THE ADVISOR. An Estate Planning Publication from The Law Office of Stephen Bezaire SOME CLARITY CONCERNING FEDERAL ESTATE TAXES

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1 THE ADVISOR 2700 E. Foothill Blvd, Ste 306, Pasadena, CA (626) Spring 2013 An Estate Planning Publication from The Law Office of Stephen Bezaire SOME CLARITY CONCERNING FEDERAL ESTATE TAXES As many of you are no doubt aware, there has been much uncertainty in recent years concerning the Federal Estate Tax. The Federal Estate Tax Exemption in effect for 2011 was $5,000,000 and $5,120,000 for It was scheduled to return to only $1,000,000 on January 1, 2013; however, as part of the Fiscal Cliff negotiations that took place in Washington last year, the American Taxpayer Relief Act of 2012 was passed at the very beginning of January. The portions of this Act which affect Federal Estate Tax provide as follows: 1. The Federal Estate Tax Exemption per person is $5,250,000 and is indexed for inflation. 2. The Federal Estate Tax Rate is now 40% on any amount exceeding the exemption, which has been increased from the 35% tax rate in The Federal Gift Tax Exemption per donor is $5,250,000 and is likewise indexed for inflation, so it will track the Federal Estate Tax Exemption. 4. The Gift Tax annual exclusion is $14,000 per donor per year. 5. The concept of allowing a surviving spouse to inherit the Federal Estate Tax Exemption of their deceased spouse (commonly known as Portability ) has been made permanent. The above changes are permanent in that current law does not provide for an expiration date for these changes. As a result, it is now clear that a single person can have an estate of up to $5,250,000 and not have to worry about Federal Estate Tax. It is also now possible for a Husband and Wife to pass up to $10,500,000 in assets using both of their exemptions. What has changed, however, are their choices for how to accomplish this. FORMULA TRUSTS VS. DISCLAIMER TRUSTS In the past, the only way for a Husband and Wife to save both of their exemptions to reduce/eliminate the Federal Estate Tax on the survivor s death was through an A-B Trust. This trust provided that when one spouse died, the estate was divided into a Survivor s Trust (Trust A), which contained the assets of the surviving spouse, and a Bypass Trust (Trust B), which contained the assets of the first spouse to die. Such an arrangement allowed the survivor to use their exemption on the Survivor s Trust, and their deceased spouse s exemption on the Bypass Trust, so that the Federal Estate Tax Exemption of the first spouse to die was not wasted as would be the case if the entire estate went to the surviving spouse on the first death. The drawback of this approach, however, was the cost and complexity of the legal, accounting, appraisal and tax work that needed to be done to divide the estate into two trusts upon one death, and also the tax and accounting work necessary to maintain the two trusts during the lifetime of the surviving spouse. Prior to 1997 the Federal Estate Tax Exemption was only $600,000. From 2001 the Exemption was gradually increased from $1,000,000 to eventually $3,500,000 in Many couples who had set up A-B Trusts during these periods did so because

2 their estates exceeded $600,000 (prior to 1997) or exceeded $1,000,000 or $3,500,000 (prior to 2009). Given the fact that the current exemption is now $5,250,000 and this amount will be increased to keep up with inflation in the future, many of these couples no longer need an A-B Trust, or perhaps no longer need a Formula A-B Trust. In previous articles we have discussed the fact that there are two different types of A-B Trusts : 1.) Formula A-B Trusts and 2.) Disclaimer A-B Trusts. We discussed how the Disclaimer A-B Trust gave the survivor the option of dividing the estate into two trusts upon the first death rather than requiring a division as a Formula A-B Trust does. The Disclaimer A-B Trusts could prove to be a valuable option given the new $5,250,000 Federal Estate Tax Exemption. Example: John and Mary have an estate that totals $4,000,000. They set up a Disclaimer A-B Trust. John dies and Mary decides the estate will never increase to over $5,000,000 during her lifetime so she elects not to divide the estate into a Survivor s Trust and Bypass Trust, instead she elects to simply inherit John s entire half. This allows her to avoid the cost and complexity of performing the legal accounting, appraisal and tax work necessary to divide the estate. Upon Mary s death, if the estate totals $5,250,000 or less their heirs would pay no Federal Estate Tax. If Mary and John had set up a Formula A-B Trust, she would have been legally required to perform such work even though this would not have resulted in any tax savings (since the Federal Estate Tax Exemption was $5,250,000). EXEMPTION PORTABILITY As discussed above, the Fiscal Cliff tax bill passed at the beginning of this year provided that Federal Estate Tax Portability is now permanent. As some of you may already be aware, in December of 2010 Congress passed a tax bill that introduced a new estate planning concept known as Portability. Portability provides that a surviving spouse can inherit their spouse s Federal Estate Tax Exemption without having to go through the time and expense of dividing the estate into two trusts, which is required when a couple has a Formula A- B Trust. All that is required for a spouse to inherit their spouse s Federal Estate Tax Exemption on the first death is for the surviving spouse to file a Federal Estate Tax Return (Form 706) for their spouse s estate. If this is done, the surviving spouse is deemed to have inherited the Federal Estate Tax Exemption of their deceased spouse, so that when the survivor dies their estate has both exemptions available to reduce or even eliminate the Federal Estate Tax. Portability, therefore, provides another reason why a couple should consider converting their Formula A-B Trust to a Disclaimer A-B Trust, even if their estate exceeds the current Federal Estate Tax Exemption of $5,250,000. Example: John and Mary have an $8,000,000 estate and they also have a Disclaimer Trust. Upon John s death Mary elects not to divide the estate into a Survivor s Trust and a Bypass Trust; however, she does decide to file an Estate Tax Return to inherit John s $5,250,000 Federal Estate Tax Exemption. By electing Portability Mary has avoided the cost and complexity of the work necessary to divide the estate into two trusts upon John s death. Upon Mary s death, if the estate totals $10,500,000 or less their heirs would pay no Federal Estate Tax since Mary s estate utilizes both Mary s $5,250,000 exemption and John s $5,250,000 exemption to pass her estate free of Federal Estate Tax. As a result of the changes in the American Taxpayer Relief Act of 2012, it is important to review your estate planning documents (i.e. trust, Will or other documents) to see if any adjustments need to be made. Married couples may wish to consider converting their trust to a Disclaimer A-B Trust if they have a Formula A-B Trust, and single persons who were making gifts using the $10,000 (now $14,000) Gift Tax annual exclusion to reduce their taxable estate may now wish to reconsider such gifting if their estate does not exceed the new $5,250,000 Federal Estate Tax Exemption threshold.

