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Do Only Fools Rush In?

Columnist: Susan M. Teel
December, 2011 Issue

Susan M. Teel
All articles by columnist
“If the current estate tax laws expire in 2012, why should I review or change my estate plan now? Shouldn’t I wait?” A dear, 85-year-young, long-term client recently left me this message. As the “tax relief versus revenue needs” debate increases in volume, underscored by mounting political pressure and rampant confusion over tax theories, Congress is frozen and clients are too. Where does a healthy debate leave a thoughtful person who’s simply interested in leaving a rational, tax-savvy legacy?

Under Tax Reform Act (TRA) 2010 provisions, expiring December 31, 2012, each person has a cool $5 million exemption—the amount he or she can gift tax-free (married couples get $10 million). Any new estate tax legislation must address whether the $5 million single exemption amount stays, is reduced or increased (most unlikely); the “portability” provisions allowing a deceased spouse’s unused exemption to shift to the surviving spouse will be extended or lapse; the estate tax rate will remain 35 percent or increase to earlier rates of 45 to 55 percent; the gift/estate tax exclusions will remain united or be uncoupled, leaving different exclusion amounts as in prior years; the “stepped-up” basis that lets a beneficiary take a new basis in an inherited asset equal to the value at decedent’s death remain or the “carry over” basis regime will return (hopefully unlikely).

If past Congressional gridlock is a clue, answers are unlikely to be available soon—maybe not until the eve of the “temporary” law’s expiration. Without legislative change, once again the more draconian exemption, tax rate amounts and other provisions of the 2001 tax act (EGTRRA) will be reinstated.

But let’s step back and consider actual filing statistics for estate tax returns and projected revenue effects. Earlier this year, the Brookings Institute issued a Tax Policy Analysis, which considered 100 percent of U.S. taxpayers. It concluded if TRA 2010 remains unchanged, approximately 8,600 estate tax returns will be filed for 2011 decedents, of which only 3,300 will owe estate tax. Of this number, fewer than 50 small farms and businesses (estates in which 50 percent of the total worth consists of such assets) will owe any tax. If we return to 2001 EGTRRA ($1 million exemption), after deductions and credits, numbers increase, but remain relatively low. Nationwide, roughly 114,600 returns will be filed with 52,500 owing tax.

Examining these statistics, it becomes clear that, regardless of which estate tax regime is finally adopted, fundamental planning for the majority of taxpayers (clients whose net estates are somewhere south of $5 million or $10 million for couples) still revolves around the questions: Is a value plan in place, such as a will or trust? Is the plan up-to-date from both a tax as well as a non-tax perspective? And, Could the nominated personal representative find the original planning documents?

Will the personal representative know how to interpret the documents? More avoidable attorney’s fees and expensive litigation is caused by failure to address these simple questions than by estate tax issues. Updating requires checking to ensure assets are properly titled to a trust, beneficiaries’ gifts (by size and asset) are still appropriate, family changes have been accounted for (divorces, newborns, newly married children’s spouses) and properly mesh with the planning, and disabled beneficiaries receive assets in the proper form.

If marital deduction-bypass tax formula planning has been the crux of a will or trust, is the formula appropriate to the $5 million exemption? What if the $1 million exemption returns? How does the formula work with currently owned assets? Is a family farm or business part of the estate? What proportion? Is a current business succession plan in place? Is the tax formula still “good?”

Using marital (possibly a QTIP) and bypass trusts (considered in earlier columns) continues to serve important purposes regardless of the exemption amount, but the funding formula should be correct. The worst mistake is to mandate creation of a marital trust, intended to be operative when the exemption was considerably smaller, that absorbs all or nearly all of the assets, leaving nothing to fund the bypass trust. In such a case, the surviving spouse’s estate may be left with little or no tax shelter.

A single “family flex trust,” funded first with assets equal to the existing exemption amount, that looks like the traditional bypass trust but gives the trustee broader powers than traditionally incorporated (with careful crafting of tax controls), might be a good alternative. A family flex trust may let the trustee, usually the surviving spouse, change certain allocations and distributees of assets, while maintaining creditor protection and providing tax shelter. Wider use of a disclaimer trust—leaving assets to the surviving spouse, but creating a trust to hold “disclaimed” assets that can still provide an income stream to the survivor as well as emergency access to principal—is also an excellent, flexible option.

The big message: Don’t put off making fundamental changes! Procrastination could derail the entire plan. Costs of litigation due to stale or omitted provisions or expensive clean-up costs may far exceed the costs of planning “too early.” Let your estate planning attorney advise you on what’s important now versus what you can safely delay.


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