How our Estate Tax System Survives Everything
But estate tax is over—right?
For the past couple of years I have been asked countless questions about estate tax repeal.
Everyone knows that President Bush made the elimination of so-called death taxes the first priority of his administration, and a law to address the issue passed in 2000.
But for most estate owners, the low’s impact on multigenerational planning remains cloudy. With the confusion, the two questions I hear the most are ,
Will there be estate tax repeal or not?
What decisions are ahead—either way?
So, let me share some personal perspectives and outline how multigenerational planning has changed for businesses and the families who own them.
They tax me. They tax me not.
Before 2000, US wealth transfer taxes were repealed four different times—1802, 1870, 1895, and 1902
But in the same period wealth transfer taxes were enacted five times—1797, 1864, 1894, 1898, and 1916.
What are the lessons of history and math?
If there is always one more enactment than repeal, then it stands to reason that estate taxes will always be with us.
From 1916 to 2000, we had one estate tax law that Congress put through many makeovers and facelifts resulting in gaps, overlaps, and contradictions. Their handiwork turned estate tax planning into both science and art—far beyond most taxpayers.
Now comes 2000, when current estate tax was incrementally reduced until repeal in 2010. But, staying with the idea that there is always one more enactment than repeal, the law calls for the return of the pre-2000 estate tax system in 2011.
What are the lessons for your estate plan?
There is good news—sort of. You can guarantee no estate taxes for your heirs, but you have to die in 2010. If you want a longer lifespan, then your estate plan has to respond to three different estate tax situations.
1. Estate tax phase-out—until 2010
2. Estate tax repeal—during 2010
3. Estate tax comeback—beyond 2010
A law as bewildering as this one is usually due to politics—trying to please everybody while pleasing nobody. And politics are even less likely to disappear than estate taxes.
Tax-free wealth? Not likely!
The 2011 sunset provision provides a hedge against unforeseen revenue shortfalls. After all, no one can reasonably predict economic conditions ten years in advance—and these first two years have been enough of a shock.
If economic conditions support repeal, then Congress can and likely will extend repeal before the sun sets. A big if—but assume it happens and 2011 rolls around with no estate tax. You can transfer assets tax free—right?
What about your capital gains exposure?
Estate tax law has protected transferred assets from capital gains tax. Highly appreciated family assets sold during your lifetime are subject to substantial capital gains. But for estate tax purposes assets are valued at the time of death, effectively erasing that growth.
With repeal that protection comes to an end, and those capital gains—excluding a tax-free amount—will fall upon your heirs when they ultimately sell inherited assets. So there will be a new—and possibly more expensive—tax on multigenerational wealth.
What about your new estate tax exposure?
The second threat to multigenerational wealth transfer comes from state governments. The federal estate tax does not all go to the federal government. A healthy portion is allocated to the states in which estate owners reside.
Right now state governments can ill-afford the loss, and some are initiating state estate tax laws to replace them. Ironically, the first state to enact an estate tax law was President Bush’s home state, which has substantially improved upon the deal it used to have with federal estate tax law.
Estate tax is not the real issue.
So, if you thought the new estate tax law would simplify your planning—it’s wishful thinking. But to make tax planning the basis of estate planning is the wrong approach.
The concept of an ideal plan remains simple. The ideal estate plan assures that your assets will go to the right people at the right time and in the right manner. And there is no mention of estate tax law in that statement. Estate tax planning is only one element of the getting the right assets to the right people at the right time and in the right manner.
In my experience every family has unique financial and personal circumstances. They have their own philosophy about the stewardship of multigenerational wealth and the family’s responsibility to use their wealth to benefit the larger community. All these factors are more critical than tax law to creating a plan for the growth, security, and continuity of your family’s wealth.
Such a plan draws on diverse expertise from several professional disciplines. All of them come together with knowledge, insight, and communication skill to design and implement a plan that will last for generations.
The Economic Growth and Tax Relief Reconciliation Act of 2001 brings new complexities, but it does not alter the issues or the planning process.
Besides, before 2010 rolls around there will be multiple congressional elections and at least one administration change—enough for plenty of tinkering with tax law. But even that tinkering will not alter the fundamental goals of affluent families.
You decide your own real issues.
The best plan starts with the best questions—questions that challenge assumptions and reexamine past decisions. Here are ten questions to start the process on your own.
Do you have a solid concept of the right amount of inheritance to protect your children’s future yet still energize their ambitions?
How important a goal is the stewardship of family assets, and are your children and grandchildren prepared for that role?
How well does your current plan address the differences in your children’s abilities, aspirations, and circumstances in relation to the legacy you want them all to receive?
How important is a tradition of philanthropy in the goals you envision for multigenerational family wealth?
How have economic downturn and slow recovery affected the value of the assets you intend as a legacy for the next generations?
Have you prepared for special needs of family members, and can you assure control over money will be aligned with control over needs?
Have you envisioned your own future medical and elderly care and created financial resources to meet the need?
If you own a business, will estate tax law changes adversely affect your plan for future transition of ownership and control?
Your estate plan may feel secure, but could planning strategies of key shareholders in the business pose future problems for your family?
Are you tracking life insurance company ratings to make certain your coverage will remain intact no matter where transfer taxes end up?
Estate plans and businesses
Backers of estate tax repeal cite dire statistics on the demise of family businesses and farms. I can cast estate tax as a villain in the wealth transfer story, too, but that doesn’t make planning business continuity around future tax liability is complete or reliable.
Managing risk and opportunity
Business continuity planning tends to start with negative what-if scenarios involving the loss of key shareholders or key employees. But beyond defensive necessities like funded buy-sell and key-person agreements, a sound continuity plan opens a range of long term opportunities—like financing for growth, more favorable client or vendor relationships, more flexibility for rewarding your key people. For a family business the assurance of continuity comes from integrating your business vision with your estate planning goals.
The vision thing again
The traditional vision is to transfer ownership and control from founder to family successor either during lifetime or afterwards. In contrast, one vision common to today’s economic changes looks at the business as a strategic family asset. As it grows the business can be merged with a strategic partner, acquired by an institution, taken public, or bought out by management. Then the asset is reinvested in the next entrepreneurial enterprise, continuing the pattern over generations.
Either way there are complex ownership, management, finance, and tax considerations to plan—not to mention family psychology. But all of them can be planned and must be planned if your own vision is to become a multigenerational reality.
Estate plans and insurance
For affluent families, estate planning and life insurance planning typically come together for funding estate tax liabilities, but there are additional reasons applications that make life insurance integral to estate planning.
If estate tax is repealed
The rallying cry of estate tax repeal has been preventing the breakup of family business. But equally important is preserving large inherited assets that cannot be divided among heirs. Most commonly, when there are other shareholders in a family business or when active heirs are to share the business with passive heirs, life insurance provides liquidity that can mean the difference between family legacy and family feud.
If estate tax is transformed
The transformation of estate taxes into other forms of tax still means a portion of your estate will go to the government. These changes may require radically different planning strategies, but life insurance will still provide funds that your heirs would otherwise have to come up with to meet tax liabilities.
If estate tax returns
There are only three options to pay estate taxes. Your heirs could sacrifice family assets, or they might finance the payment with substantial interest. But life insurance generally proves the lowest cost option by providing a tax-advantaged fund.
You should evaluate current policies and companies to determine their suitability and performance in each of the potential tax scenarios ahead. The return of estate taxes will not be a threat if policies remain in effect.
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