More On Tax Planningfrom The Advisor's Professional Library
- Annuities: Estate Tax The value of certain types of annuities may be included in an estate’s value. Understanding the intricacies of these inclusions is a critically important aspect of estate planning.
- IRAs: In General Individual Retirement Accounts are highly popular tools for contributing funds that grow on a tax deferred basis. Depending on the type of IRA, the accumulation can be tax free.
Starting January 1, 2010 we have to be prepared for no estate tax, no Generation Skipping Tax, and carryover basis for those who die in 2010. This seems pretty simple, but is complicated by two major considerations: What will happen in 2011 if no legislation is forthcoming, and what happens if the Congress enacts legislation retroactively in 2010?
No estate tax in 2010
Assuming Congress does nothing, those who pass away in 2010 will not have to pay estate tax regardless of their level of wealth. In "Federal Estate Taxes Loom," I described one of the implications of this as a possible "Throw Momma from the Train" scenario, as beneficiaries stand to receive larger inheritances without the bite of estate tax. Although I made light of it, the potential public policy implications of this alone should have been enough to spur Congress into action. Removing nefarious intentions from the discussion, should families make end-of-life planning decisions based on this potential financial windfall? Does anyone seriously want to talk about this with clients? Can we afford not to?
Another serious issue concerning the elimination of estate tax is more esoteric. In most estate planning documents, the funding of trusts is determined by "funding formulas." Most of these formulas relate to the current estate tax. The idea is usually to fund trusts to a certain level to minimize or eliminate estate tax for those funds. The problem for people dying in 2010 is that their funding formulas will relate to an estate tax amount that doesn't exist. As estate tax comes back with a vengeance in 2011, the funding formulas for these 2010 funded trusts need to work, or the surviving spouse may pay more estate tax than they would have to if funding formulas were not tied to 2010 estate tax levels. Wealth managers need to evaluate the need to amend revocable trusts so estate settlement and trust funding formulas are not stymied by a one-year lapse of estate tax limits.
No Generation Skipping Tax in 2010
Planning techniques for taking advantage of 2009 Generation Skipping Tax (GST), levels were discussed in "Federal Estate Taxes Loom." Based on the increased probability of there being no GST next year, planners and clients need to decide if 2010 might be a better year to make multi-generational gifts, especially if the size of these gifts exceeds GST exemption limits. The potential for retroactive legislation once again complicates this planning issue.
Another huge issue for 2010 is the switch, from date-of-death step-up treatment of cost basis of assets, to a carryover basis treatment for inherited property from someone who dies in 2010. Generally, at the death of an asset owner, the cost basis of the asset has been "stepped up" to date-of-death value, allowing those who inherit these assets to sell them with little or no capital gain (or loss) consequence.
For assets of individuals who die in 2010, the survivors will inherit the cost basis as well as the asset, so any sale of that asset will be a taxable event. The idea, of course, is revenue production that is broader based than the estate tax. The problem is that carryover basis treatment has been tried before. In the Tax Reform Act of 1976, a carryover basis regime was passed, but Congress repealed it before it was put in place for fear that the recordkeeping and tracking issues would be so ponderous as to be insurmountable. We all know that many of our clients come to us without adequate basis information, and many hold assets until death to use step-up to "wipe the slate clean." This common planning technique will not be available to those who die in 2010. Wealth managers should notify their clients that cost basis records should be organized and updated, just in case.
There are two exceptions to carryover basis treatment. A decedent's executor has up to $1.3 million dollars of "step up allocation" to increase the basis of assets (up to their date-of-death value). The second exception allows a $3.0 million step-up allocation for those assets left to a surviving spouse, either outright or through a Qualified Terminable Interest Property (QTIP) trust. Wealth managers should review clients' wills and revocable trusts to make sure they maximize these exceptions.
Other issues: State estate tax
For those states that haven't "decoupled" their state estate taxes from the federal tax, state revenues will decrease and cause these states that have predictable estate tax revenues to legislate quickly or lose out. Wealth managers need to be aware of new, state estate tax pitfalls and unexpected results. Some state estate tax laws give a credit for federal estate tax paid, and of course, these will go away as well. Be prepared.
Although many give because they can and they want to, some give to avoid paying estate tax. Charities across the country have been lobbying hard to preserve an estate tax regimen at the federal level to motivate giving. In turn, the government took advantage of this motivation by pushing the funding of what might otherwise be federally funded social programs to the private sector. With no federal estate tax to motivate, donations in 2010 may be down in an already difficult fundraising cycle. Importantly, some clients may wish to unwind charitable plans in place thinking they are no longer relevant. Wealth managers need to review these plans to make sure clients understand the benefit these plans will give in 2011 and beyond.
A comprehensive discussion on planning implications of 2010 estate tax law repeal goes far beyond the scope of this article. Wealth managers must work closely with clients and their legal and tax counselors to fully understand their client's unique situation, and appetite for making changes to accommodate a legal framework that may (or may not) change in the near future.
One thing is clear, all the planning done now could be made moot, in fact can be detrimental to a client's financial situation, if Congress enacts legislation retroactively in 2010. It is unclear what level of "grandfathering" will be available to those who make irrevocable decisions based on current law or 2010 law. Un-ringing the bell may prove a difficult thing to do. Stay tuned.
John Bock, JD, CTFA is a senior vice president and fiduciary advisor at Key Private Bank. He serves as a fiduciary expert on the relationship management team, and can be reached at firstname.lastname@example.org.