Estate Tax Repeal?   What Do I Do Now?

This is my home on the first day of Spring. Makes one wonder where the center point of spring is. We know it's not Key West or Maine's Fort Kent. Perhaps it's the District of Columbia?

Spring in the Capital usually arrives on time. Legislation, on the other hand, seems to know no season. What blooms in nature we know is beautiful. On the other hand, what blooms in Congress is unpredictable.

For those of us who do Estate Planning, we simply wait. Our clients are waiting as well.

Will the estate tax be repealed?  I don't think so. Will the exemption be increased? Yes.

Increasing the exemption can remove many estates from the tax rolls, thus saving most family farms and closely held businesses from a tax assessment that would jeopardize their future viability, without materially affecting future tax revenues. Repealing the estate tax, on the other hand, would have a negative impact on non-profits and the state tax coffers. Thus, if Congress could control its spending so that the lost revenues* would be matched by decreased expenditures, the non-profits and the states would still be scrambling to secure funding for expenses that simply will not go away.

A study done by PricewaterhouseCoopers found that the repeal of the estate tax would diminish charitable giving through bequests by $3 billion per year. In Vermont, we can only guess at the impact on non-profits.

However, it may be easier to estimate the impact on our own estate tax. Every state has what we call in the trade a "Sponge Tax". This is a tax equal to the credit allowed on the Federal Estate Tax Return for taxes paid the state. Florida, for example, collected $780 million in estate taxes in 2000. In short, this "invisible" tax constitutes revenue sharing. Repeal the estate tax at the federal level and it is automatically repealed at the state level. Now what will the States do to make up for the lost revenue, which is estimated to total $9 billion a year in 2011?

More uncertainty. Should we wait?  In this connection, even the prior bill repealing the estate tax gradually implemented the changes so that death within 10 years could still trigger a tax. You may want to consider using a "disclaimer" as a key component of your estate plan.

Most estate plans for married couples facing a possible estate tax, incorporate a Bypass Trust (a/k/a the "Family Trust", "Trust B", the "Non-Marital" Trust, "Credit-Shelter Trust", and a few other creative titles). The trust is characteristically funded through the use of a formula clause designed to take advantage of the available exemption (currently $675,000 and scheduled to increase periodically so that by 2006 it will rise to $1 million).

If the exemption increases, the formula will adapt and the funding of the trust will usually increase. Consequently, many estate plans now in existence will respond well to an increase in the exemption. On the other hand, they are not designed for a repeal of the estate tax.

If, however, the trust were to be funded by a "disclaimer", the surviving spouse would determine the amount of the funding upon the first spouse's death. If at that time the estate tax has been repealed, the surviving spouse may decide not to fund a trust whose sole purpose is estate tax avoidance.

In many estates, a Bypass Trust serves other useful purposes. Using a trust designed for "disclaimer" is not for everyone. Furthermore, there are some technical requirements that need to be met including a deadline of making the election within nine months from death.

Before talk of repeal, disclaimers had become popular as a result of a need to integrate large IRA's into a plan. Many taxpayers had discovered that their retirement plan had become their most significant asset and they would have to make a choice between estate and income tax savings. Preferring to delay that decision until the latest possible date, they frequently selected their spouse as the primary beneficiary and their trust as secondary. This gave the spouse the ability to disclaim all or part of his or her entitlement if the estate tax savings resulting from the funding of the Bypass Trust outweighed the benefits of tax deferral resulting from an IRA Rollover. Now, more than ever, it is important to consider designing your beneficiary designations to allow for qualified disclaimers.

For more information, please see the following links:

Qualified Disclaimer Trusts
Glossary of Trust Terms

Enjoy the Spring, when and if it arrives. For those of our clients who are still in Florida, please be aware that it is not safe to come back yet.

* The Joint Committee on Taxation estimated the cost of the Bush estate tax repeal to be $236 billion, but this only covered the 9-year period from 2002 - 2010. The Center projected the 2011 cost by increasing the JCT estimate for 2010 ($55.3 billion) by the rate of growth in the economy.

Jack Davidson

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