Financial Planning for June 2001

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No Estate Tax? Really?
It’s official and the current President Bush can indeed say, "Read my lips – NO MORE DEATH TAX."

That’s a great attention getter, but is it really true? Not quite. If you read this month’s tax article, you will note that most of the tax cuts to take effect are phased in over a number of years. Many of them don’t take full effect until 2010. Many of them sunset in 2010. Don’t let this minor little annoyance take you off guard when you begin to plan your tax life over the next few years.

One of the provisions of the new law that will not take effect immediately will be the reduction in estate taxes, so don’t throw out your current estate plan too soon. Despite today’s headlines, there are still solid reasons for estate planning that go beyond saving your estate for your family and continuing to use some of those techniques your advisor told you about.

First of all, realize what today’s income tax cuts really are – opportunities to raise taxes in the future. That isn’t meant to be malicious or provocative, just true.

When President Regan’s tax cut was passed in the early 1980’s, supply side economists expected great dividends for the economy and thus, the federal government. But along with those tax cuts also came a reduction in the number of “tax loopholes.” Then we started having budget problems and tax rates were raised, but the loopholes were not restored. The net effect was an increase in income taxes and the tax burden was ultimately further increased in the late 1980s and the 1990s.

The fact is, Congress makes the tax law. Congress meets regularly and the budget is under constant scrutiny. Tax cuts that are allowed today can just as easily be reversed in the future. Often times, this has the unintended effect of preventing people from making sound planning decisions.

So what are the realities of the new estate tax law? In general, the top tax rate will be reduced from 55% to 45% by the year 2009 and the estate exempt from tax will rise from it’s current $675,000 level to $3,500,000 during the same period. In the year 2010, the tax will be completely obliterated and in the year 2011, they will be restored. This is reason 1 not to abandon estate planning.

Reason 2 for continuing with estate planning is it just makes good business sense and, more importantly, personal sense. With this in mind, let’s take a look at a few of the techniques used prior to the new law and why they may still make sense.

Family Limited Partnerships and Family Limited Liability Companies

If you have a large estate with multiple investment accounts and perhaps various real estate holdings, putting your assets into one or more family partnerships or limited liability companies still can save you and your heirs a lot of headaches. In fact, while these vehicles have been used to effect estate tax savings, the primary purpose for using these entities has always been for business purposes, not tax savings. So bear in mind that the Internal Revenue Code requires a valid business purpose for the formation of those entities.

Placing your liquid assets into one partnership and your high risk assets (real estate) into a limited liability company has the effect of protecting the liquid assets from potential liability claims arising out of the high risk assets.

The fact that the phase-out of the estate tax is gradual means you will still have some level of tax until 2010 and after that one year hiatus, the tax will come back unless the repeal is extended. This means it is still useful to move some of the value from you to your heirs now and in the future.

If, as we would suppose, you value family relationships, utilizing Family LPs and LLCs will minimize disagreements over asset divisions upon your death. This should limit potential family rifts and it's easier to pass partnership units to a new owner than it is to file multiple deeds splitting up inherited real estate.

Finally, if you have real estate holdings in various states, your estate will be subject to probate, and thus various fees, in most if not all of those states. In general, there is no such requirement to pass partnership units from one owner to another.

Planned Giving Trusts

One of the hot topics for nonprofit entities today is to ask donors to place assets in trust for the benefit of the nonprofit entity. This can take the form of a trust where the principle of the trust will go to the charity upon the grantor’s death and the grantor will continue to receive income, or the reverse. If the grantor still wants their heirs to receive a substantial inheritance, insurance trust(s) are established to pass the insurance proceeds to the heirs upon the grantor’s death.

This is still a valid planning means for several financial planning ends. First, in the case of providing a legacy to the heirs, the insurance will still go to those heirs. Meanwhile, the grantor can benefit the desired charities and get a current tax deduction for the donation. Even if there are no heirs to receive legacies, it still makes sense for the grantors to receive a current income tax deduction for the value of the charitable contribution. The joy of giving is lost if one is dead.

Bypass Trusts

Bypass trusts are used to allow married couples to take the full value of the estate exemptions. For example, in 2002, the estate exemption will be $1 million. For a married couple, it will be $2 million. If a spouse dies and leaves everything to the surviving spouse, the ultimate effect will be to limit the estate exemption to $1 million.

Thus, bypass trusts were devised to put the first $1 million (or the amount of the estate exemption) into a trust of which the survivor was the trustee. While the heirs are the principle beneficiaries, the spouse still receives the income and thus, effectively receives the use of the assets until death. When the second spouse dies, the trust is not part of their estate since they never owned the principle, or had the right to the principle. This preserves the exemption amount for both spouses.


Whether or not you believe the estate or death tax will ultimately ride into the sunset, the mere fact that its gradual repeal sunsets on December 31, 2010 dictates you continue to employ solid financial planning techniques to eliminate potential death taxes down the road. Coupled with the non-tax benefits derived from the use of various planning techniques there is a strong case for continued use of trusts and other business entities for tax planning. Once the President has signed the new tax law, let’s sit down and revisit your current estate plan and be certain you’ve taken all the necessary steps to protect yourself and your family now, and in the future.

Have a great June.


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