How to Prepare for Estate Tax Changes

There seems little doubt that the federal estate tax rules will fade away into the sunset at the end the decade. Through 2009, the current law allows for a $3.5 million personal exemption or $7 million in combined exemptions for both spouses, if they have taken the necessary steps to capture both exemptions.

The federal estate tax disappears totally for estates having to file for deaths in 2010, making it a unique occasion in the history of federal “death tax” avoidance.

To clarify what is expected to occur, a client with a $3.5 million estate is an example. If the federal estate tax falls back to its 2001 level when there was a $1 million personal exemption and a marginal 55% tax rate and dies in 2011, the estate taxes would be $1.375 million.

Based on that illustration, what planning will be appropriate as far as new estate tax rules going forward from 2011?

First, there is indication that the 2010 death tax “holiday” may never occur. The Administration and Congress will find a way to agree that it would be too costly to give up 2010 for collecting the federal taxes for deaths that occur that year given the deficits and the political climate.

Let’s assume federal estate taxes will not disappear. We can expect personal federal estate tax exemptions to drop from the current $3.5 million per person level. Although this may take place in 2011, it may be legislated at $3.5 million for 2010 only and it is also possible that future estate tax exemptions will be indexed for inflation beyond 2010.

We can look for the marginal federal estate tax rates to run from 45 percent to 55 percent. It is quite likely that rates will be maintained at the 45 percent marginal rate, while possibly setting an additional 55 percent marginal rate for very large estates.

Beyond the federal estate tax, it is equally important to be aware of the estate tax provisions of states and their impact. They often have different exemptions and provisions.

Second, be proactive with clients. There is a sense of urgency. Clients are aware that changes are pending and wonder about the impact should they die in the next couple of years. The initial conversation with a client should include two issues. First, anticipate a need to redraft the client’s will and trusts in conjunction with the client’s attorney. Second, take advantage of the marital deduction and unified gift and estate tax credits.

Third, producers should sit with all their clients, prospects and centers of influence to review their life insurance plans. Quite candidly, periodic reviews are obligatory today, especially when there are changes involving economic, political and tax issues, as well as family needs and dynamics.

Fourth, have a contingency plan for clients. The recent Wall Street meltdown is a lesson no advisor dare forget: clients were not prepared. Clients deserve to know that regardless of what happens, their advisor will assist them in protecting their family. To meet the challenges, personal uses of life insurance will be critical for supplying family members with an income source after the death of the income earner, providing cash to pay estate taxes, mortgages and other debts; assuring amounts for the beneficiaries; equalizing inheritance and leveraging the annual gift tax exclusions.

Fifth, clients should solve liquidity needs. These include paying administrative costs and anticipated tax liabilities, as well as any indebtedness and funding for business needs such as deferred compensation arrangements, death benefits for a key person/employees’ families, replacement of a key employee, replacement of lost revenues due to loss of a key employee and provisions financing the purchase of the business.

Clients need to review the surviving family’s lifestyle, since the recession could have altered their future financial security. This requires re-evaluating the budgetary and cash flow planning for family members, taking the likely income and estate tax changes into consideration.

Sixth, clients should take steps to reduce or even eliminate estate taxes. There are numerous planning techniques that can help reach this objective: gifts, Qualified Personal Residence Trusts, Grantor Retained Annuity Trusts, a Family Limited Partnership, selling depreciated assets and gifting net proceeds, private annuities and annuity maximization as well as other strategies. Leveraging these strategies with a life insurance product can make a large impact for estate beneficiaries.While no one knows what course the federal estate taxes law will take in 2010 and beyond, it is very important to engage clients in a review of all issues so that they are prepared to protect their family and their estates, now and into the future.