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An MBJ Analysis

New laws muddle estate (or death) taxes

Estate, or death, taxes cause both financial and emotional issues. On the one hand, taxing a person because they died seems morbid. On the other hand, allowing accumulated wealth to lodge in small family groups generation after generation is considered by some to be un-American.

From the Treasury’s standpoint, the issue is more political than economic since only about 2% of U.S. deaths, or 50,000 estates a year, are subject to the tax anyway.

Primarily due to the hue and cry that arose from tax reformers over the last few years, Congress felt compelled to change the estate tax system last year. Professor Joel Slemrod of the University of Michigan says politicians faced three choices. They were: Live with the estate tax, reform it, or throw it out. Their choice? All three.

Under the new law, the estate tax will gradually diminish until it is repealed for 2010. Then, at midnight on December 31st of that year, it will reappear as if the calendar were turned back to today. Though the estate tax exemption begins its voyage toward temporary obscurity this year, the gift tax does not. The gift tax exemption rises to $1 million and there remains indefinitely. Thus, one may avoid taxation of his estate by dying during the later part of this decade, though he may not give it away tax-free.

What does all this mean for tax planning professionals? To check the pulse of people who make their living in the tax arena, I queried several practitioners and found substantial agreement among the members of the group.

First, no one expects the law to continue in its present form to the point of eliminating estate taxes completely. For example, Ronny Loeb, an attorney with Butler, Snow, O’Mara, Stevens & Cannada, expects that the estate tax exemption will be frozen between $1 million and $2 million sometime during the decade ahead. Jody Varner, an attorney with Brunini, Grantham, Grower and Hewes, puts the likely freeze amount at about $2 million.

Secondly, no one thinks that estate tax planning should be ignored or discontinued. Bill Dossett, attorney with Watkins Ludlam Winter & Stennis, suggests that estate plans need to be reviewed every two to three years since it is unrealistic to draft estate documents today to cover all the possible scenarios that may arise over the decade ahead.

Several of this team of tax professionals warn against leaving wills un-amended that contain bequests defined by the estate tax exemption amount since that amount is scheduled to change each year. For example, Loeb points out that a will leaving the children an amount equal to the estate tax exemption and the remainder of the estate to the spouse could result in the spouse receiving nothing as the exemption amount climbs in years to come.

Life insurance maintained to pay estate taxes is another issue. Walt Dallas, an attorney with Barnes, Broom, Dallas and McLeod, says that life insurance proceeds will be needed for estate liquidity and suggests that clients not cancel existing policies since, under the current law, the estate tax will return at the end of this decade.

Policies, once cancelled, may be difficult to replace if the client’s health has deteriorated. Additionally, Jack Palmer, CPA, with the Horne CPA Group says that surrendering life insurance policies can generate unexpected income taxes.

I also queried the panel on whether making gifts to reduce estate taxes was still valid given the shifting landscape. In general everyone agreed that a gift program makes sense for elderly clients in poor health who are unlikely to survive the decade. Gifts, even taxable gifts, remove the assets and the gift tax from the estate if the client lives at least three years after making the gift.

In addition to removing the gifted assets from the estate, any appreciation in value between the date of the gift and the date of death is likewise outside the reach of the estate tax. Since the gift tax is based on the value of the asset at the date of gift, Varner says that now is a particularly good time to gift securities if you think the economy and the stock market is going to rebound soon. Tax savings would result since the value of the gifted property is less now than it would be later, and thus, the gift tax is lower.

When considering whether to gift or retain assets, don’t forget that the income tax basis does not change for gifted assets like it does for inherited assets. Thus, gifting property passes the eventual capital gains tax liability on to the children or other beneficiary whereas letting the property pass through the estate eliminates capital gains tax.

It was interesting to note the effect of the September 11th terrorist attacks on estate tax planning. Palmer says that the terrorist attack has generated more interest in estate planning from his clients than the new estate tax law. Some clients who had put their estate planning on hold pending passage of the new tax law are now anxious to get a plan in place.

This piece has attempted to simplify, as much as possible, a subject that has always been extremely complicated. The poorly-drafted legislation passed last year only adds confusion to the mix.

Loeb summed it up this way, “The law as it stands today is simply too complicated and is really a disservice to everyone. Our politicians should really be embarrassed that they allowed the 2001 Tax Act to become law.”

Joe D. Jones, CPA, is publisher of the Mississippi Business Journal. Contact him at cpajones@msbusiness.com.

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