By Scott Keffer
Don’t you just hate it! You were told it would be done in two days, but it took four. They said it would cost under $1,000, but now it’s almost $2,000. They said, “You’ll only be on hold for a minute,” but here you are ten minutes later. Over-promised and under-delivered—over and over and over again, we are forced to accept it.
Well, it happened again.
We were promised estate tax repeal. The unfortunate reality is that the hope of estate tax repeal has been dealt a severe blow by the latest political maneuver called HR 1836. Far from “repealing” or “abolishing” the estate tax, this latest legislation is a clever bit of political marketing designed to disguise the fact that estate tax repeal occurs for only one year, and in that year, it is actually replaced by the capital gains tax!
You may have seen a review of the bill, but just in case, let’s look at it very quickly. The bill creates three distinct periods of estate tax law during the next 20 years—how’s that for simplification? By examining the three distinct periods, it becomes clear that this bill provides no lasting relief from estate taxes:
The lengthy phase-in period. Between 2002 and 2009, the maximum estate tax rate slowly reduces from 55 to 45 percent. The five-percent surtax rate paid on assets valued between $10 and $17.184 million is eliminated.
The amount that can pass tax-free at death will increase in 2002 and 2003 to $1 million; in 2004 and 2005 to $1.5 million; in 2006 through 2008 to $2 million; and in 2009 to $3.5 million. In 2004, HR 1836 makes one further change to the exemption levels by repealing the family-owned business deduction.
The momentary repeal/tax substitution. In year 2010, the bill provides a momentary estate tax repeal by eliminating the tax for one year. However, the estate tax will be replaced with the capital gains tax by eliminating the stepped-up basis. In the 1970s, Congress passed a very similar repeal, but it changed its mind even before the repeal became effective. Their reasoning: taxing capital gains at death was administratively impossible.
Reinstatement of present law. Beginning in year 2011, estate tax law reverts back to present law, as if there had never been a change.
Warning: your current estate plan may now be obsolete! Therefore, it is crucial that you get a second opinion of your estate plan. History has proven that the only way to reduce capital gains and income taxes, and eliminate estate taxes, is to use the same time-tested strategies that the mega-wealthy have been using for almost a century.
Dr. Harold Moon, and his wife Maria, had both worked very hard to build a family and a practice. They were comfortable as “empty nesters” and were happy to have their five children educated and married. Somewhat surprisingly, their wealth had grown to over $4,000,000, with $2,000,000 of that in retirement plans. They felt very good about that, but if they were honest, they would agree that they didn’t have financial peace of mind.
Maria’s lunch with her friend Julie made her increasingly more convinced that they needed to address this area of their life. Julie talked about a process that she and her husband, also a doctor, had been through. It focused on their dreams first, by helping them discover what they wanted their wealth to do for them. Then, it helped them incorporate tools, tactics and strategies to reduce and eliminate taxes.
“Bud!” That’s what Maria always called Harold when she was serious about something. “We need to go through the process that Julie told me about.”
“We’ve already been through financial and estate planning,” he retorted. Maria continued at her normal rapid fire pace, “But do we know what happens under our current plan? How long can we keep spending what we’re spending? Have we done everything we can to reduce income and capital gains taxes? Are we paying any estate taxes under our current plan?”
Harold sat silent, just staring of the window. He was trained to always have an answer, but in this case, he didn’t. Worse yet, they were all good questions—ones that he had asked himself many times before—and he didn’t have the answers. This was really hard for him.
“Had they really done all that they could do to protect their wealth?” he wondered. The only thing that became clear was that whatever they had been doing, it wasn’t working.
Someone once said, “Insanity is doing the same thing you have always done and expecting different results.” Einstein said it a different way: “The problems we face today can’t be solved at the same level of thinking we were at when we created them.” An old southern philosopher said it even simpler: “The horse is dead. It’s time to dismount!”
So, Harold and Maria agreed to go through the process.
First, they were taken through a discovery session, which resulted in a set of written documents: a vision statement, a list of priorities and measurable financial goals. Frankly, Harold had thought it was foolish to spend so much time “discovering” what they really wanted their wealth to do. However, he had to admit the result was extraordinary. He had a new clarity about what he wanted, like he had never known before. And, he and Maria were in sync, like they had never been before.
Next, a test of his current plan yielded a list of critical issues that they were unaware of. It surprised Harold that there were so many gaps and inconsistencies in his current plan. One of the most startling: over $1,350,000 of his $2,000,000 in retirement assets would be lost to taxes when they passed to their heirs.
It also showed them that they had $1,000,000 of “surplus wealth” in their profit sharing plan. It was money they would never need for their own lifestyle, and would only be worth less than $300,000 to their children when they both passed away.
“So, how do we fix this situation?” he asked. He was shocked to find out that there are 104 tools, tactics, strategies, options and opportunities available to reduce and eliminate taxes, and that the answer was a comprehensive, integrated plan that typically combines four to eight of them in the most advantageous way.
Their integrated plan had six of the 104. Let’s look at the one designed to deal with the surplus retirement assets. The strategy is a discounting strategy. The concept is to remove the surplus monies from the retirement plan and then transfer them out of the estate into an estate tax free environment by discounting the monies for income and gift tax purposes.
Step one was to discount the income tax due on the $1,000,000 withdrawal from the profit sharing plan. Harold was excited about the fact that the income tax could be discounted anywhere from 60 to 75 percent through the use of a valuation tool, saving him over $250,000 in income taxes. Then the monies would be transferred to a Heritage Trust, again with a discounted value for gift tax purposes.
A Heritage Trust is a foundational legal tool in multi-generational wealth planning. It is a trust designed to preserve family values and protect family wealth from estate taxes for three generations or more. It provides protection against loss as a result of divorce, creditors, lawsuits and other potential financial misfortunes. These trusts, which are irrevocable, can provide benefits for the life of your children, their future spouses if you choose, all of your grandchildren and even your great grandchildren.
The results for them: the entire $4,000,000 to their heirs, $0 to estate taxes, and $1,000,000 to their favorite charities, which for them was a family-controlled charitable entity. Harold actually felt over-delivered, extremely satisfied that he was able to use the same time-tested strategies that the mega-wealthy have been using for almost a century, to avoid over $1,600,000 in taxes.
Between now and the year 2010, there will be five congressional elections and two presidential elections. Do you care to entrust your financial future and the future of your heirs to the ever-changing currents of political Washington? Do you want more promises—or real results?
Scott Keffer is president and founder of Wealth Transfer Solutions, Inc., a legacy planning company in Pittsburgh.