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Blogs - Advisor Intel
Tax Deal a Game Changer for Estate Planning
Monday, January 7, 2013
Partner Insights

The impact of last week’s tax accord in Congress -- officially known as the American Tax Relief Act of 2012 -- is likely to be far wider and more complex than many have imagined. And many of these complexities will directly impact financial advisors.  

What makes this deal such a game changer? A lot of it comes down to the estate tax. Few, if any, clients believed we’d ever have a permanent $5 million exemption. But not only is that exemption now permanent, it is also inflation-adjusted and portable -- that is, a widow or widower may be able to use the estate tax exemption of the spouse who dies first.

The fear that drove waves of clients to engage in estate planning in the closing months of 2012 may never appear again. Outside the ultra high-net-worth sector, most clients will not fear the estate tax. Most will no longer care (although there may be some lower concern for state estate taxes). Estate planning has changed forever.

The estate changes also have implications to the income tax planning that planners are regularly involved in. We’ll illustrate a few of the many changes, but keep in mind this is barely an appetizer. (If you want more information, I'll be giving webinars on this on Tuesday and Wednesday.)


The backdrop for these changes is a change in the effective tax rates for the highest earners. The act makes permanent the tax cuts enacted as part of the 2001 tax act, so that for most Americans, the prior tax rates remain in effect. But higher-income clients, the mainstay of many planners’ practices, face a tougher income tax regime.

  • A new 39.6% top marginal tax bracket has been added for those earning over $400,000 for single taxpayers, $425,000 for head of household taxpayers, and $450,000 for married taxpayers.
  • These same high earners will also face a new higher 20% tax rate on dividends and capital gains.
  • These rates are further aggravated by the 3.8% Medicare tax on investment income, which also applies starting in 2013 on adjusted gross income over $200,000 for singles and $250,000 for married couples.
  • Itemized deductions and personal exemptions are phased out on income of $250,000 single and $300,000 for married couples filing jointly.

When all these factors are combined with state income taxes, affluent clients could face a combined tax rate of more than 50%.

The immediate challenges will be ascertaining the real and often unexpected impact of the new laws on planning -- and educating clients to deal with these new realities. What might you to do alleviate this painful new income tax burden? And how might your actions interact with the client’s estate planning? There are a host of options, each with its own unique twists.


For many high-income clients, an estate planning move has complicated the traditional tax strategy of harvesting gains and losses. Obviously, planners prefer to have all assets in house, so that asset allocation and gain/loss harvesting can be controlled and best executed. And yet some clients have always insisted on maintaining some investment assets under a different roof. That obviously necessitates some coordination with whoever is managing these other assets in order to be certain that the asset allocations and harvested gains and losses match up as intended.

In 2012, like no other year in the history of the estate tax, wealthy clients formed and made gifts to sophisticated irrevocable trusts. Many of these trusts are located in states with laws especially favorable to trust administration. (Alaska, Delaware, Nevada and South Dakota were the top picks.) And many, perhaps most, of these 2012 gift trusts were structured as grantor trusts -- in which the client who set them up remains taxable on the trust’s earnings, even if the earnings remain in the trust and are not (or even cannot) be distributed. So before planners can harvest gains and losses they’ll have to determine who is taxable on the trust income (i.e., whether it is a grantor trust or not), and who is managing the investments of each of these trusts to coordinate overall asset allocations and gain/loss harvesting.

But the process may be even more complicated. Many of the 2012 gift trusts were also formed as “directed trusts.” This means a designated person -- often called an investment trustee or investment advisor -- has the authority to make investment decisions, rather than the general trustee. So harvesting gains and losses, or modifying asset allocation or location decisions, may require the coordination of several different trustees, trust investment advisors and ultimate investment managers. Planners should start asking clients now who else they’ll need to coordinate with come December.


(3) Comments
Good article. A minor correction is the name of the act, which is the American Taxpayer Relief Act of 2012. I would enjoy a follow-up article on the act's effect on widows and widowers. That is, what happens to a widow with $5m to $8m, and whose deceased spouse has an old trust funded with a $1.5m exemption at death, plus the taxable growth since then?
Posted by David W | Monday, January 07 2013 at 2:36PM ET
Marty, Great article, as always! Two comments on asset titling is "step up in basis" and hedging bets on low cost basis assets. The last "freebie" is the step up to FMV at first death to allow surviving spouse to sell assets with zero capital gains tax....EVEN if they do not pay a penny of estate tax. My second comment is the focus on the tax free build up inside a life insurance policy. Maybe there are actually two freebies left.....
Posted by Susan B | Monday, January 07 2013 at 3:03PM ET
I must agree with you: the article is really awesome, so many useful and interesting stuff in it. To bad that the process might be too complicated. I like all of your articles! My parents (I have showed them this site) and I are your biggest fans. You do a great work to help to deal better with personal finances. A lot of your advices helped prevent me from one hour payday loans and other ways of borrowing cash. Thanx a lot for your job!
Posted by David G | Thursday, January 17 2013 at 5:49AM ET
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