Presented on Wednesday, March 9, 2011 by Richard Heaton of Garrett & Heaton, LLP

1. Orange County Bar AssociationTrusts and Estates Section MeetingPractical Aspects of Estate Tax Changes of 2010 Presented on Wednesday, March 9, 2011 by Richard Heaton of Garrett & Heaton, LLP

2. Tax Relief Act of 2010 • Signed into law by the President on December 17, 2010. • Includes a comprehensive set of income tax, estate tax, and unemployment insurance provisions. • Most of the provisions are temporary, in place for 2011 and 2012 only, effectively extending the Bush-era tax cuts.

3. Estate Planning Impact • Requires review, but not necessarily modifications to existing plans • Provides ways to increase basis, while preserving zero estate tax for modest estates • Makes having B and C trusts for even modest estates more attractive • Makes A-C (Optional B) plans workable in most situations

4. Existing Estate Plans • The AB, ABC, and Optional AB that have been utilized for so long all still work, but they may not meet the clients’ desires. • It is useful to classify the size of estates: Mid-Size Large “Just a Millionaire” Modest $10 Million $50 Million

5. Existing Estate Plans • In large estates, the traditional ABC planning may not change • The potential change in planning is most likely for the modest estates of $2 million to $10 million • Assets put into a B trust will not get a step-up in basis Consider the following example…

6. Example: UPS Stock • Client funded bypass trust with UPS stock when the exemption was $600,000 • UPS stock appreciated to well in excess of $20 million • IRS tried to ignore the bypass trust, but was unsuccessful due to good planning If a similar situation happened with today’s law…

7. Comparable Example (today) • Bypass trust funded with $500,000 in highly appreciating stock that appreciates to $5 million at second death. • If stock was in the B trust, it would not get a step-up in basis. • There would be no estate tax, but there would be a lost basis step-up of $4.5 million at an income tax cost of $1,125,000. • Alternatively the stock could be put into a traditional C trust that was QTIPable, resulting in a step-up at second death. • This assumes the portability of the $5 million of the exemption at the death of the first spouse.

8. Reliance on Portability • Simple plans relying on portability, and giving everything to the surviving spouse in a simple A Trust, are problematic. Example: • Estate worth $10 million at first death with no appreciation • Entire estate left to surviving spouse assuming full DSUEA • If spouse remarries, and new spouse dies, there could be unnecessary tax at the death of the surviving spouse • DSUEA is based on the amount available to the last predeceased spouse • Timely estate tax return must be filed

9. Increasing Basis • Various ways to have options to increase basis and preserve a zero estate tax for modest estates Examples: • Survivor’s Trust and QTIP Trust • A-C (Optional B) Plan

10. Modest Estates • A trust C (which is QTIPable) is virtually mandatory, in any type of blended family situation. • Even in nuclear families with lengthy marriages, the B and C trusts can offer substantial protection against subsequent gold diggers, undue influence, and creditors.

11. A-C (Optional B) Plan • Assets of the predeceased spouse automatically go to a C trust, which is able to be QTIPed. • If surviving spouse elects not to QTIP part of the C Trust then the assets go into a traditional bypass trust. • This allows the surviving spouse an extended time to make a decision, longer than 9 month disclaimer period. • Should allow for at least 15 months to decide (assuming an extended return) • Election valid on first 706 filed even though late

12. A-C (Optional B) Plan • If no estate tax return is filed in a timely manner, then the deadline is the first estate tax return filed after the due date • Thus, an election out of QTIP treatment may be made even after the 15 month deadline, though this is naturally not advisable.

13. Potential Solution • The A-C (Optional B) Plan seems to be very workable in most modest estates. • Works well in blended families and nuclear families to prevent gold diggers and undue influence. • Allows the surviving spouse a longer period of time to determine whether to receive a potential step-up in basis or to fund the B Trust. • Has the advantage of not worrying about portability or loss of portability due to remarriage.

14. Example: Peter’s Estate Taxable estate of $8,155,027 Savings from not paying estate tax 2,854,259 Savings from not paying income tax (due to step-up in basis) 1,181,005 Difference $1,673,254 Conclusion: Peter’s Estate should not pay estate tax

15. Rule of Thumb • If an estate is worth $14.25 million or more, then the step-up in basis will not be worth the payment of the estate tax. • Example of an exception: If an estate has negative-basis property, that is property with liabilities substantially in excess of basis, then it may be well worth paying estate tax even in a taxable estate that is over $14.25

16. Negative Basis Example Gross Value $54,000,000 Adjusted basis $ 4,000,000 Mortgage $44,000,000 Equity $10,000,000 Potential Gain $50,000,000 Estate Tax Savings $ 3,500,000 Income Tax Saving $15,700,000 Conclusion: Pay the estate tax

17. Potential Future Effects • Estate tax rate has gone down from 55% to 35% • Traditional planning will need to be reviewed • Consider Estate tax vs. Income tax paid on trustee fees • Inflation factor highly significant: if COLA is a mere 1.5%, then the exclusion for a married couple next year will be increased by $150,000 to $10,150,000

18. Thank you! This presentation is available on the Garret & Heaton, LLP website at: http://gh-llp.com/resources.html