If these higher tax rates return in
2011, they will create significant liquidity
problems for many clients. Planners need
to start raising these issues with today. What happens if the clienclients t is inca-
pacitated between now and 2011, or
becomes uninsurable?
Es t ate Taxes
Treatment of insurance
Clients who decide to buy
additional life insurance
to cover this contingency
should consider placing the
insurance in an irrevocable
life insurance trust (ILIT) to keep
the death proceeds outside their tax-
able estate. Because of the current legislative uncertainty, it may be appropriate to adopt contingency formulas
in the insurance trust to provide for
passage of assets in various scenarios.
For example, if insurance is held in
an ILIT but is unnecessary to provide
estate-tax liquidity to the estate, a
formula provision in the ILIT or the
will could pass assets to the client’s
favorite charity. Prudent planners
seeking flexibility should also include
limited powers of appointment in
virtually every ILIT.
Many clients have estates, including
life insurance, in the range of $1 million to $2 million. Many planners have
advised clients that given a federal
estate-tax exemption of $2 million
to $3.5 million each ($4 million to
$7 million collectively for a couple), they
did not need to place their life insurance
in an ILIT because the individual estate
tax exemption and/or the joint exemption
of the married couple would produce a
nontaxable estate. However, a return to
a $1 million estate-tax exemption could
mean that many clients will have a taxable
estate, with the result that 41 percent to
55 percent of the insurance proceeds
could be lost to federal estate taxes.
If a client is going to move an
existing life insurance policy out
of a taxable estate by 2011, the
three-year look-back provisions
of Section 2035(a) mean that the
transfer should occur at least three
years before the beginning of 2011.
That date, Jan. 1, 2008, has already
passed. Even so, clients would be
wise to make transfers sooner rather
than later, to start running the three-year deadline.
Qualified retirement assets
With the higher exemptions and rules
permitting nonspousal heirs to make
withdrawals from inherited IRAs and
retirement plans over their lifetimes,
many estate plans have provided
that the retirement plan will pass
to younger family members to take
advantage of their longer life expectancy while passing other assets to a
surviving spouse.
What happens if the reduced exemption causes the retirement assets
to be taxable? Assume a client in a
second marriage had a $1.5 million
IRA and $2 million in other assets.
Under his current plan, the IRA
passes to his children from a prior
marriage while the $2 million is held
in a QTIP trust for his current wife. If
he dies in 2009, no estate tax would
be due, assuming his spouse survives
him. On the other hand, if the client
dies after 2010, a federal estate tax of
approximately $200,000 could apply
to the transfer of the IRA to the children. If the children withdraw funds
from the IRA to pay the $200,000 in
estate taxes, they will create a taxable
income of $200,000. If the children
then withdraw additional sums from
the IRA to pay the income taxes, they
will incur additional income taxes.
Each withdrawal from the IRA to pay
tax will create a new tax. The plan
should be revised either to:
■
Reduce the IRA bequest to the
available exemption
■
Pass other assets (e.g., a life insur-
ance policy) to the children to pay
the estate-tax liability
■
Or pass nonIRA assets to the children, while passing the IRA to the
surviving spouse, perhaps in trust.
Unfortunately, no one can predict
with any certainty what Congress is
going to do with the transfer-tax rules
in the next three years. Virtually every
estate plan will have to be re-examined in the next three years either to
account for a return to 2001 or to
deal with the terms of any permanent
legislation that is passed.
Who benefits from this chaotic
environment and the return to 2001?
Several groups will reap the greatest rewards: Roughly half the states
that remain coupled to the federal
estate tax could receive an unexpected revenue boost. Charities will
see increased estate contributions
(particularly of IRD assets) to avoid
estate taxes. Fee-based planners who
provide estate planning advice and
estate attorneys will be inundated
with work. CPAs will have more tax
returns to file. The insurance industry should see substantial increases in life insurance sales to fund
estate-tax liabilities. Politicians will
see increased contributions to their
campaigns. And the client/taxpayer?
He’ll be paying for all of it.
John J. Scroggin, J.D. LL.M., AEP, practices
tax law in Roswell, Ga. He is editor of the
NAEPC Journal of Estate and Tax Planning,
and a member of the Board of the National
Association of Estate Planners and Councils.
Contact him at
www.scrogginlaw.com.
