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Build Flexibility Into Estate Plan


June 8, 2006

Read Time

4 minutes


By Tara Siegel Bernard
A Dow Jones Newswires Column


NEW YORK (Dow Jones) – With scrapping the estate tax now off the table, and Congress working to ease the so-called death tax burden for the wealthy, investors should dust off their estate plans and ensure it can bend with evolving legislation.

Estate planning attorneys are advising individuals to draft or revise these plans so they include flexible clauses – if they're not already in place – that can adjust with changes to the federal estate tax laws. Affluent families should also be cognizant of their home state's estate tax rules because even if federal exemption amounts were increased, they still need to plan around certain state laws that'll continue to ensnare taxpayers with smaller estates.

On Thursday, Senate Republicans lost a vote to proceed towards legislation that would permanently repeal the estate tax. While those efforts were largely viewed as a political statement – not many were counting on a repeal given its costs – the focus is now shifting towards a compromise which could boost the exemption from the tax and lower the tax rates.

In 2001, the Bush administration enacted a law in to temporarily phase out the federal estate tax. Currently, $2 million of an estate is exempt, although individuals can typically leave everything to a spouse tax-free, with the remainder taxed at rates as high as 46%. The tax is scheduled to disappear in 2010; in 2011, the law expires and the rate reverts back to 55%.

"The lesson for us has been we need to have a great amount of flexibility in a client's estate plan to take in account that those rules might change in the next couple of years," says Robert Alan Romanoff, partner and head of the asset planning and preservation group at Chicago law firm Levenfeld Pearlstein LLC.

For instance, he says one couple's plan dictates that the estate tax exemption amount – currently $2 million – should be transferred to their children upon the first's spouses death, with the remainder going to the surviving spouse. However, to avoid having too much going to the children should the exemption amount rise, they put a cap in place.

That would help avoid problems under, for instance, a proposal set forth by Sen. Jon Kyl, R-Ariz. His plan would exempt the first $5 million of a person's estate, or $10 million a couple. Estates between $5 million and $30 million would pay capital gains tax rates, currently 15%, while estates greater than $30 million would be taxed at 30% rate.

"Wills or trusts written (before the 2001 tax changes) should be updated, even if the law doesn't change at all," adds Ralph Engel, a partner with Sonnenschein Nath & Rosenthal LLP's trust and estates practice in New York. He suggests revisiting your estate plan every five years to be sure it's up to date.

The estate planning set also needs to review their state estate tax laws when crafting a plan, as tax differences among the states are becoming more pronounced. In light of federal tax-law changes made in 2001, about 18 states and Washington, D.C., have started to impose their own estate tax on top of the federal estate tax. In some states, the state exemption is much lower than the federal, meaning that people could be hit with state estate taxes even if they escape the federal levy.

For instance, while the federal exemption may stand at $2 million today, it's only $675,000 in New Jersey. Given escalating real estate values, one can see how even a workaday middle-class family could become entangled. In New York, the state exemption stands at $1 million and the tax rate ranges from 6.4% to a whopping 16%. So for someone with a $2 million estate – which equates to a $1 million taxable estate – heirs would pay tax of $99,600 to New York, while ducking federal tax, calculates Sonnenschein's Engel. Move to Greenwich, Conn., and no tax would be owed because the exemption is $2 million.

Another thing to keep in mind: There's speculation in estate planning circles that a popular strategy – utilizing the grantor retained annuity trust, or GRAT – could become less attractive, to help make up for revenue lost on lowering estate tax rates or increasing the exemption amount. Currently, GRATs, with certain caveats, allow you to give heirs large gifts while paying little or no gift taxes.

Some estate planners have heard that estate tax legislation could rewrite the GRAT rules so that "some gift tax would have to be paid, or (gift tax) exemption used," explains Len Adler, a J.P. Morgan Private Bank wealth adviser based in Palm Beach, Fla.

If that were to happen, he said, GRATs would no longer be a "no lose" proposition.

Adds Levenfeld's Romanoff, "It's entirely possible that techniques that work well today might be changed. I am speaking with clients about doing GRATs now before any (potential) change in legislation."

(Tara Siegel Bernard is one of five Getting Personal columnists who write about personal-finance issues ranging from new tax proposals to education-funding strategies to estate planning.)

-By Tara Siegel Bernard, Dow Jones Newswires; 

Filed under: Trusts & Estates

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