Don't Wait

There's no time like the present to do estate plan

Pardon my cynicism," says Curt Weil of Weil Capital Management in Palo Alto, California, "but I can't believe the 'death tax' will really disappear." His prime estate planning attorney, Jim Quillinan, concurs: "It's really business as usual for the next five years and then we will see."

While most advisors agree with Weil about the permanent disappearance of the inheritance tax, there are a few things you can do now to prepare for an unknowable scenario. Weil's firm is doing "more education work than before, more 529 plans, and charitable gift trust work," and he's not alone.

Education is high on the list for many planners, since many clients have misconceptions about what the new tax law and its sunset clause mean. Laird Lile, a trusts and estates attorney with Lowry Hill, a Minneapolis-based money management firm, says that the biggest challenge is clients' "awareness that the shelf life of estate plans has decreased dramatically." Steve Long, a tax attorney with Ballon Stoll Bader & Nadler in Manhattan, agrees. "I spent much of last year trying to explain to people that we still have an estate tax. A lot of people think it is not there anymore."

Lile, in the firm's Naples, Florida office, says it is more likely that the tax will not go away. Long agrees. "The statute is such a disaster that as a planner I've got to figure that Congress will come back to it sooner rather than later," says Long. "And with politics, they'll come back to it sooner because of recession, or if Bush loses a re-election bid, or the deficit is such that revenue needs to come from somewhere. All these things are in play."

One challenge for estate planning professionals is convincing clients that it makes sense to part with some money now in the form of gift tax, Lile says. "For the people we work with, that continues to be a concern, not because people don't believe there will be an estate tax in 2010, but because they want to hold onto more of their money and are reluctant to incur a substantial gift tax."

So What Can You Do?

There are a number of techniques you can use that you may not have considered.

529 plans Gail Cohen, senior VP and chief trust counsel at Fiduciary Trust Company International in New York, is big on 529 plans, which she says are underutilized. "While these are not new, the tax law passed last year changed some of their attributes and made them much more attractive." Says Cohen, "Specifically, it's similar to an IRA in that the funds put into it grow tax-free, and the income on the funds is also tax-free. It's not like an IRA because what you contribute is not tax-deductible"--making it more like a Roth. But what made them more attractive, says Cohen, is that formerly the money coming out was taxable. Now, as long as it's used for qualified college expenses, it's not. And qualified college expenses cover a lot of ground--books, computers, vocational school.

If the beneficiary doesn't want to go on to higher education, the beneficiary can be changed within the same family. The owner of the account, or donor, thereby retains more control over the money and even the investments within the account than is usual with trusts set up to remove assets from an estate. Since control of assets can be a big sticking point with donors, this appeals to many clients.

The 529 offers the added benefit for estate planning of gifting up to $11,000 per year into as many of these accounts as you have beneficiaries--and you can put in five years' worth of funding in the first year. Assets are not removed from the donor's estate until the donor has lived the full five years, but for a donor with 10 beneficiaries, or a couple who each use their $11,000 per year gift opportunity, this can amount to over a million dollars out of the estate at the end of the fifth year.

Zeroed-out short-term GRAT Says Jeff Erickson of Lowry Hill, "Volatility is your friend." He and Lile fund a GRAT for a period of only two to three years with a higher-volatility, higher-return stock already in a client's portfolio. If the stock does well during that short period of time, the increase in value goes to the beneficiary and the grantor retains the stock. If the stock does not do so well, the grantor has not been harmed. According to Erickson, "The rate we're trying to beat is an IRS rate, actuarially based, of 6%. If you have a return greater than 6% by the end of the period of the trust, the excess amount goes to the beneficiary."

Zero-cost collars For a client with a large concentration in a particular stock, you can use a zero-cost collar, says Erickson. This is selling an out-of-the-money call. "If a stock is a $50 stock, you can sell a call priced at $70--a three-year position--and with the money that you get for selling that call, you buy a put--an out-of-the-money put below the value of the stock, probably at $46. This allows you to have up to $70, but limits your downside to $46. During that period of time, you also get to keep any dividends the stock would generate," Erickson points out. "Set those two prices based upon making the amount you received for the call and equal to or as close to the amount you have to spend for the put. That's where zero cost comes from. You pay for downside protection by limiting your upside. The IRS is okay with it as long as the band is wide enough that they would not perceive it a deemed sale." He points out that this works well for elderly clients who have a large position in a particular stock of low basis. It avoids the capital gains tax in selling for diversification, and at their death the stock is stepped up in value for the heirs.

Declined property funding a trust Says Louis Kokernak, a planner in Austin, Texas, "I've spoken to a a few estate planning attorneys . . . some are recommending that credit shelter trusts be named as secondary beneficiaries to retirement plans." The idea behind this is that if the primary beneficiary chooses, he or she can decline just enough of the benefits to fully fund the credit shelter trust based on the actual exemption in effect that year.

The Old Standards

Bear in mind that, considering the doubtfulness of the estate tax's permanent demise, planning strategies such as qualified personal residence trusts and standard GRATs are also useful. Richard Schultz, of Schultz Financial Management in Santa Ana, California, uses a combination of these to provide income to the client (GRAT) and continued use of a home (QPRT) while removing these assets from the estate of the client. The present value of a future interest in the home is gifted to the QPRT, and may be discounted by 50% or more if the span of time is 10 years or more. Assets gifted to a GRAT, such as rental property, stocks, or a business interest, "may be discounted by 70% or more depending on a number of factors," Schultz says.

"These irrevocable trusts can be structured so that at the end of the term of years (e.g., 10 years), the assets will be transferred to a defective grantor trust that provides for a 'power of substitution,' Schultz says. "This type of trust is considered 'defective' for income tax purposes, since any income or capital gains incurred will be taxable to the giftor. However, for estate tax purposes, the trust can allow the trustor to bring assets back into his estate in exchange (power of substitution) for an asset of equivalent value (e.g., bonds, notes, etc.)."

Whatever the final fate of the estate tax, there are many options still open. Timely strategies such as these can help you make your clients' final plans more rewarding to them and to their heirs.


Reading Up

Estate & Business Succession Planning: A Legal Guide to Wealth Transfer, by Russell L. Fishkind and Robert C. Kautz. (Wiley, 2002)

For a thorough desk reference on the various aspects of estate planning and succession planning, this is an excellent choice. Lucid writing combined with chapters on a wide variety of topics including ILITs, generation-skipping transfer tax, lifetime gift exemption, and living wills, as well as chapters on business valuations, buy/sell agreements and their funding, and family limited partnerships will get the process going in most situations. Personal aspects of estate planning are not neglected, as living wills and disposition of personal effects are also covered.

Each chapter covers its subject in depth. The chapter on family-owned business deductions, for instance, has material on everything from initial qualifying rules and the 50% test to ownership and qualified heir tests and recapture rules. The chapter on split-dollar life insurance covers different types of split-dollar arrangements, financing arrangements, and tax consequences, among other subjects. If you need information on supplemental needs trusts, you'll find material on safeguarding the trust, sources of funding, and some of the concerns that should be considered when choosing a trustee.

Scenarios of hypothetical families and their estate planning issues make individual situations clearer, and offer examples of how various strategies can work or cause problems for the family if not corrected. Advantages and disadvantages of strategies are spelled out clearly, so that the planner or client can make decisions or understand why a given action was taken.

Obviously a one-volume book is not an exhaustive source, but this book is thorough and offers a comprehensive look at the common and not-so-common problems inherent in estate planning and business succession plans. --Marlene Y. Satter

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