BusinessWeek Investor: Estate Planning
Waiting for the Death of the Death Tax
You can still do some responsible planning before the fog clears
For a brief moment last summer, attorney Harold Hudson saw his career flash before his eyes. Congress had just voted to repeal the estate and gift tax--the No. 1 item driving clients to Atlanta-based estate-planning specialists Hudson & Smooke. "I started to think, `What business can we possibly switch to?"' he recalls.
False alarm. President Clinton vetoed the estate-tax repeal, just as its Republican backers had expected. But as the 2000 political season reaches a crescendo, financial planners, attorneys, and their clients face a real quandary: No matter who wins control of the White House and Congress, some substantial reduction of the estate tax appears to be nearly certain in 2001. But what kind of reform, and how much? Those questions are creating uncertainty for families who want to pass on their wealth without paying a penny more than necessary to Uncle Sam.
Usually, estate planners say that the best way to pay less tax at death is to transfer as many assets as possible during life. Planners urge clients to "give until it hurts," even if that means using up your lifetime tax exemption (currently $675,000) and paying gift taxes immediately. The more you give your heirs while you're alive, the less the total gift and estate tax bite will be.UP IN THE AIR. But the prospect of estate-tax reform--whether outright repeal or only a sharp rate reduction--has cast a shadow over that conventional advice. "If I tell a client to go into his pocket and pay a tax now, and that tax gets repealed next year, I'm going to have one unhappy client," says George Levendis, senior partner for estate planning at Washington law firm Patton Boggs.
So planners are waiting and weighing the politics. Few believe that outright repeal of the estate tax is likely, even if Republican George W. Bush leads a GOP election sweep. After all, last summer's repeal, designed more to rally the Republican faithful than to serve as a workable law, would have kept the tax largely intact until 2010. But death-tax foes see hope in the fact that even liberal Democrats favor reducing the levy. Vice-President Al Gore has said he'd support a rollback, perhaps along the lines suggested by New York Representative Charles Rangel: raising the amount exempted from tax from $675,000 to $1.1 million (or $4 million for owners of family farms and small businesses), and reducing the top rate from 55% to 44%.
The most likely outcome: Congress will cut the estate tax's steep rates by 20% or so, resulting in a top rate between 40% and 45%. It will raise the lifetime tax exemption to between $3 million and $4 million. "When all is said and done, we're still going to have an estate tax--especially for the superwealthy," says Clint Stretch, director of tax policy for accountants Deloitte & Touche. The details depend on which party controls the White House, the Senate, and the House.
So what should you do while you're awaiting election returns and legislative action? First, don't neglect the basics: Tax or no tax, you need a will (or, in some states, a revocable living trust) and an executor to ensure that your property ends up where you want it upon your death. Parents with minor children need to recruit guardians and authorize trusts. "In any estate plan, taxes come second," says Laurie Hall, partner at the Boston law firm Palmer & Dodge. "Doing what's right for yourself and your spouse and kids is most important." That could include arranging trusts to care for disabled heirs or to ensure that your children don't lose their wealth through debt or divorce.
To minimize taxes, planners usually strain to persuade clients to give away as much property as they can afford--or can stand to surrender control over--during their lifetime. Thanks to differences in the way the taxes are calculated, a gift bears less tax than a bequest: If you have $2 million for your kids, they'll net $1.29 million after tax from a gift, but only $900,000 from a bequest. Giving is especially powerful if you transfer assets that are gaining value. Say you have $2 million in a stock that's likely to be worth $5 million in five years. If you give it away now, you'll pay tax only on its current value, not on the $3 million in future growth.SLOWLY, SURELY. You'll still want to use your $10,000 annual exclusion to make tax-free gifts. You'll even want to make gifts that use up your $675,000 lifetime exemption as quickly as you can afford to. But with the future of the tax in doubt, "now is not the time to be making bigger gifts that require paying gift tax," says Gail Cohen, chief trust counsel for Fiduciary Trust International in New York. "It's a good time to wait and see what happens to the tax."
Your ability to wait may depend on your circumstances. Say you own a business or an undeveloped plot of land, and you have an unbeatable offer from a buyer. Your heirs will benefit most if you transfer the property to them before you sell. In such a case, "you've got to strike while the iron is hot, even if it means paying some taxes," says Levendis.
If so, you'll want to look at planning tools that reduce the taxable value of your gift. If, for instance, you put that undeveloped land into a family limited partnership, each of your heirs gets an equal stake, but you retain management and control as the general partner. Since they can't control the property, your heirs can claim their shares are impaired. Appraisers usually mark down the value of such shares by as much as 35%. That means you'll pay gift tax on $6.5 million instead of $10 million.
A similar technique applies to transferring your home or vacation house to your children. Under a qualified personal residence trust (QPRT), you retain the right to occupy the house rent-free for a fixed number of years--which reduces the value of the house for gift-tax calculations. Indeed, some planners are urging clients to accelerate plans to establish QPRTs. The reason: The Internal Revenue Service doesn't like these trusts and has tried to get Congress to shut them down or at least limit them. "If we get substantial estate-tax reform, we might see the IRS looking for loophole-closers--and QPRTs have been on their loophole list for years," says Mitchell Gaswirth, an estate expert at the Los Angeles office of law firm Proskauer Rose. A trust established this year would probably be protected.
Few of these concerns are likely to matter much to the superwealthy. Unless political lightning strikes and full tax repeal somehow becomes law, "the $20 million estate is still going to face a hefty tax bill," says attorney Jonathan Forster of the firm Greenberg Traurig in Tysons Corner, Va. But for the merely well-off, gift and estate tax reform could mean substantial savings--especially if they play their cards right.By Mike McNameeReturn to top