Change In Estate Tax Should Result In New Tax Planning Concepts

By Richard S. Lehman, Esq., principal of Richard S. Lehman P.A.; Boca Raton, FL
Posted: January 11, 2002
South Florida Business Journal

A previous article discussed the major changes in the Estate tax law for 2001 and a major tax trap that could negatively effect surviving spouses. This second article will discuss the tax planning concepts that will frame our minds for dealing with the new bill.

As mentioned in the first article, estate planning documents must take into consideration the possibility that there may or may not be a full repeal of the estate tax. If one is not going to continually revise one's will or trust, new wills and trusts should include alternate clauses; one governing the situation if the estate tax remains after 2010; the other governing the consequences of a repeal. It may be these written documents will need a descriptive narrative spelling out the testator's intent.

Next, estate planners will need to focus much more on the effect of gifts in the overall plan. Whereas in the past gift giving made tax sense for several reasons, particularly in the case of a family business, this may change under the new law which increasingly permits more and more to be excluded from the estate tax while placing a $1,000,000 cap on the amount of gifts that may be given free of tax. Gifting will become expensive tax wise as compared to no estate tax. Because of this, the $10,000 annual exclusion which has not been repealed will be a tool that should find an expanding use. Since the total gift tax Exclusion Amount is limited to $1,000,000 per donor; donors will want to make sure that gifted property is that which will have the most opportunity for appreciation post gift.

There will be a significant emphasis on "indirect gifting" by those motivated to move wealth to the next generation sooner rather than later. This will involve creative uses of long term loans, trusts and other entities to make sure that when "gift like" transfers are made; they will not be considered completed gifts for tax purposes.

Furthermore, the estate planning tools that have been used to minimize the amount of a gift to a beneficiary will become even more valuable planning tools for those wishing to pass wealth to younger generations. Traditional estate planning tool such as private annuities, grantor retained annuity trusts, family limited partnerships, self canceling installment notes, and the like will continue to be viable ways to minimize the gift tax. In many of these situations however, good estate tax planning might turn out to be a serious income tax mistake if repeal actually occurs and the "carryover basis" rules described later apply for income tax purposes.

Life insurance will continue to be a key element for estate tax planning purposes for several reasons; first because of the possibility that repeal may not ultimately occur and there still will be estate taxes to pay. Secondly, there will still be significant taxes as a result of death because of the state death taxes that may very well increase; and the income taxes that will result to beneficiaries because inherited property will have the decedent's original basis for purposes of calculating taxable gain on a sale. There will also be new life insurance products. Some might consider decreasing term coverage until repeal, but care should be taken to provide for conversion to permanent coverage in the event repeal does not occur.

One will also need to start planning for an income tax change that will only occur if there is repeal. Presently, the "stepped up basis rules" apply to property inherited from a decedent. These rules provide that a beneficiary's basis for income tax purposes in inherited property is equal to the fair market value as of the date of death. In a typical situation where property acquired from a decedent has increased in value during the decedent's life this rule allows the recipient of the property to avoid income tax on gain incurred on that property. The new rules change this and instead provide for a "carryover basis" which generally require the recipient of inherited property to receive the same cost basis in inherited property as the decedent's basis. This will result in significant income taxes on the sale of inherited property that has increased in value during the decedent's life.

There are relief provisions that reduce the income tax exposure on appreciated property inherited from a decedent. Every estate may "step up" the basis for property distributed to beneficiaries by an amount equal to $1,300,000; and surviving spouses will be able to increase their basis in inherited property by an additional $3,000,000. These "step ups" in basis will result in the need to carefully allocate basis to specific assets as part of post mortem tax planning. In the event the estate tax is repealed and the carry over basis rules come into effect, one will immediately need to consider techniques to avoid the consequences of the carry over basis rules of which there seem to be plenty.

The new law will put special burdens on all of the professionals in this field including lawyers, accountants, trust officers, insurance people, financial planners and a host of others. There will be a need to estate tax plan in the midst of ever changing exclusions, rates and basis rules over the next nine years; only to eventually wind up back to where we are today. This will create a great need for coordination among all of the clients' professionals in a cooperative multi disciplinary endeavor.

At the same time professionals need to be aware that the new law has traps that are ripe for malpractice. Among others, the unstudied use of existing formula clauses may do a grave injustice to a decedent's intent under the new law.

Richard S. Lehman, Esq. (LL.M in Taxation) is the managing partner in the Boca Raton law firm of Richard S. Lehman P.A. The firm specializes in tax law focusing on tax and asset protection planning, document drafting and litigation strategy in the areas of income, estate, trust taxation and probate litigation. Contact him at (561) 368-1113

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Richard S. Lehman

* Georgetown University J.D.
* New York University L.L.M. Tax
* Law Clerk to the Honorable William M. Fay – U.S. Tax Court
* Senior Attorney, Interpretive Division, Chief Counsel’s office, Internal Revenue Service
* Author: “Federal Estate Taxation of Non-Resident Aliens,” Florida Bar Journal
* Contributing Author and Editor: International Business and Investment Opportunities” Florida Department of Commerce, Division of Economic Development, Bureau of International Development (translated in German, Spanish, and Japanese)