UNDERESTIMATING THE VALUE OF A BYPASS TRUST AND OVERESTIMATING THE VALUE OF SPOUSAL ESTATE TAX EXCLUSION PORTABILITY: DON’T MAKE A $28,000,000 MISTAKEN ASSUMPTION
STATE TAX LAW UPDATE
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Underestimating the Value of a Bypass Trust and Overestimating the Value of Spousal Estate Tax Exclusion Portability: Don’t Make a $28,000,000 Mistaken Assumption
By: Alan S. Gassman, Esq., Kenneth J. Crotty, Esq., and Eric Moody, J.D.
Tax and financial advisors are now evaluating which clients will no longer need bypass trust arrangements and which clients may have more of a need than ever. So often we think in terms of only present values, without taking into account growth in value, inflation, future earnings, and possible remarriages.
We have found that our initial impressions on how to advise clients are not always the best answers after running a number of spreadsheet analyses.
CLICK HERE to view a spreadsheet system that we created to look at a number of scenarios. You may be shocked at the results described below.
If you were to have invested $5,250,000 in the S&P 500 in 1981, it would be worth over $100,000,000 now! At the same time, if the estate tax exclusion was $5,250,000 in 1981 and grew at the Consumer Price Index rate over the same thirty-year period, the exclusion would have only risen to about $12,600,000.
Many people think that the actual rate of inflation is substantially higher than the government adopted CPI index. If our calculation of the actual rate of inflation (one percentage higher than the CPI index) is correct, then the growth of the $5,250,000 exclusion over the same historic thirty-year period would be $16,832,454 instead of $12,595,497. However, clients should not assume that their exemptions are going to grow at the actual rate of inflation.
To determine how the numbers may play out and the potential estate tax savings of a bypass trust, we assumed that a couple had $5,250,000 in investment assets, and had a home valued at $2,000,000 at the first spouse’s death. We ran three scenarios: (1) The spouses do not set up a bypass trust and instead rely on portability and the combined exclusions on the second spouse’s death; (2) The first dying spouse could place half of the investment assets into a living trust to become a bypass trust ($2,625,000), while the surviving spouse retains and invests the remaining half; (3) The spouses could place all of their investment assets in a joint trust that would become a bypass trust on the first death. We also assumed that the surviving spouse would save $100,000 a year after paying taxes and making gifts. In order to stay conservative, we have also assumed that this $100,000 net amount will not increase with inflation as it would normally be expected to do.
We then calculated the surviving spouses’ estate tax liability in the above scenarios using two sets of numbers. The first set of numbers assumed the investments, both the initial and the yearly additions, grew at the Compound Annual Growth Rate of the S&P 500 from 1982-2011 (10.98%), with all dividends reinvested. The second set assumed the investments grew at a relatively conservative after-tax rate of 7% per year, with all dividends reinvested. In both sets of data, we assumed yearly 1.5% fees and costs for the investments and trusts. We also assumed that the family home values and the estate tax exclusion grew at their historical compound annual growth rates from 1982-2011.
We know it sounds complicated, but the charts make it very easy to follow.
And what we found is very simple: Assuming a spouse survives for thirty years after the passing of the first spouse, the use of a bypass trust under the conservative investment growth projections could result in estate tax savings of almost $8,000,000; or under historical growth projections, estate tax savings of over $28,000,000! That is not a typo: $28,000,000!
In other words, DO NOT RELY ON PORTABILITY AND THE CONSUMER PRICE INDEX TO FACILITATE AVOIDANCE OF FEDERAL ESTATE TAX!
What does the above example show us?
1. You have to run the numbers! Common sense would indicate that this couple did not have a serious estate tax concern with a standard “one-half each” bypass trust plan, but the numbers give a much clearer version.
2. Run the numbers with the clients to show them the different assumptions and scenarios so that they can make their own decisions.
