Which Direction is the Estate Tax Headed?

Taxmageddon, Fiscal Cliff and the call for fairness


by William H. Black, Jr., CLU, ChFC

Mr. Black has been in the pension administration business for over 30 years. As president of PensionSite.Org., he is responsible for the marketing efforts of the firm and assists producers nationally with the sales of split funded defined benefit plans. He is a 22-year member of the Million Dollar Round Table (MDRT) and has six Court of the Table and 14 Top of the Table qualifications.


The estate tax, derisively referred to as the “death tax,” is once again poised to change. Will it change for the better or worse depends on what Congress does in the coming months. The coming tax rate changes could increase by 57 percent, but that is just the rate. What about the actual dollar amount of taxes on one’s estate?

There is a lot of discussion about “Taxmageddon,” the “Fiscal Cliff,” etc., all the words to represent the increase in taxes coming Jan. 1, 2013. What are the tax increases and why? The tax increases involve income, payroll, estate, gift, generation-skipping and new taxes on unearned income. Since the Social Security (payroll tax) holiday is over, we need “fairness” in our tax-system, and we need to pay for the deficit when the Bush tax cuts are set to expire, etc.1

Below is an example of what is to come:








Percent Change



Tax on












Capital Gains




Taxable Interest




Ordinary Income





You may be asking yourself, “What does this table have to do with estate taxes?” It has nothing at all to do with estate taxes, other than to point out the increase that’s on its way. This information will be useful to motivate your clients to begin proactively planning in order to handle their estate taxes. Now is the time to speak to your clients about the techniques to minimize the inevitable levy. For example, qualified plans for the self-employed, or a closely held business and professional practice. That alone will help reduce income taxes and capital gains taxes. All contributions are income tax deductible, which grow on a tax-deferred basis, protected from judgment creditors and allow for the accumulation of significant wealth when structured and designed properly. These taxes are an immediate concern and will have your client’s attention.

Taxing the taxable estate

When discussing income and capital gains taxes, it is natural to discuss the estate tax levy when estates are over $5,120,000 for single filers and $10,240,000 for married joint filers. The taxable estate is the sum of all assets your client owns or controls. The taxable estate includes the value of their business, real estate, stocks and bonds, cash and even their life insurance. Life insurance proceeds are income tax-free but if the client owns it, it is also included in the taxable estate. This is why the titling of assets is important.

Below is a summary:


Tax Changes For Estates1






Estate Tax Exemption:
Single Filers
The trustees are stewards of the foundation’s assets and must operate the foundation in the best interest of the charitable endeavor, while they may pay themselves a reasonable fee; it is not a family piggy bank

$5.12 million

$1 million

Estate Tax Exemption:
Joint Filers

$10.24 million

$2 million

Top Estate Tax Rates:




However, the estate tax exemption is scheduled to drop from $5,120,000 and go back to a threshold of $1,000,000 in 2013. The estate tax rate is scheduled to rise from 35 percent to 55 percent, which represents a tax rateincrease of 57 percent (55%/35%). If you add the amount on which the taxes are levied, i.e., anything over $1,000,000 instead of anything over $5,120,000, the tax increase in dollars is astronomical.

It’s critical to keep in mind the tax rates for gifts are virtually the same. While everyone may gift $13,000 to as many individuals as one wishes ($26,000 for married couples), anything in excess of this amount is subject to gift taxes.

Assume you have a client with a taxable estate of $6 million. In other words, just slightly above today’s estate tax threshold. Further, assume this is a single taxpayer. How does the expiration of the current estate tax structure affect this taxpayer? Let’s take a closer look:

Estate Tax in 2012:
($6,000,000 total estate – $5,120,000 exclusion) x 0.35 tax rate = $308,000 estate tax due

Tax in 2013 if Estate Tax Reverts:
($6,000,000 total estate – $1,000,000 exclusion) x 0.55 tax rate = $2,750,000 estate tax due

That is an increase of 893 percent! ($2,750,000 /$308,000)

You may wonder how a married couple would be affected. We’ll assume the same fact pattern as above, but instead of assuming our taxpayer is single, let’s assume it is a married couple. One difference with the married couple is they each have a $5,120,000 estate tax exclusion. If the first spouse to pass does not use the exclusion it is “portable,” meaning the surviving spouse can use it in addition to their own.  However, the estate tax is not due until the second spouse’s passing. In other words, there is no mandatory estate tax at the passing of the first spouse unless one elects to do so.

Estate Tax in 2012 at Second Death:

($6,000,000 total estate – $10,240,000* exclusion) x 0.35 tax rate = $0 estate tax due
*Each spouse is entitled to $5,120,000 exclusion for a total of $10,240,000


Tax in 2013 if Estate Tax Reverts:

($6,000,000 total estate – $2,000,000** exclusion) x 0.55 tax rate = $2,200,000
**Assumes each spouse has a $1,000,000 exclusion for a total of $2,000,000

This means the tax goes from $0 to over $2 million, which is a good deal of money by any measure that the heirs will not get to use.

