Reflections on this last week

What a crazy week it was.  Perhaps it was too much turkey.  Maybe it is the end of the year and the holiday frenzy or blues.  I don’t know, but clients seem to be exhibiting behaviors which are at times predictable and at other times buying into the frenzy.

Mrs. X who first visited my office about two months ago called in a panic.  She and her husband had moved to Grand Junction about 8-10 years ago.  We visited about updating their estate plan to conform to Colorado law as well the changes in their life involving their heirs.  One child had died.  Two others were suffering from disability and they did not feel they could leave their estate to them outright for fear their current governmental benefits would be terminated.  Yes, they did need to make some changes. 

Our office gets the call from Mrs. X on Thursday (60 plus days after we talked about needing to update their documents) in a frenzy.  Her husband was having surgery the following Tuesday and could I please draft a financial power of attorney for them to come in and sign today.  Their crisis was now my crisis.  I was able to move other client priorties to help them and they plan to come by the office on Monday (Mr. X won’t be able to get out of the car and actually come in to the office due to his health condition) to sign the document.  I don’t understand the thinking about being proactive in your estate plan.  None of us like to talk about yet alone dwell on our own mortality, but we do like to be prepared.  We do like to have our ducks in order.  I have pleaded with clients over the years to stay on top of their planning and don’t procrastinate, but I am getting hoarse.

Other clients are quite concerned about the economy. In one estate we negotiated a deed in lieu of foreclosure (in effect selling the property back to the bank) for an estate which owned property out of state.  The banks are really in an upheaval and trying to get them to respond is very very difficult.  Many clients are in a panic.  For some the down turn has presented real problems with their retirement planning, cash flow, etc.  Legal services are said to be discretionary spending and I believe this to be the case.  Many clients are planning just to get them by, hoping in the future, they can do the planning they really want to do.

Other clients, such as a couple I visited with this last week, are looking at the depressed values as a planning opportunity to transfer assets to their heirs.  They are considering gifting of assets at reduced values.  The lower values combined with lower interest rates provide real planning opportunities which may not be seen for some time in the future.  Freezing the estate values (currently low) and gifting or selling the assets to your heirs can be a great technique to maximize the amount you can pass to your children.  Some of the techniques being considered by clients include self-cancelling notes, sales to intentionally defective trusts and grantor retained annuity trusts.  Although sophisticated and complex the results can be very rewarding.

And last but not least there is the family who cannot understand why a sibling and daughter would have left a handwritten will (yes, those are legal in Colorado) leaving her estate to an ex-boyfriend instead of to her family.  Apparently, she had broken up with the boyfriend some 10 years ago, but never changed the handwritten will. Leaving an old will lying around without changing or revoking it can have unintended consequences.  Although the family claims there was a later will it has dissappeared. Hmmm.  Something smells kind of fishy, but there just is not much which can be done.

All in all a pretty exciting week, with a lot of activity.  Most is predictable, but a lot is not. With only 3 1/2 weeks to go until the end of the year, the pace seems to be picking up.  With a new Congress seeking ways to give out money (and hopefully finding ways to pay for it) one can expect lots of exciting law changes this next year to be watching.  Many of them will impact the readers of this blog.

President-Elect Obama Estate Tax Reform- Thoughts on what might happen

As 2009 has been approaching there has been much anticipation as to what Congress and the President might do with the estate tax.  Currently, each individual can pass $2,000,000 free of estate tax to his or her heirs.  In 2009, this amount will increase to $3,500,000.  In 2010, the estate of a decedent will not pay any estate tax (the exclusion is unlimited) but the heirs of the decedent in 2010 will not receive all of the assets of the decedent with a basis adjustment (the so-called step up in basis). Under current law no income tax is paid by the heir inheriting the decedent’s assets because of this basis adjustment. In 2010, however, the heir will have to use the basis of the decedent (with some exceptions) which means the heir will have to pay tax on the gain when the inherited asset is sold as the decedent would have to do.

