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Financial Planning > Tax Planning

Doing the Planning, With Or Without An Estate Tax

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Now that 2009 has ended and Congress has not acted, there is no federal estate tax-for now at least. This development leads to a number of questions. Will Congress reenact the estate tax in 2010? If so, will it be reenacted retroactively to the beginning of 2010, or will it have prospective application? Or will Congress do nothing and allow the estate tax to return in 2011 with a vengeance at a $1 million exemption and a top rate of 55%?

There are a number of ways that Congress might address the estate tax this year. First, Congress may reinstate the estate tax retroactively to the beginning of 2010 at levels at or near 2009 levels, with a $3.5 million exemption and a top rate of 45%.

Another option would be to enact the estate tax sometime during the year with a prospective effective date, so that there would be no estate tax for a period of time during 2010, but with an estate tax instated at some time during the year. A variation on this might be that Congress would reinstate the estate tax in 2011 at 2009 levels.

Or Congress might do nothing and let the estate tax return in 2011 with a $1 million exemption and a 55% top rate. The bigger question is: What can be done while we are in this period of uncertainty?

What the rules say

Let’s review what the rules are for 2010:

o The estate tax and generation-skipping transfer taxes are repealed for 2010.

o The gift tax exemption is $1 million.

o The highest marginal gift tax rate is equal to 35%. If Congress reinstates the estate and generation-skipping transfer taxes retroactively to the beginning of 2010, the highest gift tax rate will rise as well.

o The step-up in basis rules are replaced by modified carry-over basis rules.

For 2011, the following rules are scheduled to come into effect if Congress does not act:

o The estate tax and gift tax exemption amounts will revert to $1 million.

o The generation-skipping transfer tax exemption will be something more than $1 million, based on inflation since 2003.

o The highest marginal estate and gift tax rate will be 55%, plus a 5% surcharge to phase out the benefit of the unified credit on estates with a value in excess of $10 million.

Not only should the federal estate tax be considered in planning, the advisor should also understand that 17 states have either an estate tax or an inheritance tax–or both. Most states rates are about 10%, but some rates are as high as 20%.

With states needing cash, more states may impose estate or inheritance taxes. Even if an individual is not a resident of a state that has an estate tax or an inheritance tax, if property is owned in one of these states, that property could be subject to the particular state’s estate or inheritance tax.

The more things change…

Some things do not change, even in the face of continual changes in the tax laws. One thing that will not change is that people will still die, and they will die unexpectedly. Young couples will want to protect their families in the event of such an unexpected loss. Businesses will still need to make plans to deal with the death, disability, or retirement of an owner or key employee. And families will still be interested in providing for children with special needs.

Protecting a business

The death of a key employee can affect a business and the families that rely on that business for support. While it may be obvious that a business should insure its building, machinery and other equipment, it may be even more important to insure its most important assets: its managerial skill and experience.

And the odds of a person dying before age 65 are not remote. In a business with two male owners who are both age 45, the chance of one of the owners dying before age 65 is nearly 25%. If the business will be continued after the death of a key employee, life insurance proceeds can be used to obtain a replacement, replace lost profits, provide a financial cushion or make survivor income payments.

Planning in a repeal environment

Given the carryover basis rules that are (so far) in effect for 2010, life insurance and life insurance trusts will continue to have a place while the estate tax is repealed. Life insurance can grow tax-free and will not be subject to income tax after the person whose life was covered dies. Also, using life insurance trusts in conjunction with the annual gift tax exclusion ($13,000 per person in 2010) can allow leveraging of the exclusion to even greater benefit.

You may also want to take out a short-term life policy to provide funds to pay income taxes on property that will be subject to a carry-over basis; or to equalize distributions among beneficiaries who received assets with a built-in gain and others who received property where the basis step-up was allocated.

Also, it is important to keep records that indicate what was paid for particular assets. Provisions should be added to current estate planning documents that give an executor the power to allocate the allowable basis increase to assets that could be included in the deceased’s estate, regardless of whether those assets pass under a will (probate assets) or outside of a will (non-probate assets). Executors should be indemnified and held harmless for making this allocation (recipients of low basis property may complain about allocations). Or specific direction could be given to the executor to allocate the basis step-up among assets.

For individuals who die in 2010, until the resolution of repeal and retroactive reinstatement of the estate tax, the executor will want to delay distribution of assets to beneficiaries and forgo sales of assets during 2010. Also, with the carryover basis rules in effect in 2010 and the ability of a spouse to add an additional $3 million in basis to property, leaving assets to a dying spouse may allow couples to take advantage of more of a basis step-up.

Factoring in taxable gifts

Something to consider is to make taxable gifts in 2010. The gift tax during 2010 is 35%, while the highest rate in 2009 was 45% and the highest rate is scheduled to rise to 55% in 2011. Note that that Congress may restore the 45% rate retroactively to the beginning of 2010, but that gift tax returns for gifts made in 2010 are not due until April 2011, or with extensions, until October 2011.

Joseph Stenken, J.D., CLU, ChFC is advanced sales marketing counsel at the UNIFI Companies, Forest Park, Ohio. You may e-mail him at [email protected].

Objectives of Estate Planning in a Repeal Environment

o Maintain protection against premature death

o Find and maintain records to track basis

o Consider making taxable gifts

o Consider leaving assets to dying spouse for increased basis step-up.

o Hold executors harmless for making basis allocations

o Delay resolution of estate until estate tax details are clearer


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