There has never been a time of greater uncertainty about the estate tax. As this article goes to press in early November, it is impossible to know if legislation will be passed after the November elections clarifying or dramatically changing the estate planning landscape. If Congress does nothing, the estate tax will come back on Jan. 1, 2011, with a $1 million exemption and a 55% tax rate.
Whatever the result, as the estate planning environment evolves, planners should make a concerted effort to communicate with clients and help them assess planning. Because of the tremendous volatility, special or different forms of communication might be helpful to focus clients. Consider postcards, special newsletters and other means of communicating. Perhaps bullet lists of action ideas might engage clients. Don't rely only on email, as many clients may simply overlook it.
Most clients are not planning; instead they remain frozen, waiting for the tax laws to be clarified. But when certainty comes, it will likely bring with it fewer planning options. Consider informing your clients about the following issues:
* Roth IRAs. Presumably you've already had discussions about converting (or not) with clients, and for the appropriate clients, the conversion has been completed. But don't stop there. Encourage clients to update their powers of attorney, expressly authorizing agents to recharacterize and sign new beneficiary designations.
* IRAs. The stepchild of planning remains a great asset-protection play, even when they are nondeductible. Whatever happens to the tax laws, for many clients maxing out IRAs, even nondeductible ones, is a good move.
* Elder/infirm abuse. This problem continues to grow. Properly completed living trusts, powers of attorney, living wills and health proxies are a key protection. Too many clients have ignored their declining health and other issues. Even clients who are reluctant to address tax planning should not overlook estate planning basics.
* Titling. Titling of assets needs to be monitored and restructured to reflect changing tax laws (repeal and carryover basis) and changing exclusion amounts (2009=$3.5 million; 2010= zero; 2011=$1 million). Because of dramatic fluctuations in asset values, clients heading into 2011 should review how assets are owned and how those assets are divided between husband and wife. Clients with fewer assets, anticipating the 2009 $3.5 million exclusion and repeal of the estate tax, may not have evaluated asset ownership in many years. But with a mere $1 million exclusion on the books for 2011, this could be critical for them to address.
* Insurance. Review all insurance coverage. Update for changes in asset value (market meltdown) and the roller-coaster estate-tax rules. Clients who have ignored planning should at a minimum ensure that their insurance is properly structured (e.g., owned by a trust, sufficient to address estate tax costs with the possibility of a $1 million exclusion, etc.).
Insurance can sometimes offer a practical stopgap measure while the tax laws are in flux. For example: If you are uncertain whether the estate-tax exclusion will be $1 million or $5 million, consider two $1 million convertible term insurance policies big enough to cover estate taxes if the exclusion remains $1 million. When Congress finalizes estate- tax legislation, one or both policies can be converted or dropped.
* Buyouts. Buyout formulas in buy-sell and shareholder agreements need to be reviewed in light of recent income tax incentives. What impact will the increased Code Section 179 deduction and bonus depreciation have on calculations of amounts due? If your client's business purchases equipment, it would generally have to depreciate it over a number of years, but Code Section 179 may permit the business to deduct the entire cost in the year of purchase. The maximum amount of permissible deductions was increased retroactively to $500,000 for 2010 and 2011.
* Dividends. Before year-end, take a look at whether clients with closely held businesses should pay extra dividends. If these dividends will be taxed at a 15% rate in 2010, paying them now may prove to be a bargain if rates rise to ordinary income tax rates in 2011. Before paying dividends on a closely held business, encourage clients to consult with their corporate attorneys to assure that they give formal notice of annual meetings and have minutes formally declaring the dividends. Be sure they review shareholder agreements to make sure it is permissible to pay extra dividends.
* Bonuses. Bonus payments before year-end may become common for closely held businesses if the threat of income tax increases grows. Before clients pursue this strategy, they need to consider more than just income taxes. What will the impact be on trusts as economic value is shifted back to the senior family member's estate? Worse, if the IRS views payment of new bonuses as proof that the senior family member is retaining control over income, the entire estate plan could be jeopardized.
* Selling. A client should evaluate the sale of real estate, family partnerships and business interests to tax-oriented trusts while values remain depressed, interest rates are low and discounts on noncontrolling interests are still permitted under the tax laws. While you've heard this mantra repeatedly, too few clients have moved.
* Disclaimer generation-skipping trust (GST) planning. This may be another option to consider in the waning days of 2010. Clients may be able to transfer assets to a carefully crafted trust that is structured to permit a beneficiary, such as a child (not a grandchild or other "skip-person" who would trigger GST tax) to disclaim. If the beneficiary disclaims, assets transfer into a GST-exempt trust. If the beneficiary does not disclaim, assets stay in a nonexempt trust for non-skip persons. This plan could provide the client with a nine-month period into 2011 to make a decision as to which is the best approach.
* Basis allocation traps. These traps exist for 2010 decedents. Code Section 754 permits partners (and members in limited liability companies [LLCs] taxed as partnerships) to adjust their income tax basis when a partner dies. This can be a significant tax benefit. However, getting the entity to make these adjustments is not automatic under many partnership and LLC operating agreements. So before your client's estate allocates the $1.3 million or $3 million spousal basis adjustments under the new 2010 rules, be sure the entity will step up the inside basis, otherwise the allocation may be wasted. This is important to wealth managers because if basis cannot be allocated to partnerships, it may be allocated to securities.
* Annual gifts. They are under increasing attack by the IRS. The courts, in a number of cases, have gotten tough on the ability to qualify gifts of entity interests to the children for the annual $13,000 exclusion. Is it worth the headache versus a cash gift? If your clients are going to use this approach, they need to be sure that the legal documents governing the entity give the recipients reasonable rights to realize the value of those entity interests currently.
With time slipping away in 2010, planners are under the gun to make sure their clients are well positioned whatever estate planning environment next year brings. Whether the estate tax remains at zero, reverts to its pre-Bush levels, or is restored to something in between, your clients must have a plan in place that benefits them and their heirs.
Martin M. Shenkman, CPA, MBA, PFS, JD, is an estate planner in Paramus, N.J. He sponsors the Law Made Easy website at www.laweasy.com.