• We would see if congress would enact some form of legislation?
• And if so, what level of exemption and tax rates?
• And would it be retroactive to January 1?
• And if they don’t do the above, is the current law’s $1 million dollar exemptions and 55% estate tax rates really going to become reality (again)?

Actually, when it comes to estate planning, we have been living with uncertainty and/or a rapidly changing landscape for arguably the last 20 years. We just didn’t always realize it. We’ve gone from exemptions….the amount that one can pass estate tax free to heirs at death…of $600,000 to $3.5 million in less than 20 years, in the period from 1990 through 2009. Top marginal tax rates went from 55% (actually, 60% for some estates) down to 45%, to now, during 2010, 0%.

In 2001, congress passed the current law (EGTRRA), in which exemptions and rates were set on a schedule to change every couple of years, over a 10 year period, and then go away for one year, only to return, in 2011, to the level at which they began.

Since 2001, the professional community….financial planners, attorneys and accountants and others…have been appealing to congress for legislation that would provide some degree of stability, so that our clients could find some level of certainty in which to plan, in a world where it seems the only certainty is change.

But, think about this. Even if congress were to pass a new law tomorrow, how long do you really think the tax rates and exemptions would last before a new law changed all that? A decade? One administration change in Washington (4-8 years)?

I, for one, have come to believe that the estate planning community needs to embrace change as a constant, particularly due to the fact that for most clients, the planning horizon for their estates is fairly long. Many couples in their 70’s, who are in reasonable health, are looking at joint lifespans of 20 to 25 years or more. Couples in their 60’s are looking at 30+ years of joint lifespan. Keep in mind; it’s not the law in effect when you plan. It’s the law in effect when you die that dictates the exemptions and tax rates.

So, how do we do that?

Use history as your guide… with recent history being the most relevant. Top marginal tax rates in the various estate tax bills that have seen, however briefly, the light of day in the past 3 or 4 years have ranged between 35% (paired with the $5 million exemption), 45% (paired with the $3.5 million exemption) and 55%, coupled with the $1 million exemption. Of these rates, the one with the least amount of support has been the 35% level. The 55% rate is the current law that’s scheduled to go into effect in January of 2011. And, the 45% rate is the 2009 tax rate that just expired, and the level which has had the most support in congress. So, clearly, the most likely estate tax rates have been 45% and 55%.

So, I would propose this: In planning for the future, why not run estate tax projections at the two most likely exemptions, $1 million, and $3.5 million, and split the difference on the tax rates, and assume 50%. For a married couple, the taxable range for estates would then run between $2 million and $7 million. So, estates between these two levels would need to make a decision about how conservative or aggressive an assumption to make about the future. A conservative approach would suggest planning for a taxable estate above $2 million ($1 million each per spouse). An aggressive approach would suggest a belief that exemptions would remain at or above $3.5 million per spouse, or $7 million per couple.

The difference in tax between the top and bottom levels is $2.5 million for a married couple or $1.25 million for unmarried individuals. A conservative approach would be to plan for gifting and wealth preservation strategies, including life insurance that would cover the higher tax under the lower exemption. The worst case? “Too much” cash in an estate.

Aggressive planning would suggest planning for the higher exemptions, and, if incorrect, heirs would inherit as much as about $2.5 million less after estate taxes.

Special care would need to be taken with estates that are illiquid, as guessing wrong about exemptions, and creating a liquidity crisis could trigger a “fire sale” of assets in order to meet the tax burden.

Let’s be clear: this type of planning is far from perfect, just like the world we live in. But, given the historical changes that we have had over the past 10 to 20 years, it just might be the most practical.

If you would like to discuss this in more detail, please contact a member of your service team or Chris Redhead at credhead@redheadfinancial.com

Sources:
www.irs.gov
Tax Foundation-January 1994:
A History and Overview of Estate Taxes in the United States, by: Patrick Fleenor; Staff Economist

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