Understanding and Planning for the Combined Effective Federal and State Tax Rates

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1 Understanding and Planning for the Combined Effective Federal and State Tax Rates Prepared by Abby Wool Landon and Karen Hobson, Williams Kastner Presented by Abby Wool Landon 2012 NAPFA West Conference

2 Abby Wool Landon Phone: Abby Wool Landon is a member in the Portland office of Williams Kastner. She is an estate planning, wills and trusts, tax, business succession and probate attorney with extensive experience advising closely-held family businesses in various capacities. Owner of her own law firm for ten years, business owner and member of several family partnerships, she brings hands-on business experience to her clients. Ms. Landon helps her clients with wills and trusts, complex business transactions, business succession and estate plans. If required, she assists them in navigating the probate process, and probate, wills and trust disputes, where it becomes necessary.

3 Disclaimer/Copyright These materials have been prepared by Williams Kastner for informational purposes only and are not legal advice. The information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Individuals should not act upon this information without seeking professional counsel. Copyright 2012 by Williams Kastner, 601 Union Street, Suite 4100, Seattle, WA

4 Transfer Taxes Distinguishing between the estate tax and an inheritance tax Estate tax is a tax that is imposed on the estate before it is transferred Inheritance tax is paid by the inheritors when they receive a gift Oregon's transfer tax originally misnamed an 'inheritance' tax, corrected in 2012 What is the Death Tax? Politics or Law? Introducing the 2012 State Death Tax (IRC 2011) Chart Gift Tax Generation Skipping Transfer Tax (GST)

5 Combining the Federal and State Transfer Tax The US federal government enacted an estate tax in 1916 to break up the swollen fortunes of the rich. Thereafter, every state enacted a similar tax of its own Beginning in 1926, the federal estate tax allowed a dollar for dollar tax credit against estate tax levied by the states The "pick up tax" is a state tax calculated to be exactly equal to the maximum federal estate tax credit. The net result of the "pick up" tax was that part of the federal estate tax liability was shared with state governments States with only a pick up tax imposed no tax of their own EGTRRA and Beyond: June 2001, the Economic Growth and Tax Relief and Reconciliation Act (EGTRRA); the 2010 Estate Tax Repeal; the Tax Relief Act (TRA) of 2010 In 2001, the individual estate tax exemption was $1M, the rate was 55% EGTRRA gradually increased the exemption to $3.5M then no tax in 2010 TRA 2010, gift, estate and GST exemption $5M (inf.adj. in 2011 to $5.12M) w. rate 35%, and spousal portability TRA 2010 sunsets on12/31/12, estate tax exemption returns to $1M, rate 55% BEYOND

6 The Pick Up Tax and Decoupling in Recent History EGTRRA provided that the estate tax cuts phase out the federal credit to the states for estate tax between 2002 and 2005 After 2005, the federal estate tax provides for a deduction against federal estate tax for any applicable state transfer tax Decoupling: many states passed new legislation that provided for their own estate tax exemption or credit limit Some states, California and Nevada for example, continued to have a 'pick up tax.' In those states, the state estate tax is equal to $0.00 After re-tooling, three states have implemented a stand alone system: Oregon, Washington and Connecticut

7 Calculating the Transfer Tax Under TRA 2010 Unification: TRA 2010 unified the federal gift, estate and GST tax In 2011, the individual maximum applicable federal credit was 1,730,800, the tax on transfers of $5M It increased in 2012 to $1,772,800, a result of an increase in the individual exemption from $5M adjusted for inflation to $5.12M After determining the taxable estate (i.e., gross estate less available deductions), the determination of the net estate tax liability occurs as follows: Gross estate tax (as computed under IRC 2001 prescribing the unified rate schedule, applied to the taxable estate) - Less the following credits: unified credit (as allowable under IRC 2010); state death taxes (as allowable under IRC 2011 but only before 2005 and after 2012); federal gift taxes (as allowable under IRC 2012); tax on prior transfers (as allowable under IRC 2013) and foreign death taxes (as allowable under IRC 2014) = Equals: Net estate tax creating liability

8 The State of Oregon Reacts to EGTRRA After EGTRRA, the state of Oregon implemented a transfer tax, incorrectly titled an 'inheritance' tax, with a $1M exemption, and tied its tax calculation to the federal estate tax credit even though the federal credit no longer existed Effective January 1, 2012, Oregon renamed its transfer tax an 'estate tax' and dropped the complicated application of the federal credit

9 Basic Review of an A/B Plan A, the exempt amount. This is the portion of the decedent spouse s estate equal to the amount that can pass free of federal estate tax Exempt amount passes to a bypass trust (aka credit shelter trust) for the spouse or others, or outright to beneficiaries other than the surviving spouse Bypass Trust for benefit of the spouse subject to the ascertainable standard (health education maintenance and support) to avoid inclusion in spouse's estate Bypass Trust doesn't qualify for the unlimited marital deduction B, the remainder is distributed to a marital deduction trust (QTIP, qualified terminable interest property) or otherwise receives the marital deduction (outright gift)

10 Introducing the Oregon Estate of William (Bill) Sniffum Sally and Bill Sniffum were married in Washington, and moved to Oregon. They are Oregon residents for tax purposes. This year, Bill died, with a gross taxable estate of $8.12M calculated for federal tax purposes. Bill s state estate tax liability arises in the state of Oregon, with a $1M estate tax exemption. If Bill s state estate tax liability were to be governed by Washington law, a $2M exemption would apply.

