Benjamin Franklin Was Wrong!

Summary:
Benjamin Franklin penned the famous phrase: “In this world nothing can be said
to be certain, except death and taxes.” But Ben, smart as he was, couldn’t
conceive of our current Congress! Nothing is certain about taxes any longer.  (1) Everyone expects tax rates to rise to
cover growing deficits, but what form that takes and when it will happen all
remain to be seen; (2) President Obama’s proposed budgets has nasty stuff for
wealthy folk endeavoring to plan their estates; and (3) The “Now you see it,
now you don’t” estate tax remains in flux. Since you’ve no doubt heard about
repeal, possible reinstatement, and carryover basis, we’ll provide a broader
discussion of the current estate tax environment and pro-active steps you can
take.  A recent survey of CPAs said 83%
of their clients are taking a “wait and see” approach to the estate tax. Hmmm.
Sounds a bit like Nero and the fiddle.

For a
detailed 60 page analysis of the impact of estate tax repeal, including sample
documentation and more see www.shenkmaneducation.com.
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Estate Repeal, Well Maybe: Everyone expected, and still expects, Congress to “patch”
the estate tax so that in 2010 we’d have the same $3.5 million exclusion and
45% tax rate as in 2009 until Congress decides what to do for the long term. Senate
Finance Committee Chairman Baucus and Treasury Secretary Geithner stated that
they both support extending the 2009 estate tax rates for 2010 and making the
changes retroactive to January 1, 2010. You might know the result by the time
you read this, but then again maybe not. Whatever happens, issues and opportunities
should be evaluated. Importantly, there are important lessons that everyone
should learn from these events. Planning, it seems, should forever more be more
flexible.

Obama Budget – Estate Restrictions: In
addition to repeal uncertainty, changes proposed in President Obama’s budget
create additional concerns. ◙ These
include a restriction on Grantor retained
annuity trusts (GRATs) commonly used to shift growth in asset values outside
your estate. GRATs will have to last a minimum 10 years. This is significant
because if you don’t survive the 10 year term the assets will be included in
your estate. The addition of this mortality risks will make GRATs, which hare
commonly two years under current law, impractical for many seniors. Hug your
insurance agent. If you use a 10 year GRAT odds are good that you’ll want to at
least consider a 10 year term insurance policy to cover the risk of your dying
prematurely. The investment strategies of GRATs will have to change. You can’t
immunize a single asset class GRAT with cash and sit on it for a 10 year term,
With a 2 year GRAT that was tax-groovy.  ◙ Discounts, long the bane of the IRS, and fodder for
more cocktail conversations than any other tax topic in history, will be
subject to new limitations. The Treasury will issue new regulations specifying
restrictions (e.g., in a partnership agreement or state law) that will be
ignored in valuing interests in family controlled entities if the ownership
interests involved are transferred by bequest or gift to family. These will
include interests that can be removed by family members. So if you’re planning
a discount move, swing before the window closes. Discount restrictions will
take some of the juice out of many tax planning techniques. But don’t despair, grantor
trusts are quickly becoming the “new tax normal.” See Practical Planner May
2009. Archives are available on www.shenkmanlaw.com.

Carryover basis Rules: For those
dying in 2010 there will be a limited basis step up. Congress effectively
created an income tax cost to replace the estate tax. If you die owning a stock
you paid $1 for and it is worth $1M under 2009 law, you would pay an estate tax
(if your estate exceeded $3.5M) but then the “investment” or “tax basis” in
that stock would be increased to $1M value at your death. IRC Sec. 1014. If
your kids sold it for $1M they would not pay capital gains tax. Under the 2010
law, unless and until Congress changes it, the basis step up is limited under
an arcane set of new rules that ever tax geek hopes they don’t have to learn. These
rules are called “carry over basis”. Every estate will get to increase the tax
basis in assets owned at death by $1.3M (only $60,000 for non-resident aliens,
sorry Sigourney). $3M more can be allocated to increase basis of property
received from a deceased spouse. These rules will require substantial
recordkeeping by everyone, regardless of the size of your estate, because
everyone is potentially subject to income and capital gains taxes. The rules
are arcane, even for tax laws! Unlike the fiddling Nero — do something! ◙ Re-title accounts to tenants in common
with your spouse. The planning paradigm with the estate tax had been to divide
assets 50/50 so whoever checked out first could fund a bypass trust. The new
carry over basis paradigm is to divide assets by appreciation. But just like
Doublemint gum you can get two, two tax plans in one! Tenants in common gets
you the right division under either scenario. ◙ Revise your documents! Yes, you need to. Build in
more flexibility, specific powers and instructions on how an executor should
divvy up the basis adjustments if they apply, and other goodies discussed
below.

Your Will is Probably Wrong: If your
will leaves an amount to a trust or children based on the amount that doesn’t
create a federal estate tax (a common way to write will language because of the
many changes the law has taken over the years) what happens if there is no
estate tax? Your dispositive scheme may just go haywire! You need to revise
your will to contemplate a world without an estate tax. No tax advisers ever
had this scenario in mind on their radar screen. . ◙ Consider appointing an independent
fiduciary to address tax decisions while uncertainty reigns. Putting this off
won’t help. And even if Congress reinstated the estate tax retroactively
yesterday, issues may remain for some time to come. ◙ Include statements clarifying your
personal objectives independent of tax considerations. That will help interpret
and apply your will regardless of how the tax system is jiggered.

He’s Back – The Return of Freddy Krueger: Everyone
is confident Congress will bring back the estate and GST tax. If Congress
reinstates the estate and GST taxes but does not make them retroactive what
happens during that interim window when there is no estate or GST tax? You may
not be able to set up a dynasty trust and make it GST exempt because you may
not be able to allocate GST exemption to protect a trust if there is no GST
tax. Does that put the freeze on that type of planning until Congress acts?
What if you set up a GST exempt trust and Congress retroactively reinstates the
GST tax? Will that result in a retroactive allocation of GST exemption to that
trust? ◙ Instead of
fiddling fund a trust now with a defined value clause to allocate assets among
GST exempt and non-exempt trust based on how the law shakes out. ? ◙ If you have a trust that is not exempt
from the GST tax but for which grandchildren (“skip people in tax jargon) are
beneficiaries, consider distributions now while there is no GST tax. You might
be able to make distributions subject to an agreement of the beneficiary to
refund the distribution if a GST is retroactively reinstated.

Gift Planning: Make taxable gifts! Yes, you read
right! If you’re loaded and on in years or not well, if you make large taxable
gifts at the 2010 35% maximum gift tax rate, that could be a whopping savings
from incurring the 55% marginal estate tax rate that comes into play in 2011
and later  years if Congress does
nothing.  Also, if you survive 3 years
after making the taxable gift, the gift tax you paid is removed from your
estate as well as the asset (in tax jargon that’s a net gift). That’s a winner.
Just make conforming updates to your living will since you’ll need to survive 3
years after making the taxable gifts to get the gift tax out of your estate. ◙ If you wait for the tax issues to
resolve, interest rates might be higher, asset values may be higher and tax
planning strategies more limited.

Conclusion: The uncertainty is wild, but so are the roller
coasters at Cedar Point. Jump on and have a ride. Waiting will provide
certainty, but may also waste valuable planning opportunities.