Many doctors set up estate plans early in their career, then promptly forget about them to focus on building their practices and careers. While that is certainly understandable, there have been changes in federal tax law over the past few years that can have a profound impact on your estate plan.
The Estate Tax
The estate tax, that is the tax that is assessed on the value of your estate after you pass away, can be imposed at both the state and federal level. Although Arizona has no estate tax, states such as Illinois and New York tax up to 16% of your estate, while Washington taxes estates at up to a 20% rate. Although doctors in Arizona are fortunate that we do not have a state tax, the federal estate tax can create significant tax consequences.
Estate planning has traditionally focused on ways to reduce or eliminate these tax consequences. However, changes to the federal tax code over the last five years have greatly decreased the importance of tax planning as part of an estate plan. To understand how this has changed, you must understand the recent history of the federal estate tax.
Prior to 2001, the federal estate tax applied to any estates over $675,000 per person. Therefore, many people, and most doctors, were affected by an estate tax at rates that could quickly grow up to the maximum estate tax rate of 55%. One common estate planning strategy used to minimize tax liability was to set up trusts that were known as A-B Trusts or Credit Shelter Trusts. A married couple’s assets were placed into a trust and, upon the first spouse’s death, the assets in the trust were divided, with part going into an irrevocable trust (the “Decedent’s Trust”), part going into a revocable trust for the survivor’s benefit (the “Survivor’s Trust”).
An A-B Trust allows a married couple to avoid getting hit with the estate tax twice, when each of the spouses passes away, and it allows a married couple to maximize their estate tax exemptions. However, A-B trusts can be cumbersome, as the surviving spouse does not have unfettered access to the funds in the Decedent’s Trust. The surviving spouse is often the trustee of the Decedent’s Trust and must first segregate the assets into the two trusts, then provide accountings to all of the beneficiaries of the trust. As the trustee, the surviving spouse will also owe fiduciary duties to those beneficiaries, and litigation between the surviving spouse and the beneficiaries, usually the couple’s children, over the use of the trust’s assets is not uncommon.
Beginning in 2001, as part of an economic stimulus package, Congress passed a series of tax cuts, one of which gradually raised the threshold at which the estate tax would kick in from $1 million in 2002, up to $3.5 million in 2009. In 2010, the federal estate tax was repealed in its entirety, meaning that if you passed away in 2010, you paid no estate tax, regardless of the size of your estate.
Congress re-imposed the tax in 2011, but set the threshold at $5 million per person, to be indexed for inflation, and allow a surviving spouse to transfer any unused exemption amount from the deceased spouse’s estate. For 2016, the threshold at which the estate tax kicks in is $5.45 million. Therefore, a married couple can pass on nearly $11 million to their heirs without paying any federal tax. Additionally, the top tax rate for estates over the threshold has been reduced from 55% to 40%.
The tax code also allows for portability of the first spouse to die’s exemption through the Deceased Spousal Unused Exclusion Amount (“DSUEA”). This allows the surviving spouse to use whatever amount remained from the first spouse to die’s estate tax exclusion to increase his or her own exclusion.
The Landscape Today
For many physicians and dentists, the changes in the tax code over the last ten years have rendered the A-B trusts obsolete. The main purpose of setting up an A-B trust, to minimize the estate tax burden on your heirs after your passing, can be achieved without the burdens of creating separate trusts and imposing fiduciary duties on the surviving spouse.
Having said that, revocable living trusts are still an essential part of an estate planning portfolio. There also may be reasons in your particular case to keep an A-B trust in place. Therefore, if you have an A-B trust, and neither spouse has passed away yet, you may want to consult with an attorney to determine whether to amend or revoke the trust.
 For a chart on the estate tax rates for each state as of 2015, see http://taxfoundation.org/blog/does-your-state-have-estate-or-inheritance-tax.