counsel.

One way this problem could have been avoided would have been to have Dad use the income from the real estate and/or required minimum distributions from the IRA to pay for a $2 million life insurance policy. Of course, that policy would have been held in an ILIT, and thus out of the client’s estate for estate tax purposes. Therefore, even though the tax liability may not be as high or relevant for estates under $5.25 million, the liquidity concept is still a valid concern in 2013.

ATRA is ‘Permanent,’ So How Do You Get Clients To Act?

In case you haven’t noticed, I have used quotes around the word "permanent" throughout this article. In my estimation, the use of the word permanent as it relates to the tax law changes simply means that there is no expiration date to these tax laws. Since 2001, we have had tax laws that were set to expire. It was these expiration dates that motivated many people to plan — many not until December of 2012. However, the new laws have no expiration date; and as such are referred to as "permanent." So what will motivate clients, who are notorious for procrastinating when it comes to estate planning, to act?

Lawrence Sumners, a noted Harvard economist, had the following to say about the revenue generated from estate taxes:

A simple calculation shows that our estate tax system is broken.??Assets that are passed to relatives or other personal relations are often badly misvalued relative to what they cost on an open market. The total wealth of American households is estimated at more than $60 trillion. It is heavily concentrated in very few hands. A conservative estimate given the lifespans of Americans would be that 2 percent ($1.2 trillion) is passed down each year, mostly from the very rich. Yet estate and gift taxes raise less than $12 billion, or just 1 percent of this figure each year.

What this says to me is that at some point, Congress will wake up and realize that there can be substantial revenue generated from the wealth of a few. The message to high-net-worth clients is to not wait until Congress changes its mind about the Federal Estate and Gift Tax Exemptions.

The General Explanations of the Administration’s Revenue Proposals (Green Book), released by the U.S. Department of the Treasury, provides some insight as to certain steps that Congress may be considering in an effort to curb the ability of the wealthy to avoid estate taxes. For example, Congress has already proposed the elimination of the lack-of-control and lack-of-marketability discounts when valuing family-owned or closely held businesses. Without these discounts, the value of the asset transferred would be much higher, and therefore the amount that someone can gift without paying gift taxes would significantly decrease.

Congress is also looking to impose a minimum 10-year term for Grantor Retained Annuity Trusts (GRATs). GRATs are trusts where the grantor retains the right to receive an annuity, with the remainder passing to beneficiaries at the end of the term. They are typically funded with assets that are likely to earn more than the Internal Revenue Service’s section 7520 rate (1.2 percent for the month of February 2013) during the term, so as to pass the appreciation of the assets to the trust beneficiaries free of gift and estate tax.


There are still compelling reasons to advise clients to create estate plans and purchase life insurance. Although the reasons may not seem as dire to clients as when they were approaching the fiscal cliff of 2012, clients now more than ever need to be educated as to proper planning. As a knowledgeable advisor, you will be one step ahead of your competition.■

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