New estate tax rules call for new planning tactics

NEW YORK Tue Feb 26, 2013 12:10pm EST

The entrance to the wine cave of a $37 million dollar luxury home at One Pelican Hill Road North is seen in Newport Beach, California April 13, 2012. REUTERS/Lori Shepler

The entrance to the wine cave of a $37 million dollar luxury home at One Pelican Hill Road North is seen in Newport Beach, California April 13, 2012.

Credit: Reuters/Lori Shepler

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NEW YORK (Reuters) - After years of changes and political arm-twisting, the federal estate tax rules became clear and stable with the year-end fiscal cliff deal. They are now set permanently into the tax code - at least until the tax code changes again.

The amount an individual can exclude from estate taxes (including gifts given during his or her lifetime) is an extremely generous $5.25 million per person for 2013.

That leaves very few people who will be subject to the tax. After all, a couple could exclude $10.5 million from estate or gift taxes, and with smart estate-planning - putting assets into an irrevocable trust, for example - pass on many times that amount tax-free to the next generation. The result: Just 3,800 estates are expected to be big enough to owe any federal estate tax in 2013, according to estimates from the Tax Policy Center.

That is a relief to many would-be estate tax payers. Without the year-end tax agreement, the exclusion was slated to revert to $1 million per person -- an amount that worried homeowners in high-priced real estate markets like New York and Los Angeles -- with a 55 percent tax rate on most estates.

The new top tax rate for estates is 40 percent.

"Everyone is taking a big, deep breath," says Dan Schrauth, a wealth adviser in J.P. Morgan's San Francisco private banking office.

Last year's uncertainty led wealthy clients to race though plans and gifts that ordinarily might have been been handled slowly and thoughtfully. Some, in their mad dash to act before the end of the year, gave away money and seeded trusts with quick cash. But there's scant evidence they gave away more than they really wanted to.

"I'm not seeing any clients who have remorse about doing gifting," Schrauth says.

Those who put cash into a trust may now choose to invest it in growth stocks or other assets expected to appreciate over time. Depending on the type of trust, they may also be able to swap the cash out for existing assets currently held outside the trust.

Those who ran out of time before making gifts last year won a reprieve, and anyone still thinking about getting money out of their estates can make gifts and feed trusts this year.

The annual gifting rules allow you to give up to $14,000 per person in 2014(up from $13,000 in 2012) tax-free. These gifts don't count toward the lifetime $5.25 million exclusion, and can add up quickly: A couple with two adult married children, for example, could give $28,000 to each this year, plus $28,000 to each spouse, for a total of $56,000. With education costs high and rising, these funds could seed a 529 college-savings plan for your children or grandchildren.

Ironically, a poor economy can help, because it may depress the value of securities, real estate and businesses, allowing people to get more out of their estates. Wealthy families generally seed trusts with growth stocks or businesses likely to expand; that's because once the asset is transferred, it is out of the estate and its appreciation won't be subject to any future estate tax.

While heirs could eventually owe capital gains taxes when they sell those assets, the long-term capital gains rate, at 20 percent, is half the estate tax rate.

Those who used up their lifetime $5-plus million exclusion before year-end can still give more this year. That's because the exclusion is inflation-adjusted, and it rose by $130,000 for 2013.

Even if you doubt you'll ever have such a high level of assets, it still pays to plan ahead. Pay attention to the rules in your state: Some states have estate and inheritance taxes that kick in at lower levels than do the federal ones and could take a bite out of funds you'd hoped to pass on.

The more important reason to plan is to make sure that what you want to happen after you're gone does. Who gets control of the business? Who gets the family home? Will a special-needs grandchild have the necessary funds available? Even if you don't need to do tax-motivated estate planning, you'll want to get your will in order, and make sure it still represents your wishes.

"Everybody should think about their estate regardless of the level of assets," says Barry Fischman, a partner at accounting firm Marcum. "The biggest hurdle is psychological. People say, ‘I'm not ready to do anything. I want to maintain control until the day I pass.' You have to have these conversations that really have nothing to do with the law, but have to do with the emotional attachment and control."

How much you'll want to give now depends not just on your financial situation, but on your ability to tolerate risk and uncertainty. As Schrauth says: "Clients should never make gifts that won't let them sleep at night. The over-arching theme is, what do you feel you can afford to irrevocably give away?"

(Follow us @ReutersMoney or here Editing by Linda Stern and Andrew Hay)

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