Time to Start Talking About Estate Taxes

The golden age of estate taxation may be coming to an end.
Since Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001, many clients have not worried about estate taxes. EGTRRA gradually increased the estate tax exclusion from $675,000 in 2001 to $3.5 million in 2009, and then completely eliminated the estate tax for 2010.
The problem with EGTRRA, however, is its quirky sunset provision. Unless new legislation is enacted, estate taxes return in 2011, with the estate tax exclusion reduced to $1 million.
Over the period since EGTRRA was enacted, many advisers thought that some form of resolution would be reached on the estate tax.
Well, 2011 is fast approaching and we have no resolution yet. Moreover, with the presidential election looming in 2008, it’s unclear which way the tax winds will be blowing between now and 2011.
Because of this uncertain tax climate, you should revisit the estate tax issue with your clients now.
To start the conversation, the first step is to run an estimate of what your client’s estate tax liability would be today and then in 2011.
For 2007, the exclusion amount is $2 million per person.
Basically, clients are subject to a 50% tax on the value of their estates over the exclusion limit.
You may have clients who today have no tax exposure but significant potential exposure in 2011. For instance, a married client with a $4 million estate would have little to no federal estate tax liability in 2007, assuming both spouses were able to use their $2 million exclusion amount. But in 2011, with the exclusion amount dropping to $1 million, the same $4 million estate would be over the limit by $2 million and face about a 50% estate tax liability.
The potential tax bill may come as a surprise to many clients who have not run the numbers in several years.
The second step is to find out whether your clients have current wills and trusts in place. Many clients with significant assets have not reviewed their estate planning documents in years, or even decades, and some still don’t have more than a basic will.
Confronting the possible estate tax exposure may motivate many clients to update their estate-planning documents. At a minimum, your clients should ensure that their documents are current and incorporate the necessary tax provisions to maximize the use of their estate tax exclusions.
Finally, begin a dialogue with the client and the client’s estate planning attorney to investigate more advanced strategies for handling potential taxes in 2011.
The difficulty in taking steps to reduce exposure to the estate tax, however, is that clients are often required to give away ownership or control of assets and that often conflicts with their feelings about preserving assets for retirement purposes.
This is where your expertise can help the client and his or her attorney think through the competing options and financial risks.
Many creative strategies can be used to decrease your client’s tax exposure. These include techniques such as simple annual gifting, advanced trust planning, charitable contributions and private foundations. You may find that a combination of these techniques works best, as clients often have multiple objectives for the disposition of their wealth.
One effective approach that may work for many clients is to consider using an irrevocable life insurance trust to pay for potential estate taxes.
The trust is established to own a life insurance policy on the life of a client or a client and spouse. The trust is structured so that the eventual insurance proceeds are not considered a part of the client’s taxable estate.
The insurance trust is often a good hedge because it is simple, offers flexibility and does not require the client to give up control over significant assets.
The clients can make gifts to the trust to pay the annual insurance premiums, assuming they follow some formalities to preserve the gift status.
The client’s children are generally the beneficiaries of the trust and can use the tax-free insurance proceeds to pay the estate tax.
If no new legislation is enacted, the insurance will provide a source of tax-free funds to help alleviate the estate tax burden. If compromise legislation is later reached, the insurance coverage can be terminated or the face value of the policy can be reduced assuming the estate tax exposure has fallen.
The holidays are a good time to remind your clients about estate planning issues as many clients will be visiting with their adult children, which will give them the opportunity to open a discussion about their legacy planning.
The year 2011 will be before we know it, and your clients will appreciate your proactive approach.