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Clarity Comes to Estate Planning With Tax Bill's Passage

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Advisors and their clients are one step closer to clarity for estate planning, at least for the next two years, now that both the House and Senate have passed  The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. Following passage of the bill late Thursday night in the House of Representatives, the bill  goes to President Barack Obama, who is sure to sign the bill into law since it was his compromise agreement with Republican congressional leaders that was passed by both houses.

In addition to extending the Bush-era JGTRRA and EGTRRA tax cuts on income, capital gains and dividends, the estate tax provisions in the bill that House Democrats tried and failed to amend—via an amendment by Rep. Earl Pomeroy (D-ND)—include a $5 million exclusion ($10 million for married couples), and a top estate tax rate of 35%. Like most of the other provisions in the bill, the estate tax exclusions and tax rates will expire two years from now—in another election year, as pointed out by Investment Adviser Association (IAA) executive director David Tittsworth (left)  in a Thursday interview exploring the ramifications of the tax bill process for advisors.

Pomeroy’s failed amendment was a last-ditch attempt by liberal Democrats in the House to decrease the estate tax exclusion to $3.5 million, and institute a top rate of 45%. The amendment failed late Thursday night by a vote of 233-194.

Speaking Tuesday before final passage of the bill in the Senate as well as the House, noted advisor Harold Evensky (left), president of Evensky & Katz Wealth Management, said in an interview, “If it goes through as proposed…it’ll mean, for most of us, that the estate tax has become less and less of a problem.”

Also speaking on Tuesday, before passage of the bill in both houses of Congress, advisor Diahann Lassus, of Lassus & McWherley Wealth Management, said that what "really surpised" her was the bill's provisions "giving us a choice for 2010."

Lassus (left) points out that for the "estates of people that are “not super-wealthy” and who passed away in 2010, “their families could really benefit" from having a step-up basis "instead of the carryover basis" that was the rule for 2010 with the sunset of the estate tax at the end of 2009.

(See complete interview on the estate tax with both advisors.)

The estate tax that had been set to roar back on Jan. 1, 2011, would have included a top rate of 55% and a lower estate exclusion amount.

The estate tax package in the Senate bill that was approved by the House on Thursday included the following provisions, to begin Jan.1, according to a CCH Tax Briefing Bulletin:

  • 35% maximum estate-tax rate
  • $5 million exclusion for individuals; $10 million for married couples
  • Stepped-up basis for “all assets included in the gross estate”
  • Repeal of carryover basis (used in 2010 on capital gains in estates)
  • Heirs can choose, for those who died during 2010, “carryover basis rules under EGTRRA or the revived stepped-up basis rules under the bill.”
  • Spouses can choose to use the “unused portion of the estate tax exclusion,” of the spouse who died before them

No matter what the rate and exclusion are, what actually is paid after effective

estate planning may be entirely different.

In a recent commentary, regular AdvisorOne blogger Andrew Rice of some firm cites statistics that place the actual estate tax rates much lower back in 2001, when the top tax rate on estates was higher—that same 55% that would have returned absent Congressional action on Jan. 1, 2011. 

Advisors continue to clarify the now the estate tax options for 2010. The bill as approved by the Senate on Wednesday and House on Thursday added a choice for heirs of those who died in 2010, when there was no “estate” tax, since it had sunsetted on Dec. 31, 2009, under the JGTRRA Bush tax cut bill,  but there was a capital-gains tax on the estate’s assets, based on a sometimes difficult-to-comply-with “modified carryover basis.” Now heirs can choose either the “modified carryover basis” for the estate’s capital gains or the stepped-up basis that is the Senate’s provision for the estate tax for 2011 and 2012.

The law firm Proskauer explored the nuances of that choice in its “H.R. 4853 Summary and Planning Points,” released on Monday:

“If the value of the decedent’s estate is $5 million or less (including gifts made during life in excess of annual exclusion gifts), an executor should not elect out of the application of the estate tax. No tax will be due, and a full basis step-up will be permitted.

If the value of the decedent’s estate is over $5 million, the executor should opt out if the benefits of the additional basis step-up are outweighed by the estate tax that would otherwise be due.”

"President Obama’s agreement with the Republicans was a little surprising to all of us,” said Ben Ledyard (left), director of wealth strategies at Silver Bridge, referring to the Obama-GOP compromise on the tax bill. The firm hosted a year-end tax planning call late Wednesday during which Ledyard and Andrew Correia, Silver Bridge's director of finance and taxation, noted that the original expectation was that the Congress would restore the estate tax to where it was in 2009, with a “$3.5 million to $7 million exemption and 45% [top tax] regime.”

Ledyard walked a reporter through the decision process that heirs of someone who died in 2010 would need to consider. The question is when to retroactively apply the stepped-up basis and $5 million exemption and 35% rate for the 2011 estate tax retroactively, and when to use the carryover basis and capital gains tax that had been the only tax on estates for 2010—since for 2010 there was no “estate” tax. He was asked to apply this to a $5 million gross estate and a $15 million gross estate for the heirs of a person who was married and the first member of the couple to die.

Choices for Heirs to a 2010 Estate

For example, said Ledyard, with the $5 million gross estate from a death in 2010, the heirs would receive  the $5 million (no estate tax) at, say, a "cost basis of zero," and then “pay the capital-gains tax of 15%, or $750,000.”.

Under the bill passed by the House on Thursday, that same $5 million estate, with a $5 million exemption and 35% maximum estate tax rate, would be exempt from the tax, so it would make sense for the heirs to “go back and retroactively re-file or amend the estate-tax return,” and pay no capital gains or estate tax—thereby inheriting the whole $5 million.

For the $15 million estate, under the 2010 rules, at a "cost basis of zero, with the 15% capital gains rate," the estate would have paid about $2.25 million in capital-gains tax.

Under the new 2011 rules (applied retroactively), the estate would "exclude $5 million, and pay the 35% on the other $10 million, a $3.5 million estate tax payment." So heirs to this larger estate would be better off under the capital gain rules of 2010, rather than use the 2011 regime retroactively, Ledyard suggested.

But all of this supposes there was no other estate planning, while in fact there are other steps that could be taken to bring the gross estate amounts down.

For 2011, there are new provisions for arranging gifts to children under new, re-unified rules. Those rules would allow the first $5 million for individuals (and $10 million for married couples) given to children to not be subject to gift tax. Charitable donations are also a way, “from the heart,” as Ledyard puts it, to reduce the size of the estate.

The bottom line may well be that, as Ledyard notes, “the next two years are huge opportunities for clients with more than $10 million” and for the advisors who work with them, to plan for their estates.