Robert Arlen, a Delray Beach (Fla.) tax attorney, says business has been slow lately. The problem: Clients have put estate planning on hold while they wait for Congress to decide what it will do about the "death tax." "People say: `I don't have to worry about the estate tax because they are going to repeal it,"' reports Arlen.
It is no surprise folks feel that way. After all, Congress voted to scrap both the estate and the gift tax last year, though President Clinton vetoed the bill. And George W. Bush has made repeal a key element of his $1.6 trillion tax package. No doubt something is going to happen this year to ease the burden on estates.
But the outcome may not be quite what you are hoping for. The estate tax won't be repealed, at least not anytime soon. Even if it is, killing the death tax may actually make life more complex for wealthy families.
It has been 25 years since planners have seen so much confusion over the estate tax. What are the likely revisions in the law? What will they mean to you? And, most urgently, what should you do while awaiting final word from Washington on the structure of those changes?
KICKING AROUND. First, don't wait to do a will and a living will. Make sure you've dealt with all the basics--guardianship for your kids, disposition of your assets, and clear instructions for your health care. And you may still want to put together a basic living trust.
But many clients are right to take it slow when it comes to tax-related planning, say estate lawyers. If you have assets of, say, $2 million or less, you are relatively young and healthy, and your principal goal is to trim estate taxes, it may make sense to hold off. But if you're older and wealthier, your goal is to set business succession, or make sure your spouse has access to cash after you die, don't wait to do a plan.
Two versions of estate tax reform are kicking around the Capitol. And they will have different consequences, especially for the largest bequests.
Democrats, and some Republicans, would simply exempt bigger estates from tax and lower the rates on those that are hit by the levy. Today, estates of less than $675,000 are tax-free. That will gradually increase to $1 million by 2006. One possible change: boost the exemption to $1 million right away and to perhaps $4 million over the next couple of years. At the same time, tax rates could be lowered from a maximum 55% to roughly 35%.
By contrast, Bush and most GOP lawmakers would phase out the tax completely. But there are two catches. The tax would not be fully repealed until at least 2009. And that may be linked to a big hike in capital-gains taxes.
Here's how. Now, when you die, the cost basis of your stocks and other assets is "stepped up" to its value at the date of death. As a result, your heirs pay capital-gains taxes only on the difference between what the stock was worth when you died and its value when they sell.
If estate taxes are repealed, that might change. Cost basis for inherited assets would be the price you first paid, rather than value at your death. Say you bought shares in XYZ Corp. for $1,000, they are worth $100,000 when you die, and your heirs sell them right away. They would owe capital-gains taxes on $99,000. Today, your estate may owe tax, but your heirs would owe no capital gains levies at all. There is "slim to no chance" that the estate tax will die without the change in capital gains, says Jonathan Forster, a Tysons Corner (Va.) tax attorney.
WAIT-AND-SEE STRATEGY. To make matters more complex, the first $2 million of an estate would probably be granted stepped-up basis, while the rest would be hit by the tougher carry-over rules. "It's going to be an accounting nightmare," predicts Ben Ledyard, vice-president at Wilmington Trust, a Delaware bank.
Still, if you already have a plan, you can take some steps while you await the outcome of the tax debate. The first involves gifts. Today, you can give up to $10,000 per year per recipient, and as much as $675,000 over your lifetime, without having to pay the gift tax. In many cases, it is better to give even more and pay the gift tax than it is to keep the assets in a taxable estate. Still, the last thing you'd want to do is pay the levy just before it is repealed.
But it's a great time to give away stock. Thanks to the plunging market, you can sign over lots more shares without triggering the gift tax than you could last year. Says Laurie Hall, a partner in the Boston law firm Palmer & Dodge: "If you have tons of assets, figure you're going to still have an estate tax and take advantage of the low valuations."
One solution, says Gail Cohen, who is chief trust counsel for Fiduciary Trust Co. International, a New York money manager, is to structure big gifts as loans. If the tax is repealed, just forgive the debt. "It's a good wait-and-see strategy," Cohen says.
You might also think about hedging a bit if you have a life insurance trust. People with large estates commonly use such devices to cover the cost of the estate tax. But if your estate is going to be tax-free under the new law, you may not need the policy. You don't want to give it up yet. But you may be able to delay paying your premiums. Check with your planner or agent.
If you already have a trust, there will be two important matters to take care of once the law has changed. First, says attorney Arlen, review your will. That will be especially important if the higher estate-tax exemptions are phased in over a period of years. Many trusts are written so that each spouse can take full advantage of the exemption. But wills that are linked to such trusts often specify an exact dollar amount of the exemption. When the level is increased, be sure that the will changes with it. "Everybody is going to have to take a look at this," Arlen says.
The second issue is important if you have an irrevocable trust. These are often used for passing assets through generations. Generally, you are locked into such devices. But in some states, such as Florida, it may be possible to unwind the trust if the law changes and your estate will no longer be taxable.
Whatever Congress does, it will surely cut taxes on big estates and create many new planning opportunities. It may also make life more complicated. And it surely won't put tax lawyers and financial planners out of business.
By Howard Gleckman
With Mike McNamee