Estate Planning During a Time of Uncertainty About the Estate Tax

Decisions made about the estate tax this year will have ramifications for wealth distribution for years to come. To take one example of the stakes, consider George Steinbrenner, who died in July of 2010 - the year the estate tax is due to expire. With an estimated net worth of $1.15 billion, his heirs could save up to $500 million in federal estate taxes alone.

In 2001, Congress voted to raise the estate tax exemption incrementally. The phase-out ended in repeal of the tax, effective in 2010. Most tax attorneys expected Congress to reinstate the tax before year-end 2009. But then, following the midterm elections, the issue of the estate tax became a political football. Congress and the White House are currently negotiating the form that the tax may take in 2011 and beyond. The uncertainty makes prudent estate planning even more important than ever.

The Estate Tax Reinstated

The estate tax exclusion was formerly $3.5 million (or $7 million for couples) and the tax rate was 45 percent. In 2011 the estate tax is scheduled be reinstated, but with only a $1 million exclusion (or $2 million exclusion per couple) and with a tax rate of 55 percent. Whether that will indeed be the rate that takes effect is not yet clear.

The same Congressional dynamics (or paralysis) that allowed the tax to expire in 2010 could affect the shape of the tax in 2011 and beyond. Partisan politics and competing proposals call for diverging exemption levels and tax rates. The Obama administration proposed returning the tax to the 2009 levels and the House approved the proposal. This proposal faced Republican opposition in the Senate, however, and was defeated.

What It Means to the Average Estate

Even those who are far from being multi-millionaires could be affected by reinstatement of the estate tax. One estate planner and former IRS attorney says that a property owner can fairly easily reach the $1 million limit when combining the value of a home and retirement or savings account.

Clint Stretch, a tax principal for Deloitte Tax, says families who live in areas with high property values are particularly vulnerable. Stretch says people in his neighborhood, outside of Washington, D.C., may have spent $32,000 in the 1960s on a home that is now worth $1 million; if these homeowners have any other assets, their heirs will owe estate tax in 2011.

How to Plan Now

Even in this time of uncertainty, there are important principles that asset owners should consider when attempting to minimize the impact to their heirs of future estate taxes:

No Time Like the Present

Currently, the rules allow an annual gift tax exclusion of $13,000 per beneficiary, with multiple beneficiaries in the same year allowed. Gifting while still alive means that the beneficiary reaps an immediate benefit while the future estate is also reduced, all with no tax consequence.

Some may choose to gift in excess of the $13,000 tax-free limit. This year, the gift tax is 35 percent, compared to the 55 percent estate tax looming in 2011. Reducing the future estate can be advantageous even when the gift and estate taxes are at the same rate, because gift tax is assessed exclusive of tax while estate tax is assessed inclusive of tax. Many people are taking advantage of the current depressed valuations to shift assets from their estates to their beneficiaries.

Charitable gifting may also reduce the size of a taxable estate.

Using Wills and Trusts

The Internal Revenue Service rate that applies to a grantor-retained annuity trust (GRAT) reached an historic low of two percent in October of this year. If the assets in this irrevocable trust appreciate more than two percent, the excess passes to beneficiaries tax-free. Some may prefer the flexibility of a revocable living trust and there are many options for creating and funding trusts.

Whether or not their heirs may be burdened by estate tax, those who own property or assets should almost all create a will and keep it up to date. Also, those who have set up a trust should also have a will for any assets that may have been missed or excluded from the trust. A way to make wills flexible is to allow beneficiaries to disclaim assets after death - to engage, in effect, in a form of post-mortem planning.

In the Meantime

Bipartisan legislation has been reintroduced that would exempt up to $5 million from estate taxes and levy a 35 percent tax rate on assets over that amount. Some financial planners are not optimistic about Congressional action, however, given the political dynamics in play. But reinstating the estate tax with a lower exemption and higher rate could give lawmakers a way of raising revenue without voting to raise taxes.

A number of state, including Massachusetts, levy a state estate tax, which may further complicate planning. Property and asset owners should speak with an experienced estate planning attorney about their financial plan and how to maximize the value of their estate for their heirs.