The return of “old rules” could become a significant issue for the mass affluent. Will this happen? Most think not. Under the provisions of the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010 (TRUIRJCA), the estate tax exemption was set at $5,000,000 for 2010 and 2011, and indexed for inflation in 2012 with the current $5,120,000 exemption. The estate tax rate was set at 35 percent.

What is going to happen with the federal estate tax during the coming years? In 2011, there were a  number of bills introduced in the House that called for complete repeal of the tax, but to date none of them have been brought up for a vote.

Planning Techniques

Planning is essential as tax is due in cash within nine months of one’s passing. However, the estate may be given to the surviving spouse, regardless of the estate’s value. This will delay the taxes until the surviving spouse’s demise. There is also “portability,” of the estate tax exclusion. Portability means the spouse that passes first may transfer their estate tax exclusion (currently $5,120,000) to the surviving spouse, if the first spouse to pass did not use it when settling their estate. At one time the exclusion was “use it or lose it” and inequity has been changed with the portability feature. Nonetheless, the tax must be paid. Interest accrues on the unpaid balance and it is easy to see how taxes can overwhelm the estate quickly.

The Simple Answer: Irrevocable Life Insurance Trust (ILIT)

Anything your client owns or controls is included in the taxable estate, and if the client does not own it, it is not included. Have an ILIT own the policy (not the client) and have the premiums paid by the ILIT trustee via gifts to the ILIT from the client. Policies in this structure are generally “last to die” otherwise known as “joint and survivor.” When the insurer passes away, the proceeds are paid to the ILIT and the trust disburses the proceeds to the trust beneficiaries. The beneficiaries of the ILIT are in most instances the beneficiaries of the estate. The policy proceeds are used to pay the taxes, leaving the assets to pass to the beneficiaries unencumbered by the taxes due, as the taxes are paid with the policy proceeds. To determine the amount of the insurance coverage, set it equal to the amount of expected estate taxes and consider adding a bit more for estate tax growth.

Wait, it’s Not that Simple. Or is it?

While the ILIT provides income and estate tax free dollars to pay the estate taxes due, it is not necessarily the best solution. Consider the issues that arise if the client is a small business owner.  Frequently, one child will be in the business. The business in many cases is the estate’s largest asset, so how does one treat all children equally? If the parents think giving the business equally to their children will work, they must think again. Will one child do all the work for half the pay? No way, that is a recipe for trouble!

Another solution is the family charitable foundation. All assets given to charity are excluded from the taxable estate and therefore estate taxes. A trustee is named and at least five percent of the foundation’s value must be given annually to qualified charities. The trustees are stewards of the foundation’s assets and must operate the foundation in the best interest of the charitable endeavor, while they may pay themselves a reasonable fee; it is not a family piggy bank.

Consider giving hard to divide or illiquid assets to the foundation. Create a wealth replacement trust utilizing life insurance to provide for the heirs. Why? Cash is liquid. There are no properties or assets to argue over. With family members frequently spread over a wide geographical area, there is no issue with varied interests and abilities, leaving each heir to go their own way with their inheritance. We’ve all seen some heirs who don’t want to sell certain assets for sentimental reasons, while other heirs want cash to spend regardless of other considerations. This can solve that concern.

Other Considerations

Other ways to have the estate tax minimized is to consider gifting assets during one’s lifetime as opposed to at death. The assets’ appreciation will accrue in the beneficiary’s estate, causing growth to be eliminated from the taxable estate at death. If the gift is in excess of the $13,000 gift, one must file a gift tax return, but no tax is due if one uses the lifetime exclusion. That $1 million exclusion may be given away during one’s lifetime, no need to wait until passing away. It can be $2 million for married couples. Gifts can also be made to charity in which case they are income tax deductible for those that itemize. The deduction differs based on whether it is a public or private charity. One other consideration:  once the gift is made, the asset is gone and there is no more control over the asset.


What is going to happen with the estate tax? While no one knows for sure, one nationally recognized estate and income tax planning expert, Joe Gandolfo, speculates that the threshold will be closer to $3,500,000 and a tax rate of 45 percent.

At present, there are 2.8 million Americans with investable assets of $1 million. This does not include the value of their homes. About 2.5 million people have $1 to $5 million of investable assets; 200,000 have $5 million to $10 million, and the rest have more than $10 million2. While the need for estate planning was infrequent under the 2012 rules, it will become more important after the coming changes.



 1A Fiscal Storm is Brewing

2Obringer, Lee Ann.  “How to Make a Million Dollars”  12 October 2006.  HowStuffWorks.com. <http://money.howstuffworks.com/personal-finance/budgeting/how-to-million-dollars.htm> 06 November 2012.