Orange County Bar Association Trusts and Estates Section Meeting Practical Aspects of Estate Tax Changes of 2010 Presented on Wednesday, March 9, 2011 by Richard Heaton of Garrett & Heaton, LLP

Tax Relief Act of 2010 Signed into law by the President on December 17, Includes a comprehensive set of income tax, estate tax, and unemployment insurance provisions. Most of the provisions are temporary, in place for 2011 and 2012 only, effectively extending the Bush-era tax cuts.

Estate Planning Impact Requires review, but not necessarily modifications to existing plans Provides ways to increase basis, while preserving zero estate tax for modest estates Makes having B and C trusts for even modest estates more attractive Makes A-C (Optional B) plans workable in most situations

Existing Estate Plans The AB, ABC, and Optional AB that have been utilized for so long all still work, but they may not meet the clients’ desires. It is useful to classify the size of estates: Modest Mid-Size Large $10 Million $50 Million “Just a Millionaire”

Existing Estate Plans In large estates, the traditional ABC planning may not change The potential change in planning is most likely for the modest estates of $2 million to $10 million – Assets put into a B trust will not get a step-up in basis Consider the following example…

Example: UPS Stock Client funded bypass trust with UPS stock when the exemption was $600,000 UPS stock appreciated to well in excess of $20 million IRS tried to ignore the bypass trust, but was unsuccessful due to good planning If a similar situation happened with today’s law…

Comparable Example (today) Bypass trust funded with $500,000 in highly appreciating stock that appreciates to $5 million at second death. If stock was in the B trust, it would not get a step-up in basis. There would be no estate tax, but there would be a lost basis step-up of $4.5 million at an income tax cost of $1,125,000. Alternatively the stock could be put into a traditional C trust that was QTIPable, resulting in a step-up at second death. This assumes the portability of the $5 million of the exemption at the death of the first spouse.

Reliance on Portability Simple plans relying on portability, and giving everything to the surviving spouse in a simple A Trust, are problematic. Example: – Estate worth $10 million at first death with no appreciation – Entire estate left to surviving spouse assuming full DSUEA – If spouse remarries, and new spouse dies, there could be unnecessary tax at the death of the surviving spouse – DSUEA is based on the amount available to the last predeceased spouse – Timely estate tax return must be filed

Increasing Basis Various ways to have options to increase basis and preserve a zero estate tax for modest estates Examples: 1.Survivor’s Trust and QTIP Trust 2.A-C (Optional B) Plan

Modest Estates A trust C (which is QTIPable) is virtually mandatory, in any type of blended family situation. Even in nuclear families with lengthy marriages, the B and C trusts can offer substantial protection against subsequent gold diggers, undue influence, and creditors.

A-C (Optional B) Plan Assets of the predeceased spouse automatically go to a C trust, which is able to be QTIPed. If surviving spouse elects not to QTIP part of the C Trust then the assets go into a traditional bypass trust. This allows the surviving spouse an extended time to make a decision, longer than 9 month disclaimer period. Should allow for at least 15 months to decide (assuming an extended return) Election valid on first 706 filed even though late

A-C (Optional B) Plan If no estate tax return is filed in a timely manner, then the deadline is the first estate tax return filed after the due date Thus, an election out of QTIP treatment may be made even after the 15 month deadline, though this is naturally not advisable.

Potential Solution The A-C (Optional B) Plan seems to be very workable in most modest estates. – Works well in blended families and nuclear families to prevent gold diggers and undue influence. – Allows the surviving spouse a longer period of time to determine whether to receive a potential step-up in basis or to fund the B Trust. – Has the advantage of not worrying about portability or loss of portability due to remarriage.

Example: Peter’s Estate Taxable estate of $8,155,027 Savings from not paying estate tax 2,854,259 Savings from not paying income tax (due to step-up in basis) 1,181,005 Difference$1,673,254 Conclusion: Peter’s Estate should not pay estate tax

Rule of Thumb If an estate is worth $14.25 million or more, then the step-up in basis will not be worth the payment of the estate tax. Example of an exception: If an estate has negative-basis property, that is property with liabilities substantially in excess of basis, then it may be well worth paying estate tax even in a taxable estate that is over $14.25

Negative Basis Example Gross Value$54,000,000 Adjusted basis$ 4,000,000 Mortgage$44,000,000 Equity$10,000,000 Potential Gain$50,000,000 Estate Tax Savings$ 3,500,000 Income Tax Saving$15,700,000 Conclusion: Pay the estate tax

Potential Future Effects Estate tax rate has gone down from 55% to 35% Traditional planning will need to be reviewed – Consider Estate tax vs. Income tax paid on trustee fees Inflation factor highly significant: if COLA is a mere 1.5%, then the exclusion for a married couple next year will be increased by $150,000 to $10,150,000

Thank you! This presentation is available on the Garret & Heaton, LLP website at: