Firm Publications

Advanced Planning for the Large Estate

By Randell C. Doane, Esq. and Rebecca G. Doane, Esq., published in the Palm Beach Daily News, January 8, 2006

With Congressional repeal of the “death tax” highly unlikely and any other significant relief appearing remote, owners of larger estates should explore again the tax reduction options available to them.

The estate tax is like a chameleon, constantly changing its appearance and sometimes even seeming to fade away. In 2006, estates in excess of $2 million will be subject to a tax rate of 46 percent. That $2 million exemption will increase to $3.5 million starting in 2009, and in 2010 the tax will actually disappear. Unfortunately, the tax will reappear in 2011, with only a $1 million exemption and with a maximum rate of 55 percent.

For the last several years, Congress had promised to reform the “death tax” and even held out the possibility that it might be permanently eliminated. A few months ago, many commentators were convinced we would at least receive a much larger exemption, possibly in the range of $10 million to $20 million.

Most recently, though, the hope for meaningful relief has faded away. Those Senators who previously were the strongest proponents of elimination are now talking about “partial elimination” and most experts now believe we will end up with a permanent exemption in the range of $3 million to $5 million and a modest reduction in the tax rate.

Advanced estate planning is primarily concerned with reducing estate taxes on larger estates. Other goals – such as avoiding probate, better protecting inheritances from future divorces and lawsuits and helping assure that family wealth will remain in the family – may also involve advanced planning. However, since the estate tax can consume more than half of a large estate, the primary focus of advanced planning is usually on reduction or avoidance of the estate tax.

During the last couple of years, the implementation of many planning techniques was often postponed in the hope that the tax would be eliminated. Now that the complete repeal of the “death tax” is highly unlikely, and even the possibility of significant relief appears remote, it is time for the owners of larger estates to explore again the tax reduction options available in their particular situation. Although there is still some uncertainty in the future tax landscape, further delay in advanced planning can be costly for at least two reasons.

The first problem with delay has to do with the passage of time. The benefit to be derived from many planning techniques can only be derived over a number of years. One example is family limited partnerships (FLPs). Immediately upon implementation, the FLP will usually provide some reduction in the taxable value of the estate. However, much more of the tax reduction benefit will usually be achieved as a result of future appreciation in value of the partnership assets occurring outside of the taxable estate. Therefore, the sooner the partnership is established and the longer it can remain in place, the greater the benefit to be received.

Other popular planning strategies, such as grantor retained annuity trusts (GRATs) and qualified personal residence trusts (QPRTs) also require the passage of considerable time to be fully effective. Some techniques, such as private annuities (Pas), require implementation months or years before death and therefore should be considered sooner rather than later.

There is a second problem with postponement of planning. The Congressional Joint Committee on Taxation recently issued a report suggesting the passage of new laws designed to limit or curtail the use of many of the popular and most useful planning opportunities. That raises the specter of a most unpleasant situation where we are afforded only modest estate tax relief and some of our most productive tax reduction strategies are no longer available. Many owners of larger estates are moving to implement planning techniques now with the expectation that their planning measures will be grandfathered.

In some situations, the implementation of certain planning strategies can require the current payment of gift tax as a price for receiving a much greater reduction in the estate tax. Although we usually strive to defer the payment of taxes, the voluntary payment of the gift tax may be appropriate where it will result in an estate tax savings many times greater than the gift tax paid. Although substantial estate tax relief for larger estates now seems highly doubtful, some experts still hold out a glimmer of hope.

Accordingly, we would usually advise against a strategy that would require the payment of gift tax until we are absolutely certain the estate tax will not be repealed. Meanwhile, many of the most useful and beneficial techniques do not involve the payment of gift taxes and those methods should be explored at this time.

The estate tax chameleon continually changes colors and disappears and reappears (and has done so since 1913). However, that is not the reason to defer intelligent planning. Instead, the ever-changing rules add to the importance of taking affirmative action. Many planning methods are available in this changing environment that will significantly reduce the cost of the estate tax regardless of what the final rules turn out to be.