Death and taxes

Death and taxes

A rush to beat the deadline for favorable estate provisions keeps Capital Region financial planners busy.

Two things in life are certain: Death and taxes, as the adage goes.

But when it comes to taxes on an estate when the owner has died, certainty apparently is in short supply.

Barring congressional action, the federal 2010 Tax Relief Act is set to expire at the end of the year, and with it goes a generous exemption and favorable tax rate on million-dollar estates.

For the last two years, only the 3,500 estates nationwide that are valued at more than $5 million have been subject to a maximum tax of 35%. On Jan. 1, some 43,540 estates valued at $1 million or more will be subject to a maximum tax of 55%.

That deadline—and the fact that many are doubtful Congress will take any action to preserve the favorable provisions before the November election—has those in the Capital Region potentially impacted by the change in the law rushing to their attorneys and CPAs to take advantage of the measures before they fade into the sunset.

On top of that, historically low interest rates, combined with depressed asset values—particularly for real estate—make it a prime time for estate planning.

“We have had quite a bit of activity,” says John Blackman, a senior tax and estates attorney at Jones Walker law firm. “People are wanting to take advantage of this before it's too late.”

Over the years

Modern estate taxes date back to 1916, when a 10% rate was imposed on any portion of an estate above $50,000. When America's first billionaire, John D. Rockefeller, died in 1937, his estate paid 70%. Rates and exemptions have varied over the decades, reaching an all-time high from 1941 to 1976 with a $60,000 exemption amount and 77% tax on the rest.

In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act, which gradually lowered the maximum estate tax rate from 60% to 45%, and raised the exclusion amount to $3.5 million.

Most notably, the 2001 act repealed the estate tax completely in 2010, leading to several well-publicized instances in which wealthy people left multibillion-dollar estates to their heirs without paying any federal estate tax. One was Texas pipeline tycoon Dan Duncan, whose heirs raked in a $9 billion estate tax-free after he died of a brain hemorrhage at the age of 77.

Enter the 2010 Tax Relief Act. It brought back the estate tax, but taxes only those estates valued at $5 million or more, at a maximum rate of 35%. It also has a number of other nifty features, like allowing couples to transfer a portion or all of their own unused federal estate tax exemptions to their surviving spouse, which means that married couples can shield up to $10 million of their assets from taxes. It's what's known as portability.

The exemption from the generation-skipping tax—the additional tax on gifts and bequests to grandchildren while their parents are still alive—also rose to $5 million from $1 million. The maximum tax on that is 35% as well.

“One of the techniques we're using this year is to help clients utilize the $5 million exemption by making gifts up to that amount,” Blackman says. “It may not be available after 2012.”

There are those who believe 2012 is a perfect storm, so to speak, for wealth transfer planning. Besides the $5 million gift tax exemption, many estate planning techniques are driven by interest rates, which are currently at an all-time low. Additionally, many asset classes, such as real estate, are valued below historical norms, presenting the opportunity for estate–tax–free appreciation down the road.

However, Carey Messina, a board-certified estate planning and administration specialist for Kean Miller, notes that many people don't realize that another benefit of the current estate taxes is that they affect only those who have significantly high-dollar fortunes. In addition to the $5 million federal exemption, the Louisiana inheritance tax was phased out completely in 2004.

“For many folks, what we do is education,” Messina says. “When we tell them that the Louisiana inheritance tax was phased out and the federal exemption for a husband and wife translates into $10 million, they grin and say, ‘I don't have that problem.' It's only those people with very significant estates who are going to be looking to utilize these exemptions.”

Uncertainty on the horizon

The downside to the current estate tax codes is that they are only temporary, and there is little indication as to whether they will become permanent or additional changes will then be made. The only certainty is that if Congress does nothing before the end of the year, the estate tax exemption will automatically drop to $1 million, and the tax rate will rise to 55%.

That leaves estate planning in a state of uncertainty right now.

“When we meet with clients, we tell them there is some uncertainty out there, and they're not shocked by that,” Messina says. “They see it on television, and they read about it in the newspapers. Most attorneys who prepare wills for clients have to be flexible in their drafting approach, knowing that the exemption may be a lower amount in future years. Most of us who practice in this area understand that and draft the will in such a way that it will withstand whatever the laws are at the time.”

In its 2013 budget proposal, the Obama administration called for a return to the 2009 tax rates with a $3.5 million exemption and generation-skipping transfer tax exemption, a $1 million gift tax exemption and a 45% maximum tax rate.

There is also some proposed legislation to eliminate valuation discounts for closely held business interests, although previous measures to that effect backed by the Internal Revenue Service have failed.

Also in question is whether the federal tax credit for state estate taxes might return. That meant that those who paid a state inheritance tax didn't have to pay the federal government on the same amount. Such a measure might mean some additional revenue for Louisiana.

But those in the estate planning practice don't anticipate that Congress will act before the election. Even so, any legislation passed in 2013 could be made retroactive.

“I never would have believed that what happened in 2010 would have occurred,” Blackman says. “I never thought Congress would be that irresponsible. They did nothing and it expired. So my ability to predict what Congress will do is zero. The only thing I know for sure is that if Congress doesn't do anything, the law sunsets in 2012.”

Estate advisers say the frequent changes in the provisions in recent years have made it more difficult for clients to plan financially.

Messina recalls the confusion when the estate tax for 2010 was repealed. There was much discussion about Congress enacting a retroactive measure, but then at the end of 2010 the legislative body passed legislation increasing the exemption and lowering the tax rate—but only for two years.

“It certainly makes our job a lot harder,” Messina says. “And it makes it harder to plan.”

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