Estate Planning: It’s Not Over
Given the results of last November’s election, a repeal of the federal estate tax is now a distinct possibility faced by an entire generation of people who, only a few months ago, were planning for potential increases to the tax. President Donald Trump and several other prominent government officials have called for a complete repeal of the so-called federal “death tax,” which, aside from 2010, has been in place for about a century.
Given the apparent consensus within the majority party about repealing the estate tax, many people are understandably wondering whether traditional “estate planning” will become a thing of the past. This is a reasonable question, but, for a variety of important reasons discussed below, the answer is a resounding “no”—estate planning will continue to be an integral part of the financial planning process for the foreseeable future.
1. The Uncertain Timing Of The Repeal
Even if a complete repeal is enacted and signed into law, the timing of any such repeal remains uncertain at best. For budgetary, political and procedural reasons, among others, the effective date of any repeal could be delayed, staged over time or even made contingent on factors such as the budget. The uncertain timing could force an exercise in planning for multiple potential repeal scenarios.
2. Impermanence Of The Repeal
Because the Democrats continue to possess sufficient votes in the U.S. Senate to sustain a filibuster, the Republican majority might be forced to use a procedural technicality called “reconciliation” to pass a repeal of the estate tax. If such a procedure is used, then under another technicality the repeal effectively may be limited to only 10 years.
And regardless of how repeal happens, there’s no assurance that a future Congress would not undo it. One needs only look at what is happening right now to the Affordable Care Act.
3. The Disguised Estate Tax
If the estate tax is repealed, it is likely that the current “basis step-up” associated with the tax will also be repealed. Currently, when an individual dies, the cost basis in his or her assets generally is adjusted to the fair market value of those assets on the date of death. This means that any appreciation on those assets typically escapes capital gains taxation. Many planning professionals believe that if the estate tax is repealed, one of two outcomes can be expected with respect to the basis step-up. First, the heirs/beneficiaries might be required to inherit the assets with a “carryover basis” equal to the lesser of fair market value or the decedent’s basis. Second, the heirs might be allowed to receive the assets with a stepped-up basis, but only after any built-in appreciation is first automatically subjected to capital gains taxation upon the decedent’s passing. Statements by the Trump administration have suggested it leans toward the latter approach. In either case, while the estate tax may be repealed, there likely would be additional capital gains taxes imposed at some point on the assets, effectively amounting to a disguised or substitute estate tax.
4. Gift Taxes
While there currently is no clear plan for how the federal estate tax would be repealed, it would likely not be accompanied by a repeal of the federal gift tax. The repeal of gift taxes would be highly complicated, as it would allow individuals to shift the ownership of assets in ways that might produce unintended results. For example, the federal government likely would not want to allow a parent to transfer assets to a child so that the child could sell them and pay capital gains taxes at a lower rate, only to turn around and then transfer the sale proceeds right back to the parent. For this reason, gift taxes are likely to remain for the foreseeable future. Alternatively, a structure such as the one used in Canada, which creates a deemed sale on transfers between taxpayers (other than spouses), could be implemented.
It is also not clear whether the generation-skipping transfer tax (GST) would be repealed along with the estate tax. Like the gift tax, it could be retained, at least in part.
5. State Taxes
Keep in mind also that we have been discussing only the possible repeal of the federal estate tax. Many states also impose inheritance taxes, which still require planning and attention. Even people living in states without their own estate taxes must be careful, as some states have become quite aggressive about imposing the taxes on individuals who don’t claim residency with them but otherwise have substantial connections. At a minimum, these states are likely to impose estate taxes on non-residents who, when they died, owned real and other physical property that fell under the states’ jurisdiction.
6. General Need For A Will
Importantly, despite all of these things, estate planning has never been just about mitigating taxes. A carefully conceived and drafted will is necessary for:
• Providing for the pre-planned distribution of assets upon death, including for the support of dependents and other heirs and beneficiaries;
• Providing for an executor to manage the estate;
• Appointing guardians for dependents; and
• Funding trusts to manage and distribute assets to heirs and beneficiaries.
None of these critical matters become less important merely because a federal estate tax is no longer imposed!
7. Avoiding Probate
Another important goal of estate planning is to avoid the delays and expenses associated with moving an estate through the probate process. Avoiding probate usually involves some combination of:
• Funding of revocable trusts;
• Making lifetime gifts;
• Establishing accounts that are “payable on death”; and
• Titling assets before death so that, when appropriate, they are held under designations such as “tenants by the entirety” or “joint tenants with right of survivorship.”
Again, these considerations will remain important even in the absence of an estate tax.
8. Beneficiary Designations
Estate taxes and probate courts aside, any estate planning exercise is incomplete if beneficiary provisions have not been reviewed and updated under the relevant wills and trusts and for all retirement accounts (IRAs and qualified retirement plans) and life insurance policies. Over the course of a lifetime, people often forget who their designated beneficiaries are and fail to update them despite changes precipitated by marriage, divorce, births, deaths and other events.
9. Health-Care Proxies And Durable Powers Of Attorney
A “health-care proxy” or “living will” remains as important as ever because people are living longer and because medical treatments have become more impactful and complex. These simple documents are essential for ensuring that a person and the individuals selected by that person can determine what medical treatments will be administered—or will not be—in the event of a medical emergency or crisis.
Like a health-care proxy, a “durable power of attorney” allows a person to decide in advance who will make important decisions if the person becomes incapacitated in the future. They function alongside health-care proxies to ensure that all decisions, even before an individual dies, are made by people trusted and carefully appointed by him or her.
10. Use Of Trusts And Other Vehicles To Sustain And Distribute Wealth
While the tax impact of trusts, family limited liability companies, family limited partnerships and other classic estate planning vehicles would be lessened with a repeal of the federal estate tax, these important structures nevertheless would remain relevant.
At a minimum, they enable people to sustain, manage and gradually distribute their wealth on an intergenerational level, allowing them to create lasting legacies and sustain the people and causes they care about most. These structures can also protect assets for future generations and even provide some state income tax savings opportunities.
Some have argued that a repeal of the federal estate tax will diminish the incentive for people to distribute their wealth to charities. This may prove to be true, but regardless of the tax benefits associated with transferring wealth to charities, many will want their philanthropic work to continue, even after they die. Philanthropic planning has always been an integral consideration during the estate planning process, and it will remain an integral consideration in the future.
Lastly, effective estate planning must always involve an educational process—not only for the subjects of the plan but for their families and loved ones. It is an opportunity not only to discuss finances but also to solidify shared values, address family issues and set a course for a lasting legacy.
Financial planners, lawyers, accountants and other advisors sometimes overemphasize the value of mitigating the federal estate tax when engaging in estate planning for their clients. This is understandable, as the estate tax savings associated with effective planning can be substantial. In the end, however, the federal estate tax is only one consideration among many in the estate planning process. Its potential repeal therefore will not diminish the importance of prudent, comprehensive estate planning.