Should Estate Planning Ever Be Put On Hold Because of Potential Estate Tax Changes?

Tax reform proposals slowly are being developed in Congress, including changes in the estate tax. People are asking, “Should I delay my Estate Planning until the new law is clear?”

We’ve been down this road before, and the answer is: You shouldn’t delay.

Congress is looking at changing only the federal estate and gift taxes, not the rest of estate planning. For most people, those taxes now aren’t relevant, because of the high exemption amount. The main change being discussed is to exempt even more people, probably to the extent of repealing the estate tax.

Of course, it’s far from a sure thing the estate tax will be repealed.

Even if the estate tax is repealed, the timing is unclear. Another uncertainty is how long a repeal would be in effect. A change in control of Congress easily could result in a return of the estate tax within a few years. Also, as with the last time a major change was made, a sunset provision probably will take effect after 10 years.

The details of repeal also are up in the air.

Traditionally, we’ve had what is called the unified estate and gift tax. The two taxes (estate and gift) have the same exemptions and tax rates. Taxpayers have a lifetime estate and gift tax credit, not just an estate tax credit. Lifetime gifts above the annual exempt amount reduce the lifetime credit, so a lower credit is available to the estate.

Also, a major feature of the current law is that after property is inherited, the beneficiary increases the tax basis to its current fair market value, which is known as a stepped-up basis. Appreciation during the deceased’s ownership period avoids any capital gains tax.

The proposals discussed the most would do away with stepped-up basis. In one widely discussed proposal, the beneficiary would inherit the asset and take the same basis the deceased had. That one is known as the carryover basis.

In a second widely discussed proposal, the estate effectively would have to pay capital gains taxes as though the asset were sold on the date of death, and the beneficiary would take the asset with a stepped-up basis.

Also, it is likely the gift tax would remain even if the estate tax is repealed. The generation-skipping tax also might remain.

So, what’s a person to do about estate planning in the face of this uncertainty?

Those who currently aren’t exempt from the estate tax probably face the biggest dilemma. Ironically, it likely is best for them to go ahead with estate tax reduction strategies. Under current law, they can remove assets from their estates through gifts and transfers. The beneficiaries generally would take a carryover basis in the properties and owe capital gains taxes when the property is sold. Importantly, future appreciation would be out of the estate.

But if these wealthy individuals wait until the estate tax is changed, the assets might be locked in their estates. They might owe gift tax if they try to transfer the assets under the new law, and their estates might owe capital gains taxes on the assets they retain. They couldn’t shift future appreciation out of their estates without paying a tax first. You are likely to have more options, flexibility and lower costs by acting now than by waiting for a new law to be enacted.

More importantly, as I’ve stressed before, taxes should be only a small part of estate planning for everyone. The nontax elements of estate planning are more important and shouldn’t be delayed. Most parts of the estate plan are to protect assets from waste, mismanagement, conflict and other forms of leakage.

Traditional estate planning will continue as in the past, and you shouldn’t delay taking action because of some uncertainty over the tax law. Use this checklist to work with your estate planner.

Flexibility.

Many estate planning actions can be revised or changed later, so you aren’t locked in if the law changes. Also, many of the inflexible strategies aren’t done primarily for tax reasons, so there’s no reason to delay them.

Even inflexible strategies, such as creating irrevocable trusts, often can be structured to adapt to changing circumstances. There can be a trust provision that allows you to swap assets with the trust, as long as they are of equal value. The trustee also can be empowered to make loans of trust cash or assets to you.

The trustee can have the power to “decant” the trust. When the trust’s terms aren’t optimum, because of changes in the law or circumstances, a new trust with different terms can be created, and the assets can be moved from the old trust to the new trust.

You also can create the role of trust protector. This person oversees the trust and can make changes such as removing a trustee, moving the trust to a new state, and more.

Rather than delaying an estate plan, discuss with your planner ways to keep some flexibility in case the tax law changes.

Avoiding probate.

Some states have streamlined probate processes, so avoiding probate isn’t a big deal. But other states have slow, expensive probate processes, and it’s important to avoid probate as much as possible.

Don’t delay actions to avoid probate simply because there’s uncertainty about the tax law. Decide which assets should avoid probate and how to do it. You can avoid probate through a range of tools: living trusts, joint ownership of property, transfer on death (TOD) accounts, annuities, life insurance and more.

The will.

The estate and gift taxes don’t have much influence on the key elements of the will, so don’t delay having your will written or updated.

You need an executor (or group of executors) to manage the estate, put it through the probate process and eventually distribute the assets according to the terms of your will.

The will, of course, states how the assets are to be distributed among the objects of your affection. It also should appoint a guardian for any dependents you have. The will might create one or more trusts and also direct which assets will be transferred to any trusts you have.

Powers of attorney.

You need these documents before you have a will, because you’re likely to become disabled or need help managing affairs before you pass away.

There are two main types of power of attorney (POA).

You need a financial POA designating one or more people to pay your bills, manage investments and handle other financial matters when you aren’t able. The need might be temporary, or it might be long term. You can create a general durable power of attorney enabling the person (or persons) to take any actions that need to be taken. Or you can limit the scope of authority a person has. Limiting the scope of a POA takes the risk that an unanticipated action needs to be taken but no one legally is authorized to act.

A health care POA is the second document. There are several variations, also known as health care proxies, living wills and advance medical directives. The document designates one or more people to make medical decisions when you aren’t able to, usually in the case of a medical emergency or crisis.

Beneficiary designations.

Some assets aren’t affected by the terms of your will. They avoid probate, and ownership by automatic operation of law to the person named in the beneficiary designation form or ownership document. Your will comes into play only if you failed to name a beneficiary or named your estate.

IRAs and other qualified retirement plans usually are the most important and valuable assets in this category. When you want the next generation of owners to benefit from the tax deferral, it’s important to name individuals as beneficiaries. If you name your estate or fail to name a beneficiary, the IRA will have to be distributed and taxed within five years.

Life insurance policies and annuities also have beneficiary designations. Even some obscure assets, such as credit card points, sometimes allow a beneficiary to be named.

There’s no reason to delay a beneficiary review or change. Too many people fail to update beneficiary designations. Some of their assets go to people they didn’t intend, and the heirs waste assets fighting over them in court.

Digital assets.

The law slowly is evolving in this area, but you need to take action.

First, you need to compile a list of your digital assets: social media sites, other websites, email addresses and any others you might have. The list should include the address or other identifier, plus the access information such as username and password.

Third, make a list of any automatic payments you set up to have amounts automatically charged to a payment card or deducted from a financial account. Provide all the details about the account and how to access it. Your executor has to ensure payments are made and eventually cease.

Philanthropy.

While some people argue that major tax reform will reduce charitable giving, I’m skeptical. I believe most people make charitable contributions with little tax motivation and structure gifts to maximize tax benefits after deciding how much to give.

If that describes you, then you’ll want to plan charitable giving without waiting for the tax law to settle. The earlier you begin planning, the more choices you’ll have in structuring direct gifts of cash or property, charitable gift annuities, charitable remainder trusts, charitable lead trusts and other strategies.

Education.

Perhaps the most neglected area of estate planning is to educate and inform the beneficiaries of the estate. Loved ones need to know the basics of your estate and the plan for it.

Don’t wait for Congress. Make your plan and take actions now.