Keeping current is key for effective plans
“There’s an interesting psychology to estate planning,” says Randy Nelson, a partner with law firm Weiss Berzowski Brady in Milwaukee. “None of us plans on dying tomorrow, therefore there’s really no deadline to getting your estate plan done because as long as you get it done before you die, it’s fine. It’s one of those things that people will put off.”
The point estate planning experts like Nelson and Andrew Willms of Thiensville-based Willms Anderson make is that not only is it important to get a plan down, but make sure it is reviewed at a minimum of every three years.
Why review it so often? Primarily, it’s because the Economic Growth and Tax Relief Reconciliation Act of 2001 gradually eliminates the estate tax by 2010, but then — because Congress had to balance the budget — the tax is reinstated on Jan. 1, 2011. That leaves plenty of room for planning, according to Nelson.
“What that really tells us is that Congress and the President — whoever it is since there will be two more elections between now and then — are basically guaranteed to revisit the entire estate tax law,” Nelson says. “The increased exemptions that we’ve got between now and 2006 are pretty solid. Then I think Congress and the President will have to decide where they want to go” with the estate tax.
One of reasons for the repeal, according to repeal proponents, was to save family businesses and family farms from being liquidated to pay the estate taxes nine months after the decedent’s death. And because much of net worth is composed of illiquid assets such as a business’s value and a personal residence, a lot more people are dying as millionaires. Dying without a plan to shelter those assets from estate tax forced many families to sell off the business, or parts of it, thus crippling the ability to continue it as family-owned.
Congress passed gradual increases in estate tax exemptions — the amount of value sheltered tax-free — beginning with a jump from $675,000 to $1 million on Jan. 1, 2002. In 2004, the exemption increases to $1.5 million, and in 2006 it increases to $2 million (the level Nelson thinks has a fair chance of actually happening). Under the 2001 Act, the exemption jumps to $3.5 million in 2009, then gets completely eliminated in 2010 — because the tax is revoked that year.
Nelson notes that plans that use “tax formulas” in them should be carefully reviewed to ensure that the outcome of the plan matches the intent of the person planning it.
“If you’ve got a plan that says “The kids get some percent of the gross estate for federal estate tax purposes. …” well, if there is no gross estate for federal estate tax purposes, does that mean they get nothing?” Nelson says. “Does that mean they get zero? Maybe. … Put down on paper what you intend and keep it current.”
Blended families are most at risk for tax formulas in estate plans going awry under the new law. Typical plans would leave the exempt amount to the children from the first marriage, according to Nelson.
“Now that it’s going to $1 million, do you want the kids to receive $1 million?” Nelson says of the estate tax exemption. “What happens when you die in 2006 and it’s $2 million? Is that what you want to go to the trust for the kids from a prior marriage, or is that too much? So you could have some real unintended results.”
Going hand-in-hand with estate planning is the use of gifting to remove assets from an estate into charitable organizations or into children’s and grandchildren’s hands.
“Take advantage of the annual gift-tax exclusion,” says Willms. “The annual gift tax exclusion allows every individual to give up to $10,000 in 2001, and $11,000 in 2002 to any person or persons they choose without having to pay gift taxes. Married persons may therefore give a total of $20,000 per person this year and $22,000 per person next year. To the extent the exclusion is not used in any year, it is wasted.”
Using the gift-tax exclusion is an excellent way to transfer stock in a family-owned business, but giving up control is sometimes the hardest thing for the older generation to do, Nelson notes.
The lifetime gift-tax exemption increases from $675,000 to $1 million on Jan. 1, 2002. “Persons who have already taken full advantage of the $675,000 that could be given away free of tax prior to that date might want to consider using the increased exemption to make additional gifts in 2002,” Willms notes.
Along with those lifetime exemption gifts, Willms urges people to file gift-tax returns as gifts are made, even if no tax is due because of the exemption. This is especially true when hard-to-value items, like closely held stock, are given. There is a three-year statute of limitations on returns that begins when the return is filed, so if taxpayers are negligent in filing, not only will they be faced with penalties but the IRS can challenge valuations, even if the gift was made 20 years ago (and a gift tax return wasn’t filed on a timely basis).
Keeping accurate records will be at a premium come 2010 when the estate tax is revoked because in that year, barring changes, beneficiaries will not only inherit assets, but also the lesser of the decedent’s basis or fair market value at the time of his or her death. (There are partial step-ups in basis available, according to Nelson.) While the estate tax is still in play, beneficiaries get a basis equal to the greater of fair market value at time of death or the descendant’s basis. The difference is subtle, but will increase capital gains on the sale of inherited property under the 2010 rules.
And if the descendant was terrible at recordkeeping and his basis cannot be figured out? The beneficiary’s basis is zero. So it pays to keep up-to-date records.
“There isn’t necessarily a deadline until we sell something, and then we go back and figure out what the basis was,” Nelson says. “That’s hard enough to do while you’re alive. Once you’re dead, how successful is your family going to be?”
And last but not least: insurance policies. Some people take out life insurance to help their beneficiaries pay estate taxes when they die. With the revocation scheduled for 2010, some of those people may be tempted to cancel their policies figuring the estate tax won’t be around, so why continue paying?
That’s a big mistake, Nelson says. First, many of those policies were taken out when they were much younger and in better health, meaning premiums are lower.
“Some people might say, ‘Well, if we make it to 2006, the $2 million exemption is going to be more than enough to cover our assets,'” Nelson says. “Fine, wait until 2006. Pay the premium for another four or five years. Make sure we do, in fact, get the $2 million exemption. See how your health is. Maybe by 2006 you need or want that insurance for something other than estate taxes.”
Dec. 3, 2001 Small Business Times, Milwaukee