11 Gift Tax Applications During his lifetime, Bill Sniffum executed a power of attorney giving his agent Sally the ability to make lifetime gifts After discussion with the Sniffum family estate planning attorney and their CPA, Sally made a gift of $1M the week before Bill died Oregon does not have a gift tax law, so this reduced Bill's taxable estate in Oregon by $1M

12 Planning for the state equivalent of the marital exemption In 2012, the federal estate tax exemption is $5.12M; the Oregon exemption is $1M If the exempt amount exceeds $1M, the excess will be subject to Oregon estate tax The Oregon special marital property election, found in ORS , converts a transfer that does not qualify for the federal marital deduction into Oregon special marital property, qualifying for marital gift tax deferral for Oregon estate tax purposes No mandatory income; Assets selected on tax return but not set aside Taxable in the estate of the surviving spouse

13 Example: The Sniffum State and Federal Tax Returns Decedent Bill Sniffum has a gross estate of $8.12 million on his death in His A/B estate plan results in $5.12 million in a credit shelter trust which would exempt that transfer from federal estate tax. The remaining $3 million went directly to Sally or into a QTIP trust for Sally, exempt from federal taxation under the federal marital deduction. For state estate tax purposes, $1 M in the credit shelter trust would be exempt due to Oregon s $1M estate tax exemption. The executor of Bill's estate selects $4.12 million of available assets in the credit shelter trust to qualify as Oregon special marital property. What assets should the executor select for the Oregon special marital property? Why?

14 Assets Passing to a Trust A trust is a separate legal entity for income tax purposes, and thus must file its own tax returns A trust that is required to distribute all its income currently is considered a simple trust, otherwise the trust is a complex trust A trustee figures trust income and deductions in much the same way that an individual figures income for tax purposes, with one major difference. A trust is allowed a deduction for income distributed to beneficiaries. The beneficiary, not the trust, pays the income tax on the taxable amount of the distributions

15 Compare: Individual and Trust Tax Rates Married Individuals Filing Joint Returns and Surviving Spouses If Taxable Income Is: The Tax Is: Not over $17,400 10% of the taxable income Over $17,400 but not over $70,700 $1,740 plus 15% of the excess over $17,400 Over $70,700 but not over $142,700 $9,735 plus 25% of the excess over $70,700 Over $142,700 but not over $217,450 $27,735 plus 28% of the excess over $142,700 Over $217,450 but not over $388,350 $48,665 plus 33% of the excess over $217,450 Over $388,350 $105,062 plus 35% of the excess over $388,350 Estates and Trusts If Taxable Income Is: The Tax Is: Not over $2,400 15% of the taxable income Over $2,400 but not over $5,600 $360 plus 25% of the excess over $2,400 Over $5,600 but not over $8,500 $1,160 plus 28% of the excess over $5,600 Over $8,500 but not over $11,650 $1,972 plus 33% of the excess over $8,500 Over $11,650 $3, plus 35% of the excess over $11,650

16 Estate Planning Takeaway: You and Your Client It's never too early to start estate and business succession planning. The sooner the better. 65% of Americans don't participate in their own estate planning Taking the team approach: CPA, financial and insurance advisors, proposed trustee, estate planning and business lawyers together Consider all assets, real estate, life insurance, annuities, retirement accounts, personal property, collections, brokerage accounts, interests in businesses, bank accounts Liquidity is far more important than most clients realize What does your client want to achieve with their assets, who will inherit them and how important is tax planning? After you discuss a tentative strategy and your client begins to think about what kinds of bequests they wish to make, encourage them to make an appointment with an estate planning attorney Emphasize how important it is not to complete a do-it-yourself will, execute non-probate transfers without guidance, or select an attorney whose practice isn't focused on estate planning Provide probate and non-probate planning assistance together with the client and their lawyer

17 IRS CIRCULAR 230 NOTICE: Pursuant to federal regulations imposed on practitioners who render tax advice ("Circular 230"), we are required to advise you that any federal tax advice contained herein (including any attachments) cannot be used for the purpose of avoiding tax penalties under the Internal Revenue Code.

18 Thank You. For more information please contact: Abby Wool Landon Williams Kastner Phone: Karen Hobson Williams Kastner Phone:

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