3. Decide whether you are going to gear up to offer joint revocable trusts that will fund a credit shelter trust on the first death the same way as occurred in Private Letter Rulings 200210051 and 200101021. There are many complexities associated with these trusts, and they will not likely qualify as tenancy by the entireties assets from a creditor protection standpoint if ever challenged by a creditor, but other creditor protection techniques can be employed as and when needed.
4. Keep in mind that the married couple in the above example can ameliorate the estate tax risk by annual gifting, discount planning, and other important mechanisms that we should not forget about.
We also ran a few other scenarios in the spreadsheet. In Scenario # 1, if these same clients did nothing and one spouse died in 2013 and their $5,250,000 of investments grew at 7%, then 15 years later (in 2028) the surviving spouse would have a $17,019,386 estate and only a $13,381,812 combined exemption; so at the current 40% rate, the estate tax would be $1,455,030. If the investment grew at the historic S&P rate, the estate would be valued at $26,389,601, and the estate tax would be $5,203,116.
If the surviving spouse lived for 30 years with the same assumptions, then his or her estate would be worth $37,789,152 and the estate tax would be $7,977,462. These numbers are based upon a 7% rate of return. If the investment grew at the historic S&P rate (10.98%), the estate would be valued at $96,663,144 and the estate tax would be $31,527,059! If a bypass trust was fully utilized, the estate tax of the surviving spouse would only be $3,242,857.
Alternatively, if the couple keeps their investment assets separate so that one-half would lock up in a Credit Shelter Trust (also known as a Bypass Trust or a Non-Marital Trust) after the first death, the numbers are much more tolerable but the tax is still formidable, as shown in our spreadsheets. See Scenario #2.
State Tax Law Update
We are fortunate that most of our clients reside in Florida, but we should not forget about clients, friends, and family from other states. The Weekly State Tax Report from our friends at Bloomberg BNA Tax & Accounting discusses how various state legislatures may potentially revise their state tax codes, particularly their estate tax systems, based on recent federal tax law changes. The Bloomberg Report also provides a chart demonstrating each state’s approach to conforming to the Internal Revenue Code, each state’s treatment of bonus depreciation and enhanced expensing, and each state’s estate tax regime. The report can be viewed by CLICKING HERE.
APPLICABLE FEDERAL RATES
To view a chart of this month, last month’s, and the preceding month’s Applicable Federal Rates, because for a sale you can use the lowest of the 3 please click here.
SEMINARS AND WEBINARS
Don’t miss this incredibly useful live seminar with Jonathan Blockmachr, Samuel A. Donaldson, and many others – if you have never attended an All Children’s Seminar you have never seen the best there is!
WEDNESDAY, FEBRUARY 13, 2013 15th Annual All Children’s Hospital Estate, Tax, Legal and Financial Planning Seminar.
All Children’s Hospital Foundation is hosting the Estate, Tax, Legal and Financial Planning Seminar at the All Children’s Hospital Education Conference Center in St. Petersburg. Programs and presenters include Samuel A. Donaldson on the topic of Federal Tax Update, Jonathan Blattmachr on Myths & Realities of Charitable Trusts and Some Really Cool Generation Skipping Tax Ideas, Investments in Trusts: Charting a Prudent Course by Tami Foley Conetta, and Alan S. Gassman on the topic of Avoiding Disaster in the Sunshine State – Tricks, Traps, and Nuances That Make Florida Planning Interesting and Unique.
UPCOMING (FREE) WEBINARS:
MONDAY, FEBRUARY 4, 2012, 12:30 -1:00 p.m.
Please join us for Lunch Talk, a free monthly webinar series sponsored by the Clearwater Bar Association and moderated by Alan S. Gassman. This month’s topic is the second part of the two part series with Shannon Waller on Accelerating Law Office Teamwork with Interesting Tools You Can Use Immediately. To register for the webinar please visit www.clearwaterbar.org
TUESDAY, FEBRUARY 5, 2013, 5:00-5:30 p.m.:
Please join us for a free 30 minute webinar entitled Estate Planning for 2013 – Beyond the Obvious. This webinar will discuss planning considerations for estate and financial planners, including realities of portability, eliminating discounts, use of the joint trusts, completed gift trusts under which the client is a beneficiary, and the biggest mistakes that planners will make in 2013. This webinar will be hosted by Alan S. Gassman, Esq., Kenneth J. Crotty, Esq., Christopher J. Denicolo Esq., and our friend Tom Ellwanger, Esq.
