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Does Your Estate Tax Planning Still Make Sense?

The purpose of estate tax planning is to reduce the taxes on your estate so that you can leave more of your assets to your family and friends instead of Uncle Sam.  Does the passage of the American Taxpayer Relief Act of 2012 ruin your previously prepared estate plan?


The American Taxpayer Relief Act of 2012 ("ATRA") effectively eliminated federal estate taxes for all but the wealthiest Americans.  Not so long ago, planning to minimize federal estate taxes was a necessary consideration for many people.  However, consistent with the immutable law of unintended consequences, your pre-ATRA tax planning may actually increase the taxes your estate may have to pay, leaving less for your family.

Tax Planning Pre-ATRA

A major goal of your estate tax planning is to reduce the tax burden on your estate to the greatest extent possible, so that more of your wealth goes to your family and other recipients you choose, rather than to Uncle Sam.  Historically, your optimal estate tax planning hinged first and foremost on taking advantage of your available estate and gift tax exemption, the statutorily-defined amount of assets that you can pass at death, or give during your life, to others without incurring estate or gift taxes. 

Generally speaking, except for assets passing to your spouse or charities chosen by you, your assets in excess of your exemption amount are taxed at the highest applicable rates when you die.  As recently as five years ago, your available exemption was $2,000,000 and your top estate tax rate was 45%.  Ten years ago, your exemption was $1,000,000 and your top estate tax rate was 49%.  At those levels of exemption, you, like many successful people, faced the real possibility that your estate would owe significant estate taxes.

Pre-ATRA, many faced with the specter of estate taxes engaged in a common estate planning technique called "credit shelter" planning (your exemption amount is conceived of in the Internal Revenue Code as a "credit" against your estate tax liability, hence the term "credit shelter" planning).  The principal purpose of such planning was to allow couples to leverage both spouses' exemption amounts against estate tax, when the predeceased spouse's exemption might otherwise be lost should that spouse's estate pass directly to the surviving spouse.

In a typical credit shelter plan, the estate of the first spouse to die was divided into two shares, one equal to the exemption amount and the other being the remaining balance.  The exempt share was directed to a "credit shelter trust" and the balance to a marital trust or outright to the surviving spouse.  Whether the plan involved one trust or two, the surviving spouse was typically the primary beneficiary and so enjoyed the trust assets during the surviving spouse's life.  At the surviving spouse's death, however, the assets of the credit shelter trust and the surviving spouse's assets, to the extent of that spouse's own exemption, passed estate tax free to the next generation.  Only the amount of assets in excess of the couple's combined exemption amounts was taxed. 

However, the tax advantages of credit shelter planning came with tradeoffs.  For example, such planning is complex, requiring retitling of assets between spouses to insure each spouse has sufficient assets to take advantage of his or her full exemption amount.  Some assets, such as retirement benefits, are inconvenient to administer in a trust.  Also, surviving spouses sometimes experience a sense of insecurity when their assets are tied up in a trust, no matter how available those assets are for their enjoyment.  Finally, the full utilization of the deceased spouse's exemption amount in the credit shelter trust deprives those assets of a step-up in income tax basis for appreciated assets at the surviving spouse's death, which has the effect of increasing the capital gains tax liability when those assets are utilized by the next generation. 

Until recently, the estate tax avoidance or reduction goal trumped these countervailing considerations under the then-prevailing tax rules. 

Optimal Tax Planning Post‑ATRA

ATRA, which became law at the beginning of this year, brought the following changes in tax laws relevant to optimal estate planning: 

  • Five Million Dollar Exemption.  The $5,000,000 exemption amount that had applied in 2011 and 2012, an all-time historically high amount, became permanent.  Moreover, the $5,000,000 exemption amount will now be indexed for inflation on an annual basis.  These annual inflation adjustments are significant.  For example, with indexing for inflation, the exemption amount for 2013 is $5,250,000 and for 2014, $5,340,000. 
  • Portability.  Portability, the ability (subject to limitations) of a surviving spouse to make use of the unused estate tax exemption of the first spouse to die, first introduced in 2010 and temporary under prior law, became permanent.
  • Estate Tax Rate.  The estate tax rate increased from 35% to 40%. 
  • Higher Marginal Income Tax Rates.  The top income tax rate increased to 39.6%, starting at $400,000 of single-taxpayer income ($450,000 for a joint return).  Trusts and estates are taxed at this top rate starting at just $11,950 in income.
  • Higher Capital Gains and Dividend Tax Rates.  The capital gains and dividend tax rates are now 20%, up from 15%.
  • Medicare Surtax.  The Patient Protection and Affordable Care Act, effective January 2013 (not part of ATRA), imposes a 3.8% Medicare tax on the undistributed net investment income of your estate or trust ("Medicare Surtax"). 

With a $5,000,000 individual exemption amount which, with portability, is effectively a $10,000,000 exemption amount for couples, credit shelter planning is no longer necessary for most individuals.  Also, with the top income tax rate increasing to 39.6%, the capital gains rate increasing to 20%, and the addition of the Medicare Surtax, income tax has become for many people the more important tax to be addressed in their estate plans.

Post-ATRA, credit shelter planning for most people is no longer necessary to take advantage of a couple's combined exemption amount.  Given the attendant increases in capital gains tax exposure and trust income tax liability at the highest rate starting at less than $12,000 in income, credit shelter planning will no longer produce the best tax results in many cases.  Instead, the greatest tax efficiency in transferring your assets to your family may be achieved by passing your and your spouse's assets through the surviving spouse's estate, thereby securing a second income-tax step-up in basis in those assets at the death of the second spouse and avoiding the unfavorable marginal income tax rates for trusts.

What to Do with a "Credit Shelter" Plan?

If you have credit shelter planning in place, you should review your estate plan to determine if it still serves your estate planning objectives.  You may find that, post-ATRA, you will achieve better tax results by abandoning your credit shelter planning in favor of a simpler and more flexible estate plan, with any necessary tax planning achieved through post-mortem elections and disclaimers of assets.


Post-ATRA, the customary tax planning of the past decade may be truly antithetical to your tax avoidance goals.  A professional tax and estate planning advisor can help you understand the tax consequences of your existing estate plan and what options there are for improving it if necessary.  At the end of the day, you may find yourself with a simpler, more convenient, and more flexible estate plan that is also more tax-efficient.

© 2016 Ward and Smith, P.A.

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.

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