Brown & Associates - Attorneys & Counselors at Law, P.L.L.C.

CONGRESS REPEALS DEATH TAX(?)--PART IV
(7/15/01)

Okay, already. You think you're tired of taxes. Think about me. I have to study this stuff so I can try to explain it to you. I've had a headache for about four weeks now.

Seriously, if you have stuck with me up to now, I am really impressed. This isn't the most dynamic topic I can think of, it just happens to be the one that clients and friends keep asking me about. I'm not sure how much longer I'll continue beating the tax drum. I suppose you'll tell me if you're tired of it and if so, I'll move on.

For now, let me talk about some ways to bring certainty to an uncertain estate planning environment. Last week I talked a bit about the use of disclaimers. Before you consider including disclaimers in your estate planning, I suppose I should tell you what they are. Essentially, a disclaimer is nothing more than saying, "Joe left me his 1946 Ford Pickup, but I really don't need it--I think I'll let the estate keep it and give it to someone who really needs it."

When you do this, the law acts as if you have died and the gift will then go to whomever is named next in the trust or will. You can disclaim everything that was left to you, or just some of the property. The procedures aren't complicated, but they are technical and there are certain forms which you will have to complete in order to make the disclaimer effective.

Remember, it is absolutely critical that whatever plan you come up with be designed to meet your wants and needs. Everyone is different. While disclaimers offer flexibility which is key in this period of uncertainty, there are still going to be times when you don't want to offer this option.

You may want to provide for mandatory, rather than disclaimer, funding, but only if it is necessary to avoid or minimize estate tax or if the reason for the funding is something other than tax avoidance.

Do you foresee any other changes in estate planning?

Yes I do. I think that more married couples are going to take advantage of joint revocable trusts if they don't have to worry about the tax consequences. They are easier to manage, much like holding assets in joint tenancy, and can be combined with the right to disclaim to a credit shelter trust if needed. It is easy to equalize each spouse's share of the estate since each owns one-half of the joint trust. If they buy something or inherit something from someone else, they just title it in the name of the joint trust and, voila, their estates are still equal.

Anything else?

I've been talking with other estate planners and we all agree you are going to see fewer irrevocable trusts in the future, with the possible exception of the irrevocable life insurance trust.

The reason for this is that most clients are going to think carefully before permanently relinquishing control of some of their property. They are going to be more thoughtful in considering alternatives since, if they live until full repeal of the estate tax, they wouldn't have had to give up control of their property to avoid estate tax. Since many people with estates of this size are self-made, they aren't going to be too keen on giving away anything, especially control of their property, unless it is absolutely necessary.

Irrevocable life insurance trusts (ILITs), on the other hand, will likely become more popular, especially as the estate tax is drawing down. Until it is fully repealed, some tax planning will still be necessary.An ILIT provides a means by which a taxpayer can ensure there are sufficient funds to pay whatever taxes might be due without his family having to sell the family farm.

ILIT's can be funded with term or other insurance and when the insurance is no longer needed, the client just lets the policy lapse. Also, many states allow you to revoke your irrevocable trust if you, the trustee(s), and all beneficiaries agree. Some allow you to buy the life insurance from the ILIT for fair market value, or to transfer other assets or cash to the trust in exchange for the insurance policy. In any event, an irrevocable life insurance trust isn't as irrevocable as a "real" irrevocable trust and it may well serve a useful purpose during the 2001 to 2010 phase-out period.

You mentioned that you think lifetime gifting is going to decrease. Why?

I think this is a given. As I have noted previously, once the federal estate tax is fully repealed (if it happens), there won't be any benefit to making gifts to remove assets from your taxable estate. In fact, since the amount you can gift tax free will be far less than the amount you can pass to your beneficiaries at your death, you risk incurring unnecessary tax if you give away property while you're alive.

On the other hand, there may be times when it will still be advantageous (or at least not disadvantageous) to give property away. For example, if you have more assets than you can qualify for the step up in basis (a maximum of $4.3 million if you remember my discussion from a couple of weeks back), there isn't any reason to keep those assets until you die. If you decide to give some of this property away, though, be sure you get rid of your assets with the highest basis, while keeping those with a low basis that will be able to benefit from the basis step-up.

How will these changes effect the family owned business?

That's a good question. For one thing, after December 31, 2003 when the federal estate tax exemption increases to $1.5 million, which is more than the $1.3 million Qualified Family Owned Business Interest Deduction (or QFOBI), the QFOBI rules will be repealed.

In the past, people have been hesitant to apply for the QFOBI deduction because it included recapture provisions which could generate taxes far in excess of the business's value for family members who acquired a family business and then failed to meet the statutory requirements. The higher federal estate tax exemption will remove this threat of recapture tax while protecting up to $1.5 million of the business's value.

That's all for this week. Next week I'll talk about the effect of the Tax Relief Act on the states and a few remaining issues for businesses and certain individuals, such as those in second marriages. Hope to see you then.

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