November 2010

Federal Estate Tax Law Changes for 2011; The Continuing Case for Estate Planning Independent of Federal Estate Tax Law Changes

The lack of public debate on the potential changes in the Federal estate tax law is troublesome. As a result, the general public can get the impression that estate planning is not something that one needs to pay attention to anymore. Nothing at this juncture can be farther from the truth.

The Massachusetts exemption against estate taxes is still limited to $1,000,000 per person. That is the most amount of money that can pass to a child at death without paying the Massachusetts estate tax. The tax is approximately 11% of the assets in excess of one million dollars. The Massachusetts exemption amount is not indexed for inflation and is not likely to be increased in the near future.

The Federal estate tax to everyone’s surprise was repealed for estates of individuals who die in 2010. This repeal was an unanticipated result, because most financial professionals thought that the Congress would pass some sort of law extending the Federal exemption to $3.5 million for 2010 and beyond. In fact the House did pass such a law but the Senate, bogged down in the Health Care debate never got around to passing the Federal estate tax exemption extension. Rather the Federal estate tax just expired. In place of an estate tax, however, there is in place for estates of individuals who pass in 2010, a complicated regime of allocating limited basis step up (cost basis allocation for capital gains taxes). This limited basis allocation of up to $4.3 million will apply to assets that pass to children, a spouse, or a special trust for the benefit of a spouse.

George Steinbrenner, owner of the Yankees passed away recently. Because he died in 2010, it has been reported that his estate has saved literally hundreds of millions of dollars as a result of the repeal of the Federal estate tax for 2010.

Next year, the limited basis step up regime is repealed and the Federal estate tax and exemption amount is scheduled by law to return with an exemption amount of $1,000,000 per person, even though the Federal estate tax exemption amount had been as high as $3,500,000 for estates of decedents who passed away in 2009! Also, the full basis step-up rules are scheduled to return in 2011. So appreciated assets which are included a decedent’s gross estate will have the basis fully stepped up to date of death value for future capital gains taxes, if those inherited asset are sold in the future by the heirs.

The ambiguity in the law has the estate planning community scratching its head trying to anticipate what Congress will do next. Will Congress pass a new law covering this 2010 gap year which retroactively imposes an exemption of $3,500,000 and risk constitutional challenges to the law, or will they stick with the limited basis step up regime currently in effect with no Federal estate tax for estates of decedents who die in 2010? More and more it looks like Congress is going to keep the “no Federal estate tax rules in effect for 2010 only”. There had been some talk of changing the law to give Executors of estates the option of electing between the capital gains limited basis step up and no Federal estate tax treatment, or having the ability to elect a higher Federal exemption amount and pay Federal estate taxes on the gross estate, if any are owed, and take the benefit of and allocate a date of death full basis step up on the inherited assets. To date none of these proposals has become law. So it looks like Mr. Steinbrenner’s estate is “safe” at the moment from paying any Federal estate tax as a result of his death in 2010.

The uncertainty in the law is enough to make your head spin.

The larger question still remains: Will Congress return to a $1,000,000 exemption to raise revenue given the current size of the Federal budget deficit? If Congress fails to act before the end of this year the Federal exemption will automatically revert to the $1,000,000 figure for 2011.

So while everyone waits to see what Congress will do next, the tendency for most clients is to do nothing regarding completing or updating their own estate plans. What a mistake!

For many people, the principal motivating factor for completing their estate plan is to save estate taxes. So, the logic goes, if there is no Federal estate tax this year, there is no need to address one’s estate planning concerns. Right? This is flawed logic and the remainder of this article will address this fallacy.

If Congress allows the Federal estate tax to return with a $1,000,000 exemption next year in 2011, which incidentally is just around the corner, the result will be that many estates will be subject to what could be an enormous estate tax (the estate tax rate will be as high as 55% of the assets in excess of the one million dollars that pass to children and other non-spousal beneficiaries). Massachusetts will also impose an 11% estate tax on the assets of the estate in excess of $1,000,000 that pass to non-spousal beneficiaries. There is some credit provided against the Federal estate tax for some of the estate taxes paid to a state or to Massachusetts, but it is a limited credit.

So for couples or individuals with assets in excess of $1,000,000 the estate tax motivation for paying attention to one’s estate plan as soon as possible continues to exist.

Individuals that have old estate tax plans that have not been updated since 2003 and before, should be reviewed and if necessary amended and updated. If the Federal estate tax exemption does indeed return to the $1,000,000 level, people should think twice about reducing or cancelling any of their existing life insurance policies and should review the ownership of these policies to make sure that unnecessary estate taxes will not be paid on death proceeds from these policies paid after their death.

