Most estate planning focuses on pre-death planning - life insurance, wills and trusts, gifting strategies, to name just a few. Because of this focus, few clients comprehend the plethora of planning opportunities that exist after a loved one has passed away. To drive home the importance of post-death planning, it's important to consider the many opportunities that exist.
MORE THAN TAXES
Start with the many non-tax decisions involved in post-death planning. Several of these might be squarely in a financial advisor's purview:
* One of the most important decisions in post-death planning for many clients is determining in which state the client legally lived at death. This could have a profound impact on which laws govern the estate and what, if any, state estate tax will be owed. About 20 states have decoupled their estate-tax systems from the federal estate-tax system; determining whether the dearly departed lived in one of these states might be the sole determining factor in whether any state estate tax is due.
* Selecting which assets to distribute to which trust or beneficiary is vital for many reasons. If certain assets are more likely to appreciate than others, a better choice may be distributing them to trusts that will not be taxed in a surviving spouse's estate, or trusts that will be exempt from the generation-skipping transfer tax. Depending on the financial needs of beneficiaries, it might be best to distribute certain assets or asset classes to them.
From an investment perspective, this might avoid unnecessary transaction costs and quicken distribution time. If a family business is involved, assuring that the interests are distributed to the heirs working in the business might be the most important client goal.
* Compliance with the Prudent Investor Act is obligatory on estates, but many if not most executors and even many estate lawyers view the process as one of liquidation to cash and holding liquid funds to distribute. While in some cases this is optimal, and certainly holding more cash than might otherwise be required is common, liquidation of positions and holding only liquid assets is not always appropriate.
Decisions on what to sell and when should be made not only in the context of an investment analysis, but also in light of the needs of beneficiaries, distribution requirements and estate- tax consequences. While the step-up in basis upon death might eliminate capital gains, it does not eliminate the need for planning. The timing of a sale may fix a valuation for estate-tax purposes, and that needs to be considered in the analysis.
* Funding or not funding trusts is a decision sometimes left to the executor. Similarly, it's up to the beneficiary to decide whether to file a disclaimer declining his or her share of the estate. The combination of funding decisions, disclaimers and other flexible options can provide wiggle room. While this might seem to unravel the client's wishes, it can be used, especially in light of the rapid-fire changes in tax laws and the economic roller coaster of recent years, to reset a plan to what the decedent intended, or even improve the results. If a particular heir is in greater need, others might disclaim, shifting assets to the person in need and avoiding gift taxes. If an heir is in the midst of a divorce or lawsuit, a disclaimer may be a safeguard.
If the mechanism of portability in the 2010 Tax Act is made permanent in 2013, some estates will rely on that in lieu of funding trusts. However, the consensus for most estates is and will remain to fund a bypass or credit shelter trust (see "Wedded Bliss," May 2011).
Many wills have — and more in the future — will use disclaimer bypass trusts. In such cases, the surviving spouse will receive the entire estate outright and what he or she disclaims will pass into a trust for his or her benefit. How much should be disclaimed? Which assets should be used to fund the trust? These are all critical post-death decisions.
For wealthier clients, the more traditional bypass/marital trust plan will remain ubiquitous. In many cases, this will entail at least three trusts:
* A bypass trust up to the state estate-tax exemption ($1 million, for example).
* A trust for the balance of the federal exemption not used in the first trust ($4 million, for example, for a total of $5 million, or the current exemption amount).
* The balance in a marital trust that is generally set up as a qualified terminable interest property trust, which has to pay income to the surviving spouse annually and meet other requirements. Again, how much each trust is to receive, and what assets, are critical post-death decisions.
DEFERRING ESTATE TAXES
If a client's estate is largely illiquid, it might prove impossible to pay the estate tax within nine months of death as required. Several post-death options might be available to the estate. But they all have profound implications on the cash flow analysis.
The IRS may grant an extension under Code Section 6161 if reasonable cause exists to support an extension beyond the due date. The extension cannot exceed 12 months.
In addition, the estate tax attributable to interest in closely held businesses can be paid in from two to 10 installments, and can be deferred for up to four years after the date the tax is due. This break thus provides for up to a 14-year deferral. Note that it is only the estate tax attributable to the family business, not the client's investment portfolio, that can be deferred. If half of the estate is business and half is marketable securities, only half of the tax can be deferred. Qualifying for this deferral can alter the cash flow needs for the estate dramatically.
VALUING ESTATE ASSETS
Assets are generally valued at the date of the decedent's death. However, if the assets have declined in value, and there is a reduction on the estate/generation- skipping tax due, then the executor can choose to value assets at the date six months following death. This is referred to as the alternate valuation date. In turbulent markets, this can be a tax lifesaver.
There are many planning issues and opportunities in post-death valuation planning. Discounts have long been the magic elixir of estate planning, but for many clients what was once an elixir may now prove to be hemlock. If the client's estate is not subject to federal estate tax, the estate-tax reductions traditionally provided by discounts will be irrelevant, yet those discounts will reduce basis step-up and increase future capital gains.
Financial planners should coordinate valuation matters carefully with clients. This is particularly important for family partnerships and limited liability companies with significant security holdings.
Planners also need to be cautious about valuing assets in post-death sales. Courts have held that a post-death sale of a closely held stock position determines the value of the stock on the decedent's estate-tax return. Thus, a decision to sell an asset, or pressure to do so to comply with the Prudent Investor Act, may in fact establish the value of that asset for estate-tax purposes.
As these examples show, tremendous estate-tax planning opportunities exist following a client's death. While pre-death planning remains vital, post-death planning allows for oversights and errors to be corrected - and for new planning opportunities as well.
Martin M. Shenkman, CPA, PFS, JD, is an estate planner in Paramus, N.J. He runs the free legal website laweasy.com.