A certified financial planner explains why the IRS isn't collecting the estate tax in 2010 and offers advice to family business owners preparing succession plans
More than a month into 2010, the Internal Revenue Service is not collecting estate tax on the money that wealthy people, including small business owners, leave to their heirs after they die. The unusual situation results because the U.S.Senate did not pass legislation late last year to remedy the scheduled expiration of the estate tax.The situation is confusing and unfair, and particularly hurts entrepreneurs doing succession planning, says Jonathan M.Bergman, a certified financial planner and vice-president of Palisades Hudson Financial Group, a fee-only financial planning firm in Scarsdale, N.Y. He spoke recently to Smart Answers columnist Karen E. Klein. Edited excerpts of their conversation follow. At this point, there's no federal tax being levied on the estates of high-income people who die in 2010. What's going on? In 2009, the estate tax exemption was at $3.5 million, meaning that if you left more than that amount, it would be taxed. If you die this year, there's no federal estate tax, although some states do impose estate tax. If nothing changes, in 2011 the federal exemption levels will revert back to what they were in 2001, which is $1 million. There's a great deal of inequity involved and we're all in limbo, due frankly to Congress's irresponsibility. Are you surprised that we got to this point? You could have asked 100 financial planners a couple of years ago and not one of them would've thought we'd be in this situation now. Everyone thought that Congress would definitely pass legislation extending the tax rate through this year. There were some legislative proposals, but once the health-care debate got hot and heavy, the estate tax was off the table. I guess we thought that Congress was more responsible than it is. The estate tax changes date back to President Bush's tax cuts in 2001, is that right? Yes. In 2001, Bush pushed through tax cuts that gradually ramped up the exemption threshold after which estate tax applies. Congress instituted a 10-year sunset provision to the legislation, with a suspension in 2010 and exemption levels reverting back to 2001 levels in 2011. The political gamesmanship was that once it's repealed it was going to be very difficult to reinstate it. The Republicans don't want an estate tax at all and the Democrats don't want to be the ones accused of reinstating the "death tax," but they may be willing to run out the clock until 2011. The really bad thing is that both of them are playing political games with people's lives. What are the chances that the estate tax will be reinstated this year and perhaps made retroactive to Jan. 1, 2010? Typically, when you have an estate, you have nine months to file an estate tax return and the IRS has three years to evaluate the estate. So making it retroactive is a possibility and there could be all sorts of compromise, but I'm certainly not making any predictions. How much tax revenue is lost when there's no estate tax? Around 1% of total Internal Revenue Service collections come from estate taxes. How is the uncertainty affecting your small business clients? The problem is that you still have to plan for what happens to your business even though we don't know for sure what's going on with the estate tax. We are assuming that our high-net-worth clients will be subject to estate tax eventually. What succession planning techniques are you recommending to them? Right now, we have depressed asset values in real estate, businesses, and securities. We also have low interest rates. That means it's a great time to shift wealth to the younger generation. We have set up several family loans where older-generation family members lend at low interest rates, which are prescribed by the IRS at the "applicable federal rate," so the younger generation can acquire family businesses and real property. How does it work? Let's say you have a restaurant, Mel's Diner, and Mel Sr. owns both the restaurant and the $500,000 property it sits on. We might have Mel Sr. sell the land to Mel Jr. using a nine-year note at the 2.82% applicable federal rate. Mel Sr. rents the land back from Junior to operate the restaurant, which should be a deductible business expense, and Junior pays some portion of that rent back to Senior as interest on the nine-year note. We believe that the value of the land will increase more than 2.82% over that nine years. Meanwhile, the 2.82% is a pretty low interest rate for the borrower, but as a lender there aren't very many places where you can reliably earn 2.82% today. At the end of the nine years, Junior can pay off the note if he has the cash, he can borrow the money from a third-party lender or he can refinance the loan. He's generated revenue from the rent and made a profit on the land, not to mention we've gotten that appreciating asset out of Senior's estate. It sounds like a pretty complicated transaction. This is something you do when interest rates and asset values are low. We make sure we have contracts and promissory notes and everything is formalized. We're not pushing the envelope. We're basically having mom and dad act like the bank, but we cut out the bank's profit and keep it in the family.