Estate Tax Planning
January 4, 2010
For years we have helped our clients reduce their estate tax. As we contemplate the fate of the estate tax law, a common view is that a married couple will have a credit equivalent of $7 million. Many of our clients are able to avoid the federal estate tax that previously saw “no escape.” So do our clients no longer need tax help with estate planning? NOT!
With this environment in mind, I recommend CPAs approach clients and essentially reverse engineer their previous estate tax plans in some areas. Thinking backwards from previous strategies will likely be required. I will give you a few “suggestions” to illustrate the point of this article and you can “take it from there.”
Problem: Clients have documents that were drafted years ago. Many have only had a minimal review, if any, since they were executed.
Recommendation: A “document checkup” is in order. I have found numerous examples of old formulas or trust language that need to be changed.
Example: Five years ago your client with assets of $4 million (total net value then and now) was comfortable with giving $1 million to the children (the then credit equivalent) by way of a family trust. The document included an “all the tax law allows” formula going to children with remainder going to the spouse. Client dies in 2009 and the family finds out that the “formula” in the will now gives $3.5 million to his children and $500,000 to his spouse. Surprise!
These documents could have been reviewed and this problem avoided. It is a good idea to have the client’s lawyer review these documents periodically.
Problem: Years ago the object of estate planning was to reduce or eliminate estate tax at all cost. Clients assume if you don’t expect an estate tax, then planning is not valuable.
Recommendation: Income tax planning strategies for estate planning can save huge dollars. With many middle-sized estates “out of the reach” of the federal estate tax, a wise advisor should focus on income tax strategies in the estate plan. Looking at the whole family and the combined tax burden often can be used to re-engineer the income tax results for large savings.
Example: It is not unusual to find parents with modest taxable income and large medical deductions. They often have retirement plan accounts. Consider converting small portions of the retirement account to a ROTH every year. This would completely use the zero-bracket and maybe the 15-percent bracket. Taking a few dollars down every year can really add up especially if children are in higher tax brackets! Consider the income tax impact of any assets in the hands of the beneficiary. If parents or children have charitable giving commitments, leaving dollars in an individual retirement account (IRA) to a charity will avoid income tax on assets that might otherwise have gone to tax-paying beneficiaries. You should consider both the parents charitable plan as well as the children. A large pledge by a child could be better satisfied by the parent’s IRA than other assets of the child. A planning tip could be as simple as naming the charity as secondary beneficiary and allowing the child to disclaim the desired amount to be delivered to the charity. Digging into the next generation is like mining for gold!
Problem: Clients have spent years with strategies to reduce asset values for estate planning. Estate tax is, after all, based on the value of the assets.
Recommendation: Time to reverse engineer the estate plan. The expanded credit equivalent amount of $7 million creates a wasted income tax opportunity with step up in basis. Years ago you may have suggested a strategy of asset ownership such as a family limited partnership (FLP) to assist your client with multiple family goals which include a value discount for an interest in the partnership (due to valuation discounts for marketability, control, etc.). For every dollar the estate value is reduced, the income tax basis step up would also be lower. For most clients, the reverse logic is now appropriate.
Example: Years ago the XYZ family partnership was formed and funded with real estate properties as underlying assets. Gifts of interests in the partnerships have been previously made. Currently no one person has a controlling interest. The original intended result is to have all gifts and all remaining interests owned by parents eligible for discounting. Consider reverse engineering the plan to eliminate discounts. The new goal is an increased stepped up basis for income tax. Dissolving the partnership could be an example of a strategy to eliminate any discount. This results in the parents owning their interest outright avoiding the possible discount to their basis.
Often parent’s interest when taken individually are a non-controlling interest (say 35% each) but when added together are controlling (70%). Planning often dictates separating each spouse’s estate (perhaps in revocable trusts) to keep the integrity of the non-controlling interest. This situation could now be reverse engineered to create a non discounted interest to increase income tax basis.
Problem: Transient clients who move between states (or countries).
Recommendation: The state of residence is important for estate planning. Often documents and planning are done while resident of a state that is no longer the client’s state of residence. Clients should review estate plans for residency sensitive issues which could include any unwanted state tax result. Many states have eliminated estate and inheritance tax. However, states remain that impose tax on estates at asset levels below the federal tax free level.
Schedule meetings often with your clients to review their estates. You will often need to change planning strategies that were appropriate only a few years ago. Your focus may need to include income-tax planning. I have found most CPAs who serve individual tax clients are financial planners (whether they admit it or not). These reviews always lead to other discussions in nontax areas of personal financial planning (PFP). I am sure when you put your mind to it you can find many ways to add significant value to your clients with reverse engineering!
The mini-estate review can be value added work any time of the year. I will share with you a foolproof value added service I use with my clients. I make a list of items to watch for during tax return season that can be implemented in summer months. Many of these ideas come from the AICPA’s Advanced PFP Conference in January and talking to fellow CPAs who work in financial planning in attendance at the conference. I find the conference programs are a great source for keeping my list (and knowledge) cutting edge and practical. In meetings with clients during tax season I mention items on the list to find their level of interest and usually get a green light to cover this “after-tax season.” I make appointments with each client later in the year. These discussions about my list lead to ways I can help with their list. And helping clients with their concerns is what this is all about!
Lawrence W. McKoy, CPA, PFS, CFP is a senior tax partner in the firm Goodman & Company LLP. He serves on the AICPA Tax Executive Committee and the AICPA Advanced PFP Conference Committee. The AICPA PFP Section provides information, tools, advocacy and guidance to CPAs who specialize in providing tax, retirement, estate, risk management and investment advice to individuals and their closely held entities. All members of the AICPA are eligible to join the PFP section. For CPAs who want to demonstrate their expertise in this subject matter apply to become a PFS Credential holder.