For all people, however, there are non-tax reasons for completing one’s estate planning. These reasons generally have nothing to do with saving estate taxes. Therefore whatever Congress does or does not do should not serve as a bar to having your estate planning addressed at your earliest convenience. Here are some of the non-estate tax reasons for completing your estate plan, if you have not done so already. The following list of considerations has nothing to do with the size of your estate as well:

It is important to complete your estate planning to:

• Establish trusts to protect and invest your hard earned assets for your children. The trust would distribute money to your children or loved ones over time so they don’t receive all the funds as soon as they turn age 18, which is the age of majority under most state laws. A properly drafted trust will provide your loved ones with an orderly structure for long term management and control of your assets, to help to safeguard your kids from themselves and from their potential creditors and spouses. Trusts can also be structured to protect your children from some of the inevitable ills of life which can result from having too much money come into their hands all at once, when they may be in no position to manage it correctly. Clients have been setting up trusts for their children and loved ones, long before the Federal or Massachusetts Estate tax ever existed. The reasons for doing so are still as strong as ever, independent of any estate tax considerations. You don’t need to be a Rockefeller to benefit from a trust as part of your estate plan.

Probate Avoidance: Assets held in a “living” trust (a trust created outside of the will) will generally avoid probate court administration in all 50 states. While Massachusetts will soon be “repealing” or limiting the probate process for most estates, (except those that are contested or involve minors), one cannot guarantee that a contest won’t occur or a minor will be involved, especially if a child predeceases you leaving behind children of their own. As we know all too well, money can bring out the worst in people, so it remains advisable to own and pass assets thru the use of a private “living” (also known as an “intervivos”) trust and not thru a public probate proceeding. These are just some of the non-tax reasons to establish a trust.

• Make sure you have an up to date durable power of attorney signed and in place for you and your spouse, so that if you are away or disabled, someone else who you trust will have signatory authority for you to control and manage your assets and to pay your bills. In the event you are disabled, having a Durable power of attorney in place will prevent your loved ones from having to go to court and incur costly conservatorship and guardianship proceedings to have a guardian or conservator appointed on your behalf. A guardian or conservator must further account to the court for all things they do on your behalf. Court involvement can be both invasive and expensive. Did you know that if you own your property in joint names with your spouse, if one of you become incapacitated, the other spouse will not be able to sell or refinance your home without someone being appointed a conservator or guardian for the incapacitated spouse? A validly executed Durable power of Attorney appointing your spouse as the holder can avoid this problem. Once again, this technique has nothing to do with avoiding estate taxes and also is not dependent upon whether you are either rich or poor.
• It is important to complete a will waiving the requirement that the person who administers your estate won’t have to purchase an expensive fidelity/surety bond based upon the value of your estate. This alone will pay for the cost of most wills.

Also, if your are the parent of young children, do you want to have any say about who is nominated to take care of your kids if you are not around to do so? A will allows you to nominate the guardians to take care of your children after your demise which courts will consider as they make the guardianship appointment. My experience over the last 29 years as an estate planner suggests that for most couples with young children, this is the most important reason why they come in to complete their estate plan. Some young parents literally well up with tears when we discuss this issue. The choices are often hard and the decisions in this regard can be difficult to make. Some spouses cannot immediately agree as to who should serve as the guardians of their minor children if they both pass away. All the more reason to talk this out and get something down on paper, so that a family war over the guardianship of your children doesn’t occur after your death or the death of you and your spouse.

This decision, once again, has nothing to do with estate taxes.

• For retired individuals: Complete your estate plan to review your long term care planning needs: Because we are mortal, we either die or we fade away and need long term care. Sorry… not to be too depressing but unfortunately that is the hard truth. Have you considered purchasing long term care insurance? Do you have sufficient assets to care for you and your spouse to cover nursing home or long term care expenses at home? If you are like most people you don’t. Have you familiarized yourself with the Medicaid eligibility rules? The rules governing Medicaid eligibility to pay for nursing homes are completely different than the Federal estate tax rules and the capital gains tax rules. One needs to consult with an advisor to unscramble these rules for you and how they may apply to your particular situation. Everyone is different. Similar to a prescription, one must be “examined” to determine which “legal prescription” is right for you, your spouse and your family. And… like most things in life, in the Medicaid field, early planning and intervention is preferable to last ditch efforts. The “early bird” definitely catches the worm in this area of the law, but sometimes, even at the last minute, assets can be saved.
• The importance of completing a living will and health Care Proxy. No one should wind up like Nancy Schiavo, the young women in Florida, if you recall, who was kept alive for years. Do you remember the prolonged and public law suit that was engendered as a result of her unfortunate situation? Rich or poor, estate taxes or not, everyone should have a living will and health care proxy. The proxy appoints someone to make your medical decisions if you are unable to communicate them yourself. The living will states your desires regarding extended life support. Do you want to be on a life support machine for an extended period of time if there is no chance for your recovery?
• Complete your plan to try to create harmony in your family after your demise. Most clients desire to create an estate plan which fosters harmony between their loved ones after their death. Most people want to take care of their spouse first and their children as well. Sometimes a child may be a disappointment and estranged from the family. Some children are better with money than others. Sometimes people remarry and want to protect their new spouse from their children from their prior marriage, and at the same time the children from the new spouse. Other times the family may have a child or children with some form of disability and need to have a supplemental needs or special trust drafted as part of their estate plan to take care of that child. Many estate planning techniques are available to address these particular concerns.

The above list sets forth just some of the legitimate reasons aside from estate tax avoidance for people to complete their estate planning.

To wait around for the latest news from Congress, neglecting all of the non-tax considerations to complete one’s estate planning, is a mistake.

In the end a sound estate plan, should bring order and control to the inevitable in life, and ultimately peace of mind.