To state that there is uncertainty in the world of estate planning is to understate the obvious.
The federal estate and generation-skipping trust taxes expired at the end of 2009 for one-year only. This along with an imposition of carryover basis rules for 2010 have even the most experienced estate planning professionals confused. Adding to the confusion, the federal gift tax has not been repealed and the lifetime federal gift tax exemption remains at $1 million, with a top rate of 35 percent.
No need to rub your eyes after reading our first paragraph. You read correctly. Unless Congress acts by Dec. 31, these taxes in 2011 will be the same as they existed in 2001. For all intents and purposes, this means that the tax laws relative to the federal estate and generation skipping taxes never existed in 2010.
What should you do now?
While many financial professionals may feel the need to take a “sit back and wait” approach, we counsel against this approach. Rather, we suggest the following strategies be implemented immediately:
• Review estate plans. Clients should review their estate plans to ensure that the documents accomplish the client’s planning objectives. Plans based upon word formulas or decisions tied to transfer taxes will be significantly impacted by EGTRRA. These documents should be modified to take advantage of the lack of Transfer Taxes in 2010.
• Compare basis information. The carryover basis effectively eliminates the step up in basis for 2010. If you have a dying client, start compiling the basis information immediately. Remember the special basis adjustment of $1.3 million and the spousal basis adjustment of $3 million. The client should plan to take advantage of both of these adjustments. The tax is based on the appreciation of each asset and the type of tax is based upon the character of the property. Therefore, accumulating the basis of each asset is in the client’s best interests.
• Delay selling appreciated assets. A better approach might to be to create an account for family living expenses without touching appreciated assets. This gives heirs the opportunity to accept or decline an inheritance if that is the best course of action for them. Also, there is an opinion, albeit it not widely held, that the carryover basis only applies to assets sold in 2010. If this turns out to be the case, inheritance may be able to escape the income tax rules by holding the assets until next year.
• Protect the fiduciary. Due to the confusion surrounding the estate tax world in 2010, the fiduciary has an extra burden. It is no longer business as usual — sell the assets to pay the estate taxes or in 2010 the income taxes. The fiduciary has to compute the basis of each asset; then plan which assets to dispose of in the most tax efficient manner. An additional level of responsibility is how to interpret word formulas to satisfy the client’s inheritance. Fiduciaries should consult legal counsel before carrying out their responsibilities.
• Maximize the 2010 benefit. The lack of transfer taxes and the lower gift tax rate for 2010, enable the opportunity to make substantial gifting opportunities with a 35 percent rate versus the 55 percent rate for 2011. The temporary suspension of the generation skipping trust tax in 2010 provides a window to modify transfers under an existing commitment. Generation skipping trusts will be subject to gift tax in 2010. It appears that the year 2010 presents a great opportunity to make substantial distributions.
• Plan for 2011. The estate tax returns with a vengeance in 2011. When planning for 2010 is done, the professionals should consider the gift tax exemption of $1 million and a maximum rate of 55 percent. Projections should be made as to the total tax due to the client and the client may have to increase the amount of life insurance they own in an irrevocable life insurance trust. If the client is healthy, now is the time to purchase such insurance. A good choice to consider would be convertible term insurance with an eye to full conversion once the estate tax landscape is more settled.
• Consider changing the ownership of existing life insurance. Life insurance owned by a decedent is considered part of his estate. Therefore if $1,000,000 again becomes the estate exemption, many clients will exceed this threshold due to death benefits held carelessly within their estate rather than in an Irrevocable Life Insurance Trust.
Right now, the only certainty is uncertainty and this is a topic that financial professionals will need to revisit as the situation continues to develop — either by Congressional action in 2010 or in 2011 when the new rules go into effect.
The authors are all with Capital Investment Cos., an independent financial services and brokerage firm based in Raleigh N.C. Don Deans is vice president for advisor education. Daniel P. Munroe recently opened an advisory practice in Simsbury and is affiliated with Capital Management Group in New York. William B. Nicholson is president of Capital Insurance Affiliates in Raleigh.