In 2011 the estate tax exclusion amount is reduced to $1,000,000 per person and is set to stay at this level indefinitely.  (Note: As an aside, remember an individual can pass to a spouse an unlimited amount estate tax free (the so-called marital deduction) and an unlimited amount to a charity  (the so called charitable deduction))  During the recent election campaign (and prior to the economic freefall of the U.S. economy) President-elect Obama indicated he would support extending the exclusion of $3,500,000 indefinitely and keeping the current estate tax rate of 45%  for the value of the estate above the exclusion amount.  With the economic forecast looking dismal for the foreseeable future, will President-elect Obama and the Democratic controlled Congress accept the 2009 exemption amount of $3,500,000 or not?

Remember, during the campaign for President, then Senator Obama indicated anyone earning over $250,000 was wealthy and would likely see the taxes on their income increased under his administration if he had his say.  Is $3,500,000 wealthy?  Is a millionaire wealthy? I suppose it depends on your perspective. According to the Wealth Report by Robert Frank, as reported in the Wall Street Journal on November 22, 2008 Merrill Lynch reported there were 3,000,000 millionaires (individuals with a net worth of $1,000,000, excluding their personal residence) in 2007. If you count the residences of millionaires in the calculation of who is a millionaire there were 9,000,000 of them in 2004 according to Federal Reserve data.  As I have found in my practice there are a significant number of millionaire to be found everywhere.  Planning for millionaires is quite common place.

With a national debt of roughly 10.6 trillion (for the most current number go here) one can only expect the estate tax might just be on the agenda of a President and a Democratically controlled Congress notwithstanding the campaign rhetoric and promises.  So, what might we come to expect in 2009 in the way of estate tax changes.  I have my short list of what I think we might see.  We will no doubt know a whole lot more by the end of 2009.

First, I think Congress will act and the President will sign a bill which extends the estate tax exclusion of no more than $3,500,000. It could be less, but I cannot imagine below $2,000,000.  I believe the rate will be 45% for all taxable estates above the exclusion amount.

Next, I don’t believe they will eliminate charitable or marital deductions, but will try to make the marital deduction “portable.”   This means upon the death of the first of a married couple to die the surviving spouse will inherit so to speak all or a portion of the first to dies exclusion amount, which is not used by the first to die.  For example, if the first to die had a taxable estate of $1,000,000, which was distributed to someone other than the surviving spouse and some of the exclusion was used to avoid paying any estate tax, the surviving spouse would receive an additional $2,500,000 of the exclusion (not used by the spouse first to die), which can be used by the second to die.

This will avoid having to undertake some of the the sophisticated planning currently required to be used by the modest millionaires to insure both souse’s exclusions are used.  If such a change occurs there will be a need to file an estate tax upon the death of the first spouse (although it may be an abbreviated one).  There will also need to be a provision to avoid marrying just to get the exclusion of the first to die.  Sounds a bit grizzly, but you can see this happening as there is significant amount of money at stake.  Imagine Sue surviving Sam and marrying three more husband.  Would she get to have potentially four exclusions plus her own for a total of $17,500,000.  The devil will be in the details.

Next, we are likely to see an attack on discounts afforded estates of owners of family entities who create entities for reasons other than non-tax reasons just to get discounts on the value of the interest they own in their family entity.  The discount of the value of the interest owned at the time of death of the owner of an interest in the family entity currently enables the decedent’s estate to avoid having to pay as much in estate tax.  This “discount planning” has been on the IRS radar screen for some time and might just be eliminated during the upcoming Congressional session.

2009 will be an exciting year for planning for taxable estates.  Even with the recent economic downturn there will still be plenty of taxable estates and plenty of estate tax planning.  Many clients have been on the fence and avoiding any estate tax planning, not knowing if they should plan or not, while they waited for the estate tax to be possibly eliminated.  Although eliminating the estate tax was high on the agenda of the Bush administration the efforts were thwarted by the Democrats as the Republicans never could muster the 60 votes in the Senate to permanently repeal the estate tax.  Now that the Democrats are in control of Congress (and the prospects of the Republicans who support repeal of the estate tax being in control of Congress in the forseeable future being a long shot if not impossible for decades to come) elimination of the estate tax is certainly a non-starter and most will be lucky if the $3,500,000 exclusion continues.

