Count Down to 2013

Uncertainty Requires Flexibility In Estate Planning

By Scott Malin

Mr. Malin is a Partner with Lathrop & Gage, in the St. Louis office and is a member of the wealth strategies practice area. He can be contacted at [email protected] or 314.613.2807

In the world of estate planning, the last ten years have been a roller coaster ride. The estate tax exemption has ranged from $1 million to $5 million, with no estate tax at all for the year 2010, and the estate tax rates have ranged from 35% to 55%. After the estate tax was repealed for one year in 2010, the IRS had to spend an inordinate amount of time to publish regulations to deal with this one year anomaly, which of course were not issued until well into 2011.

The current law provides for a $5 million estate tax exemption, a $5 million gift tax exemption and a 35% estate and gift tax rate. Of course these rules are in place only until the end of 2012, at which time they are scheduled to ‘sunset’. If Congress does not take action prior to January 1, 2013, the estate and gift tax exemptions will return to $1 million, and the estate tax rates will return to a range of 41% to 55%.

Although most people think it is unlikely that Congress will allow the estate tax to return to the 2001 levels, most people did not expect Congress to allow the estate tax to be repealed for one year in 2010, or to raise the gift tax exemption to $5 million for 2011 and 2012.

In addition to the rapidly changing estate tax laws, the volatility of the stock market and the depressed value of real estate have made planning very difficult.

As an example of this difficulty, historically it was important to fund the revocable trusts of both a husband and wife in order to utilize both of their estate tax exemptions. If assets were titled in joint names and passed to the spouse upon the death of the first spouse, all of the assets would end up in the spouse’s estate for estate tax purposes, and some or all of the estate tax exemption of the first spouse to die would be wasted. In 2010 Congress passed a new law referred to as ‘portability,’ which allows a husband and wife to use two estate tax exemptions regardless of which spouse owns the assets. However, this law is also set to expire at the end of 2012. Therefore, the funding of revocable trusts is still necessary to insure the use of both estate tax exemptions after 2012.

If an estate consists of mostly illiquid assets, a forced sale in a depressed market can reduce the value of the assets available to fund the distributions and pay the estate expenses.

In addition, the significant swings in the stock market along with the drop in the values of real estate necessitate regular reviews of the titling of assets to insure that both a husband and wife have sufficient assets in their revocable trusts to utilize both estate tax exemptions. Further, with the exemption having increased to $5 million in 2011, high net worth families need to make sure the assets held in their revocable trusts are sufficient to utilize the current estate tax exemption.

A second issue relates to the ‘equalization’ of assets. Often, in planning an individual’s estate, a couple will leave certain assets to one child (e.g., the child active in the family business receives the business), and other assets (usually liquid assets) to the children not active in the family business. With the volatility of the stock market, liquid assets may no longer sufficient to equalize for the illiquid assets. At the same time, the value that an individual intended to pass to the active child through a business or the ownership of real estate may now be significantly less than it was at the time the estate plan was developed.

The depressed real estate values may also raise an issue with respect to cash flow. Often times cash is needed to pay specific bequests, expenses or taxes. If an estate consists of mostly illiquid assets, a forced sale in a depressed market can reduce the value of the assets available to fund the distributions and pay the estate expenses.

There are also many opportunities for planning in the current environment. Interest rates are at an all time low, the values of real estate and other assets are relatively low, and the gift tax exemption is $5 million for the first time in history. Taking these factors into account makes this an opportune time for estate planning. There are several planning techniques that utilize the low interest rates to reduce estate taxes and effectively ‘freeze’ the current depressed values of property for estate tax purposes.

In this volatile environment, the most important things to remember are to maintain flexibility in your estate plan to and be sure that your estate plan is reviewed on a regular basis. The flexibility is critical to avoid getting locked into a decision that looks good today but does not make for a happy client a few years from now when assets, values, cash flow or tax laws have changed. Nobody can predict the future, and Congress has proven that, so the key to estate planning in this environment is careful planning, flexibility and regular reviews.