Forget Repeal–Focus On Family Wealth Transfer Challenges
Regardless of what the President and Congress decide to do with the estate, gift, and generation-skipping transfer tax system, there will always be a need for family financial planning. Even in a world completely devoid of taxes, there will always be a need for the services we render.
Many people have assumed that in an estate tax-free environment there will be no “estate-related” reasons to provide liquidity. Quite simply, this is wrong–liquidity solves problems.
It provides income, pays down debt, allows for continuing a business, pays for education, balances inheritances among various classes of heirs, provides for a second spouse and meets the expenses of estate administration. All of these problems occur with or without estate taxes.
Even if estate tax repeal is made permanent, it makes sense to keep your attention on estate liquidity planning.
Several things have happened recently that have focused attention on estate planning. First, of course, are the complicated provisions of the Economic Growth and Tax Relief and Reconciliation Act of 2001 (EGTRRA).
Second, the depressed economy and the stock market certainly have heightened peoples awareness of their wealth and the uncertainty often associated with investments. This is a motivating factor for clients to pursue aggressively estate-planning opportunities. A key component of this planning is to provide estate liquidity through the placement of insurance products.
Consider some of the details in EGTRRA. As you might imagine, the carry-over basis regime is extremely difficult to administer. Remember when we tried this 25 years ago with literally no success? The carry-over basis regime was such a disaster that it was retroactively repealed back in 1981. Even with the advent of computers, there is nothing that indicates we will be any more successful in tracking basis now than we were some 25 years ago.
Obviously, under a carry-over basis regime, record keeping will be at a premium. This is going to add cost to the administration of estates. It will also place a huge burden on you as financial advisors to your clients. And we all know that if we are unable to substantiate basis, the Internal Revenue Service presumes your basis is zero.
You can also imagine the potential conflicts over basis allocation among various beneficiaries of an estate. No beneficiary of an estate wants to take carry-over basis unless that basis is reasonably close to fair market value at the time of receipt. This is because of the locked-in capital gain associated with the lack of a full basis step-up.
In many estates, especially when the surviving spouse may not be the parent of the decedents children, there will be significant tension over the allocation of assets to the children over a spouse.
This is particularly the case in estates that contain closely held businesses that may be run by the children of the deceased. An executor might want to allocate the stock in the business to the surviving spouse just to get the spousal step-up in basis. The executors zeal to get a basis adjustment will have to be tempered by the request of the children to allocate the stock to them even though no step-up in basis will be allocated.
Obviously, this is a major problem, one that can and should be solved with life insurance.
In cases such as these, even though no estate tax may be due, the capital gains tax burden could be very substantial. Thus, instead of procuring life insurance for the purpose of paying estate taxes, we will be placing life insurance as the solution to a very complicated basis adjustment allocation in the estate.
Obviously, a new focus for all of us in an estate tax repeal/carry-over basis era will be capital gains taxes. And, whenever capital gains are an issue, we consider using a charitable remainder trust. Under carry-over basis rules, we will be using them even more.