Estate planning has always been one of the more difficult aspects of financial planning, since advisors and estate attorneys are drafting documents designed to accommodate future changes in regulations and tax laws.
Under normal circumstances, when the tax law is not in total flux, this is a tough enough job. When the tax law is in total flux, however (as is the case following the 2001 passage of the Economic Growth and Tax Relief Reconciliation Act–EGTRRA), all of the same issues faced by estate planners still exist. But, in addition, there is no way of knowing some rather basic estate assumptions, such as whether an estate will be subject to any tax at all, and the rate at which the estate will be taxed.
Traditionally, the goal was to have clients make up their minds about what they wanted to do with their assets after their deaths. But today, rather than locking those decisions in an airtight set of documents, planners are instead forced to try to postpone as many of the decisions related to tax planning as possible. So the question becomes, what decisions can and should be postponed?
Now, faced with the toughest tax planning and estate planning environments in history, Barbara Sloan, estate attorney and partner of McLaughlin & Stern LLP in New York, took time to discuss the latest developments in the field with Staff Editor Megan Fowler, and to recommend what she thinks you and your clients should know.
What’s new in estate planning in light of EGTRRA? First of all, we need to be helping clients get comfortable with the idea that they are going to have to leave a lot of control in the hands of someone else if they die before our tax environment settles down. Once that confidence is established, then you can move forward.
Despite EGTRRA, all of the usual estate planning flexibility techniques that we have always relied on, such as leaving room for changes in the circumstances of the beneficiary, are still available.
The real issue here, however, is that we don’t just have repeal of the estate tax, we also have a transition from a situation in which assets received a full step-up in basis at the death of the client, to a situation where we are going to have a carry-over basis. This means we are going to have income tax issues that we have not had to deal with before in estate planning. And we have provisions that protect a specific amount of the decedent’s property from income tax issues, but only under very limited circumstances. Furthermore, none of our old planning techniques and drafting tools are suitable to take advantage of the new basis planning. It’s actually a whole new plan.
We could, of course, have our clients dredge up their records to support what their basis in property is; once they’ve died it is virtually impossible.
But you don’t want to be the one who looks foolish to your client by making them spend hours trying to reconstruct their assets, only to discover, six months from now, that this whole carry-over basis idea has finally been beaten to death.
Anything new in will disclaimers? Disclaimers continue to be a very popular technique to preserve flexibility under the existing estate tax planning regime. However, there are some dangers associated with them. They can sometimes be ineffective or can’t be used at all.
A disclaimer occurs when a person chooses not to accept a gift or bequest specified in a decedent’s will. A disclaimer meets certain requirements that prevent the person who made the disclaimer from being treated as though he or she made a gift to the person who actually receives the property. There are two specific problems that come to mind when trying to ensure this tax-advantaged treatment.
The first is timing. The disclaimer must be made within nine months of the gift or the bequest (meaning nine months from death, when the will becomes effective). If a client walks into your office ten months after her spouse died, and says she wants the estate to go to their children, you can’t help her. It’s too late. Even if someone had no knowledge of the bequest made to him or her, you still can’t help the client after the nine months. So you need to understand how your clients title their property and if they are the beneficiaries of any trusts, in order to advise them effectively on what interests they may or may not be able to disclaim.
The second problem is, in my opinion, far more significant. A person wanting to disclaim cannot have accepted any of the benefits of the property. That may sound simple, but it can in fact be extremely subtle.
For example, something like receiving a dividend check and depositing it would be disqualifying. That is an act of acceptance of the benefits of the property and that property can no longer be disclaimed. Treating the property as though it is owned by the disclaimant–such as voting the stock or withdrawing funds from a joint account– would also be disqualifying.
When people want to disclaim, you really have to press them about what activities they’ve already engaged in; you often discover that no qualified disclaimer is possible.
Two techniques, that solve these problems are having the executor make a partial QTIP election for marital trust, or using a special kind of trust for marital deduction planning known as a “Clayton Trust.”
This, then, becomes an education issue. Our clients know when and what can be disclaimed, but often their family members do not.
So then should estate planning be done with the entire family? This is a very tricky area. I think most estate planners would say that family estate planning in the stable family is advantageous. You can plan who is going to be taxed, on which property, and at what level, and make sure everyone is educated as to the total plan, not just their little piece of it. For that reason, it’s possible.
But there are ethical rules that apply. Lawyers have to represent each client separately. And in a family, it may be that different members have conflicting interests or may develop conflicting interests in the future. In that case the lawyer may be required to withdraw.
Any specific trust options planners should pay attention to? A revocable trust is a good idea to look into. People in many states have been using these trusts for a long, long time. They have become almost common in certain circumstances.
Let’s assume I have a somewhat elderly client and I’ve drafted a will that to the best of my knowledge takes into account as much of the current tax laws as I am capable of. But let’s assume that that client becomes incapacitated six months down the road. This individual can no longer change his or her will. A year later, a brand-new tax law comes into effect. It has completely different provisions and the client’s will needs to be changed. But because he is incapacitated and he can’t make any decisions, there isn’t any way to fix that will to account for the new tax law, even if you know exactly what the client would have done.
So the question is, what can you do for the client? You can create a revocable trust for clients. The trust can allow the client to appoint a person he or she trusts to amend the will solely for the purpose of making changes to conform to changes in the tax law if the client is incapacitated.
It’s an awesome power, one that many people may decline. But at least that puts us a step ahead of where we would have been.
It is similar in context to a trust protector. Trust protectors are generally used in instances of foreign trusts, but they can also be incorporated in a revocable trust situation.
What issues should planners watch in regard to estate planning? Between now and June 28, Congress will be voting on a series of legislative proposals to change the estate tax laws. The Democrats will likely propose bills increasing the unified credit; the Senate will vote on whether the repeal of the estate tax under EGTRRA should be extended beyond the year 2010.
In addition, we are hopeful that final tax regulations directly affecting estate planning techniques will be issued by June 30, the end of the year for the IRS business plan.
Among those regulations is the Section 645 provision permitting revocable trusts to be treated as an estate for fiduciary purposes. Another is Section 643, which deals with the definition of income and which was stimulated by the changes occurring in different states’ laws, as well as provisions dealing with S corporation stock holdings and their indirect impact on estate planning.
How should planners stay up to date? Estate planning rules are extremely technical. And the technicalities are such that it is almost impossible to educate a layman easily and have them really understand the full impact. I would recommend going forward with sophisticated tax planning techniques in cooperation with a sophisticated tax planner.
After 9/11/01, many people have stopped putting things off in their lives. Has this translated to an increase in estate planning awareness? Immediately following 9/11 there was more of a flurry among clients who, for example, had received a draft of a proposed will four months earlier but had never even bothered to look at it, which is not unusual. Most of those people read those drafts, made the changes, came in, and signed up. There were also those who came in not long after 9/11, who had no wills at all, and suddenly realized they needed to do them.
But interestingly enough, now that we are far away from 9/11, we are still seeing a number of people changing their out-of-date wills. That surprised me; I think everyone now is just more sensitive to his or her own mortality. Of the many uncertainties that we are facing with tax laws only one thing is for sure: the laws will change. It is completely inconceivable that Congress will allow us to go through all these years of EGTRRA, have one year of estate tax repeal, and then go back to the law the way it existed in June 2001.
What’s the one thing I feel sure of? Either we are going to get permanent repeal or we are going to get rid of this law with another law. The question then is, what will the new law be? And the answer is that no one has a clue.