Client Alert from the Trusts & Estates Department
Need for Review and Update of Estate Plans
If you have not reviewed and updated your estate plan recently, we recommend that you do so. There have been many changes in the federal and Washington state estate tax systems in the past few years, including major changes under the American Taxpayer Relief Act of 2012 (formally enacted in 2013 and covered in a prior KTC News Alert).
The Act made “permanent” the higher estate, gift, and generation skipping transfer tax exemptions and indexed them for inflation for subsequent years. In 2015, the federal estate, gift and generation skipping transfer tax exemption is $5,430,000, and the tax rate for estates exceeding this exemption amount is 40 percent. Accordingly, a married couple can now expect to pass $10,860,000 free of federal estate tax.
The federal law also allows the personal representative of a decedent’s estate to make an election to allow a surviving spouse to take advantage of any unused federal estate tax exemption of the deceased spouse. This new “portability” option means a decedent’s unused federal estate tax exemption need not go to waste even if not fully captured in a traditional “credit” or “bypass” trust. However, the portability option does not apply to the generation-skipping transfer tax exemption nor does the State of Washington include the portability option in its estate tax system.
Washington enacted its own stand-alone estate tax in 2005. The Washington State estate tax exemption is currently $2,054,000 and is indexed for inflation each year. Estates in excess of this amount are subject to a state estate tax at a rate ranging from 10 percent for the first taxable $1,000,000 to 20 percent for taxable estates in excess of $9,000,000. However, Washington does not have a gift tax. Therefore, if given the time and opportunity, late in life or even death bed gifting may be considered to reduce one’s taxable estate for Washington State estate tax purposes.
Under the current federal law, qualified assets included in a decedent’s estate for estate tax purposes receive a basis step up to their fair market value as of the decedent’s date of death. The 2012 Act increased qualified dividends and long-term capital gains income tax rates to as high as 23.8 percent if the Medicare surtax on net investment income also applies. Comparatively, Washington’s state estate tax rate on taxable estates between $1,000,000 and $3,000,000 is between 10 percent and 15 percent. The basis-step up on death may thus prove to be a significant tax benefit for estates with assets at or below that amount. Estate plans for persons with estates below that level which were designed with trusts to minimize estate taxes may no longer be appropriate in this high estate tax exemption, high income tax environment. Life insurance trusts and other advanced trust planning and gifting arrangements should also be reviewed under the new rules. However, those with larger estates should consider appropriate planning to mitigate the assessment of Washington State estate tax.
Changes in Washington state laws, such as those governing trust accounting and notices, have also occurred. Fiduciary appointments, including guardian and trustee appointments (particularly bank and trust company appointments) and beneficiary designations of qualified retirement plans and IRA’s should be reviewed to ensure that they are still current. Other events that may require updates include changes in family situations, changes in financial situations or net worth, purchase or sale of a business, and purchasing real estate in or moving to or from a different state.
Transfer on Death Deeds
Last year the Washington legislature passed a law providing an additional tool for transferring real property without the need to open probate. This law established a procedure that enables a person to pass Washington real property directly to one or more beneficiaries upon the owner’s death, without probate, much like a payable-on-death bank account. Under this new law, in order to complete a transfer of real property outside of probate, the owner must execute a “transfer on death” deed (otherwise known as a “TOD” deed) before his or her death.
In order to complete a TOD deed, certain formal steps must be taken. For example, a TOD deed must state that the transfer to the designated beneficiary is to occur at the owner’s death. The deed must also be recorded before the owner’s death in the county where the real property is located. The beneficiary is not required to sign, to acknowledge, or even to be notified of the TOD deed during the owner’s life.
The deed will not take effect until the owner has died. An owner may revoke the TOD deed at any time prior to his or her death, unless the deed has been executed by joint owners with rights of survivorship or by spouses as community property, in which case all owners must revoke the deed together. Additionally, the owner retains the right to sell, gift, or mortgage the property during his or her lifetime. The owner is still required to pay taxes on the property during his or her lifetime. Importantly, the beneficiary’s creditors may not assert a claim against the property during the life of the owner.
Upon the owner’s death, the real property passes immediately and automatically to the beneficiary. The beneficiary takes title to the real property subject to any encumbrances, mortgages, liens, or other liabilities of the owner. The beneficiary must record a certified copy of the owner’s death certificate. If done properly, the transfer of title is exempt from real estate excise taxes.
Because this is a new law, there is still some uncertainty as to how TOD deeds will operate in Washington. For example, it is unclear what will happen if the owner outlives all of the beneficiaries. Probate may be necessary to transfer the property under this circumstance. Additional questions arise if multiple owners wish to execute a TOD deed. If you are interested in learning more about the TOD deed option and some of the possible pitfalls in executing a TOD deed, please contact us.
Pending IRS Action Against Valuation Discounts on Transfers of Closely-Held Ownership Interests
Despite the courts’ longstanding approval of valuation discounts on transfers of closely-held ownership interests for gift and estate tax purposes, the Internal Revenue Service has periodically mounted attacks against the allowance of such attacks. A new attack from the IRS is apparently pending.
Treasury officials have recently indicated the Service is nearing completion of proposed regulations which, if upheld, may substantially diminish or even eliminate the availability of valuation discounts on many transfers of closely-held ownership interests to family members. The regulations are apparently based upon a similar proposal made a few years ago by the Obama administration.
While the exact reach of the regulations is not yet known and there likely will be legal action challenging any such regulations, we recommend that any clients who are contemplating making such transfers on a discounted basis consider making them before such regulations are issued by the IRS, which is expected to happen within the next few months.
IRS Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that to the extent this communication contains advice relating to a federal tax issue, it is not intended or written to be used, and it may not be used for (i) the purpose of avoiding any penalties that may be imposed on you or any other person or entity under the Internal Revenue Code or (ii) promoting or marketing to another party any transaction or matter addressed herein.
Alerts are published by Karr Tuttle Campbell to present information on legal matters which may be deserving of clients’ immediate attention. The information contained in this Alert should not be regarded as legal advice or opinion