TUESDAY, FEBRUARY 7, 2013, 12:00-12:50 p.m.:
Please join us for Avoiding Disaster on Highway 709, hosted by Kenneth J. Crotty, J.D., L.L.M., which will discuss how to avoid disastrous errors on gift tax returns and will demonstrate how to complete a Form 709, with an example.
MONDAY, FEBRUARY 11, 2013, 5:00-5:30 p.m.:
Please join Alan S. Gassman, Esq. for a 30 minute webinar entitled The Physician’s Guide to the 2013 Tax Laws. This free webinar will cover income tax, estate tax, the new 3.8% Medicare tax, and planning for these taxes. Planning considerations will include practice entity planning, pension planning, rental arrangements, and special mention of creditor protection and capital gains tax planning.
Christopher Denicolo, J.D., LL.M. is a partner at the Clearwater, Florida law firm of Gassman, Crotty & Denicolo, P.A., where he practices in the areas of estate tax and trust planning, taxation, physician representation, and corporate and business law. He has co-authored several handbooks that have been featured in Bloomberg BNA Tax & Accounting, Steve Leimberg’s Estate Planning and Asset Protection Planning Newsletters and the Florida Bar Journal. is also the author of the Federal Income Taxation of the Business Entity Chapter of the Florida Bar’s Florida Small Business Practice, Seventh Edition Mr. Denicolo received his B.A. and B.S. degrees from Florida State University, his J.D. from Stetson University College of Law and his LL.M. (Estate Planning) from the University of Miami. His email address is Christopher@gassmanpa.com.
Kenneth J. Crotty, J.D., LL.M., is a partner at the Clearwater, Florida law firm of Gassman, Crotty & Denicolo, P.A., where he practices in the areas of estate tax and trust planning, taxation, physician representation, and corporate and business law. Mr. Crotty has co-authored several handbooks that have been published in BNA Tax & Accounting, Estate Planning, Steve Leimberg’s Estate Planning and Asset Protection Planning Newsletters, Estate Planning magazine, and Practial Tax Strategies. Mr. Crotty is also the author of the Limited Liability Company Chapter of the Florida Bar’s Florida Small Business Practice, Seventh Edition. He, Alan Gassman and Christopher Denicolo are the co-authors of the BNA book Estate Tax Planning in 2011 & 2012. His email address is Ken@gassmanpa.com.
Thank you to our law clerks that assisted us in preparing this report:
Kacie Hohnadell is a third-year law student at Stetson University College of Law and is considering pursuing an LL.M. in taxation upon graduation. Kacie is also the Executive Editor of Stetson Law Review and is actively involved in Stetson’s chapter of the Student Animal Legal Defense Fund. In 2010, she received her B.A. from the University of Central Florida in Advertising and Public Relations with a minor in Marketing, and moved to St. Petersburg shortly after graduation to pursue her Juris Doctor. Her email address is Kacie@gassmanpa.com.
Alexandra Fugate earned her B.A. in English from the University of Florida in 2008, and J.D. from Stetson University College of Law in 2012. She has been a Guardian ad Litem for the past two years, a judicial intern for the Twelfth Circuit in Bradenton, and was recently admitted to the Florida Bar. She wants to pursue a career in business, employment, and labor law. Her email is Alexandra@gassmanpa.com .
Eric Moody is a third-year law student, scheduled to graduate in December 2012, at Stetson University College of Law and is considering pursuing an LLM in estate planning upon graduation. Eric is also an Articles and Symposia Editor for Stetson Law Review. In 2009, Eric received a B.S. in Business Management from the University of South Florida. Eric’s email address is Eric@gassmanpa.com.