Stay tuned.  The ride should be an interesting one.  The new reform will be a boom to estate planners as they continue to explore ways to leverage the exclusion Congress does let everyone keep.  Estate tax planning helped me get my children through college and now will help me help my grandchild (and maybe grandchildren) get through as well.

The votes are in!! Now what?

Now that Barrack Obama has been elected President of the United States and the Democrats in the Senate are close to having the 60 votes it needs to close off any attempt at a filibuster, what might we expect in 2009? If we assume the campaign rhetoric to be anywhere close to reality there are a few projections we can now make.

1. Highly likely. The all important estate tax exclusion is to increase under current law to $3,500,000 for decedents dying in 2009. President-elect Obama has said he supports an extension of this amount and no more beyond 2009. It would not be far fetched to expect Congress to act on the extension of this amount in 2009.

2. Highly likely. President-elect Obama has also indicated he would like to keep the estate tax rate at 45%. This means an individual with an estate of $4,500,000 (assuming he or she does not have a spouse) would have an estate tax of $450,000 (45% of the $1,000,000 over the exclusion).

3. Probable. It is likely Congress will keep the basis adjustment of assets which pass from a decedent’s estate. Now, when a person dies owning a $100,000 assets, which cost him or her, $20,000 (their basis), the heirs receive the asset along with a new date of death basis of $100,000. This means when the heir sells the asset there is no capital gain. Had the decedent sold the asset when he or she was still living the decedent would have had to of paid the capital gains tax on the $80,000 gain.

Under current law the basis adjustment would have gone away for decedents dying in 2010 (although subject to some exclusion amounts) and instead the heirs would have had to pay tax on the gain when they sold the inherited asset just like the decedent would have. It is likely Congress will change this to avoid the 2010 carry over basis regime coming into play in 2010. This is huge from an accounting perspective.

4. Probable. Planning now for a couple with a taxable estate (an estate of over $3,500,000 starting in 2009) usually requires the creation of a trust when the first spouse dies. This trust is commonly referred to as a bypass or credit shelter trust and the assets which pass into this trust when the first spouse dies are not included in the estate of the second spouse to die and therefore pass to the heirs of the couple estate tax free. It is likely in 2009 Congress (which is supported by President-elect Obama) will allow the exclusion amount to be “portable.” This means when the first spouse dies the surviving spouse will have a $7,000,000 exclusion amount to use when he or she dies.

Portability of the exclusion will allow the assets to pass to the surviving spouse without the need to set up a bypass trust when the first spouse dies. The exclusion is portable (or transferable) from the first to die to the survivor. The surviving spouse will be able to access the entirety of the couples resources without the need to utilize a bypass trust.

Since 2001 couple clients of our office have overwhelming been using a type of estate plan which incorporates a “disclaimer” estate plan. This plan allows the surviving spouse to accept all of the assets of the first to spouse to die and disclaim only as much as is necessary to insure the surviving spouse does not have assets in his or her estate more than necessary to avoid paying an estate tax. An example, would be a couple with a $5,000,000 estate, divided equally between the husband and spouse. When the first spouse dies with a disclaimer plan in place the survivor would likely “disclaim” $1,500,000, allowing the amount to pass into the bypass trust. The surviving spouse could still use the assets in the bypass trust, but on a limited basis.

It would not be necessary under the concept of portability to create the disclaimer trust. Such an estate plan would likely still work under the concept of portability, without any need to change an existing estate plan for this reason alone.. All assets would pass to the surviving spouse who would then be able to use a $7,000,000 exclusion.

The crystal ball is still a bit murky, but it will likely clear very quickly in 2009. As details of any Democratic plan come forth we will keep you posted.