Estate planning in uncertain times
By Jason Ryan
Most clients want to be able to decide how their wealth will be distributed and to whom it will be allocated when they die. However, without a solid estate plan in place, any number of costs -- probate, funeral and burial expenses, state and federal estate taxes, and professional advisor fees -- can eat away a large portion of the legacy the client has worked so hard to build.
While there has been continuing discussion about estate tax reform, the future of federal estate taxes is still uncertain. Even if federal estate taxes disappear, other taxes and hidden expenses are here to stay -- and could even increase. Now, more than ever, it's important to encourage clients to develop an estate plan or to review their existing plans if they have not done so within the last year.
Estate tax repeal: A history of change
Throughout the past 200-plus years, our country's history of estate tax laws has been a veritable roller-coaster ride: enactment and repeal, several reinstatements and repeals, followed by years of reform. As you can see from the timeline below, the government has a tendency to reenact repealed estate taxes, particularly when the country is at war:
- Enacted 1797: Estate tax enacted to pay for tensions with France
- Repealed 1802: Repealed when the threat of war ended
- Enacted 1862: Estate tax re-enacted to fund the Civil War
- Repealed 1870: Estate tax repealed
- Enacted 1898: Estate tax reinstated for Spanish-American War
- Repealed 1902: Repealed when war was over
- Enacted 1916: Estate tax back for World War I
- Reform 1930: Various changes; similar to today's estate tax structure
- Reform 1976-1993: Nine major pieces of estate tax legislation introduced
- Reform 1997: Unified credit increases and new family business exclusion
- Reform 2001: Economic Growth and Tax Relief Reconciliation Act of 2001
In the past, the federal government allocated 25 percent of the federal estate taxes collected to the individual states. In 2000, the states collected $5.3 billion in death and inheritance taxes.*
However, with the gradual phase-out of the state estate tax credit by 2005, this significant revenue source disappeared, meaning the states have had to make up the lost money in some other way. At least 25 states have already enacted tax laws to replace the funds, with more likely to follow in the future.
To compensate for the revenue loss, many states have lowered their estate tax exemption amounts. And, while many people assume their estates will not exceed the exemption threshold, thanks to the large appreciation of home and real estate values, they may find that their "middle-income" estate is, in fact,- subject to state taxes.
A taxing situation
Under current federal law, for most people, no estate tax is due if the estate is worth less than $2 million as of 2006, increasing to a maximum of $3.5 million in 2009. Additionally, heirs will receive a step-up in cost basis for most of the assets transferred to them upon the client's death. This means that if they sell inherited real estate, business interests, or the stock portfolio relatively soon after the client's death, no income tax will be paid on the gain in the asset's value as of death. However, if estate taxes are repealed for 2010, that's a different story.**
With the estate tax repeal, once an appreciated asset is sold, a capital gains tax could be due on every dollar of gain from the time of purchase until the time of sale by heirs. While a method for a limited cost basis step-up would remain, heirs may need additional funds to pay for income tax liabilities created upon the sale of inherited assets.
The new method could also mean more diligent recordkeeping -- ensuring that clients have the proper documentation for all purchases and sales of assets, no matter how old.
Other planning considerations
Keep in mind that there's much more to estate planning than just taxes. The purpose of estate planning is to make sure heirs receive their assets at the time and in the manner that clients wish. Following are some other points to consider in overall planning for the transfer of the estate, regardless of federal estate taxes:
- Family members who have special needs
- Protection from creditors
- Efficient asset distribution to family members
- Family business succession
- Charitable giving
*USA Today, December 16, 2002.
**Under current law, the estate tax is actually repealed for 2010 but returns for 2011 and thereafter.
As required by the IRS, you are advised that any discussion of tax issues in this material is not intended or written to be used, and cannot be used, (a) to avoid penalties imposed under the Internal Revenue Code or b) to promote, market or recommend to another party any transaction or matter addressed herein.
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