How to plan for a higher estate tax
John F. Wasik is a Reuters columnist and author of The Audacity of Help. The opinions expressed are his own.
The estate tax is in limbo this year, so if you are looking at a significant inheritance, death may pay some dividends.
As a vestige of the 2001 tax act, the so-called “death” tax disappeared this year, although convoluted rules on valuing estate assets often resulted in higher income taxes. With other issues such as the global financial meltdown, a recession, health care and financial reform dogging it, Congress didn’t get around to fixing the estate levy.
Don’t get any ideas. Death and taxes will still have a sting … eventually. Congress will likely do something about the tax before the end of the year – probably after the November election – so don’t count on a free ride. You’ll still need to do some cautionary estate planning.
While no one knows what Congress will do, it’s a fairly sure bet the tax will return in some form next year. Record budget deficits mean Congress will be looking for revenue sources. Unless Washington acts, the tax will jump back to the old, pre-Bush-era 55% rate, with a $1 million exemption in 2011. That’s quite a hike considering that last year, when the tax was still in effect, you could get a $3.5 million break per person at a top rate of 45%.
There’s little question that the estate tax and related rules are extremely complicated. An overhaul would require a comprehensive look at the myriad trusts and other vehicles used to reduce tax liability.
One of the biggest unanswered questions is whether the new tax – and I predict one is coming – will be retroactive. If we’re still mired in a downturn, I don’t foresee any Draconian tax changes. Congress usually opts for “grandfathering” (extending) a tax break into the past rather than imposing a huge, new tax.
In the interim, prepare for the coming estate-tax changes with some basic planning. Don’t wait for Congress to make up its mind.
• Talk to an estate planning attorney and fee-only financial planner. Do you have a basic estate plan or living will that tells loved ones what to do if you’re seriously impaired? Do you have directions as to what to do with assets upon your demise?
• A living trust may be a better vehicle if you have a sizable estate, but they are complicated and need to be planned carefully. Beware of “trust farms” that try to rush you into boilerplate vehicles. It took my wife and I one year to design our trust.
• Have you looked at life insurance planning with your adviser? Remember, life insurance proceeds are still tax-free to beneficiaries, and it’s unlikely they will be taxed any time soon.
• Did you want to set aside money for charities? Have you considered charitable remainder trusts for this purpose? Donations can be gifted in any number of ways to reduce future tax liability.
• If you need to fund college savings vehicles, you can contribute to 529 plans to reduce the size of your estate.
One proposal that passed the House would have made last year’s estate tax levels permanent, although it failed to pass the Senate.
When it takes up the issue again, it’s possible that Congress will tier the tax depending on the size of the estate. For example, an estate valued at less than $5 million may be subject to a 45% tax with 5-percentage point tax increases for each $5 million in estate value capped at a maximum 55% rate.
There’s also a pressing question as to what kinds of exemptions Congress will allow before the tax kicks in. One House proposal called for $2 million to pass from one spouse to another, meaning that $4 million per couple may be exempt.
Whatever you do, don’t wait until the end of the year. Talk to your trusted advisers now. Like the false demise of a certain American writer, rumors of the death of the estate tax are greatly exaggerated.