3 SETTLING A TRUST Revocable Living Trusts are created to hold a person s assets, so that when they die, the assets do not have to be put through the probate process. Some trusts are also created to make the most use of the Federal Estate Tax Exemption allowed a person, to avoid or reduce the estate tax in their estate. Even though a trust may prevent having to probate an estate upon a death, there still remains some settlement work to be done, and the steps required to properly settle the estate depend Federal Estate Tax Exemption in effect upon the person s death, the type of trust and the size of the estate. The following briefly summarizes the settlement work typically required depending on the type of trust: WORK REQUIRED OF ALL TRUSTS: 1. Obtain Death Certificates: As a rule of thumb, one certified copy of the death certificate should be obtained for each piece of real property owned by the decedent and each institution where the decedent s assets are held. 2. Deposit the Decedent s Last Will with the Court: California law requires that all persons who have custody of the Last Will of a decedent deposit it with the Superior Court for safekeeping. 3. Give Notice to all Heirs and Beneficiaries: The trustee of a trust must give written notice to all beneficiaries of a trust and all heirs of the decedent within 60 days of the date of death, which must comply with Probate Code Section Give Notice to the Department of Healthcare Services: The representative of the estate must give notice of the death to the DHS in Sacramento. This is to allow them to assert a Medi-Cal claim for reimbursement in the estate if the decedent used those benefits during their lifetime. 5. Provide an Accounting to Trust Beneficiaries: The trustee of a trust must provide a written accounting of trust assets to the beneficiaries, which must comply with Probate Code Section Obtain a Taxpayer I.D. Number: The trustee must obtain a Taxpayer I.D. Number for any irrevocable trust. This is the number under which all income on the trust must be reported until the assets are distributed to the trust beneficiaries. 7. Clear Title to Assets: The decedent s name must be removed from all trust assets and placed in the trustee s name. This will allow the trustee to distribute them to the persons entitled to receive them under the trust. 8. File an Estate Tax Return: If the estate is taxable (i.e. for a single person, over $5,250,000) a Federal Estate Tax Return (Form 706) must be filed to report and pay the tax due in the estate. This must be filed within 9 months of the date of death. 9. Pay Debts of the Decedent: All debts of the decedent and costs of administration (i.e. accountant, attorney and appraisal fees, if any) must be paid before distribution to trust beneficiaries. 10. Notify Social Security: Social Security must be notified of a person s death so that further payments can be stopped. For a married couple, giving notice to Social Security will automatically trigger their calculating the amount that will continue to be paid to the surviving spouse. 11. Claim Life Insurance: Claim forms must be filled out for any life insurance policies on the decedent s life. 12. Retirement Accounts: Claim forms must be filled out for any retirement accounts for which the decedent was an annuitant. A surviving spouse beneficiary will need to complete a spousal rollover and any non-spouse individual beneficiary will need to complete an inherited IRA form. Work Required for an A-B Trusts or ABC Trusts First Death: The work required on the first death when a couple has an A-B or A-B-C trust is that work required for a basic husband and wife trust above, but in addition further legal, accounting and appraisal work must be done to realize the tax savings these trusts where intended to achieve. The spouse must first inventory the estate, and then apply the formula found in the trust to determine how much of the estate should be

4 transferred into the Trust A portion and the Trust B (and Trust C, if applicable) portion. The spouse must then transfer the assets based upon that decision and file an Estate Tax Return with the IRS. Work Required for an AB or ABC Trust Second Death: If the couple had an A-B/C Trust, when the surviving spouse dies there are now two/three trusts to settle. The tasks described above must now be performed with regard to each trust, except that there will not be an estate tax return for Trust B regardless of the size of that trust. There will be an estate tax return for the Trust A (and Trust C ) if the value of that trust exceeds the exemption (currently $5,250,000). Both trusts must be inventoried, an accounting must be provided to the beneficiaries by the trustee, and the assets must be distributed. The Law Office of Stephen P. Bezaire has a department devoted exclusively to the settlement of trusts and the probate of estates. The settlement of a trust can be a simple matter, or it can be a complicated combination of legal, tax and accounting issues. In almost every case, however, the services of a qualified estate planning attorney are indispensable, which is why we offer our clients a free settlement consultation upon the death of a loved one. CERTIFIED SPECIALIST Stephen P. Bezaire is a California State Bar Certified Specialist in the area of Estate Planning, Trust and Probate Law. The California State Bar certifies certain attorneys as being specialists in the various areas of law. In order to earn the designation Certified Specialist an attorney must have met certain educational, practice experience, peer review requirements, and pass the Certified Specialist Exam for their field of practice. In addition, they must meet certain continuing education, practice experience and peer review requirements in order to maintain their standing as a Certified Specialist every 5 years. Certified Specialist Estate Planning, Trust and Probate Law is a California State Bar designation for practitioners in the area of Estate Planning Trust and Probate Law.

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