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Duncan: Learn these estate planning changes

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After many years of complete uncertainty with the federal estate tax, there is now a law in place that provides some level of predictability. Further, in 2013, Indiana repealed its inheritance tax. Indiana’s inheritance tax was known as one of the most onerous of all the states and resulted in many snowbirds making Florida their permanent home.

Effects on estate planning

duncan-greg-mug Duncan

While the federal law was not the hoped-for outright repeal of the death tax, it does provide certainty and a permanent exemption at the highest historical levels – $5.34 million per person ($10.68 million for a married couple) in 2014. The law also made permanent “portability” of the exemption amount, which means that the portion not used by one spouse at death can now be used by the surviving spouse. The exemption amount (whether your own or obtained from a predeceased spouse) can now be used to make lifetime gifts or gifts at death, which is a tremendous advantage compared to the historical $1 million limit on lifetime gifts. The death tax rates have decreased over the years from a high of 55 percent to the current 40 percent rate.

This means that, for 99 percent of Americans, estate planning will shift away from death taxes. The focus will shift to life insurance, income tax and business-succession planning. For those of high affluence and whose estates exceed the exemption amount, planning will continue as usual, with particular attention to the impact of the new income tax laws on their plans. The trust and estate professional will need to hone skills to get up to speed with non-customary services to remain relevant and add value for clients.

For the married couple of modest means or who are affluent but whose estate does not exceed the high exemption of $10.68 million, complacency is not the answer. It is still necessary to plan.

What should practitioners review with clients?

Familiarity with the new income tax laws will take time, and prior estate planning techniques should be reviewed for tax law impacts. Many “old” trusts may need to be actively managed to minimize the income tax consequences. The net investment income tax can be very burdensome to many trusts.

Life insurance policies should be reviewed and managed. Many policies were purchased to pay death taxes at a time when the exemption was much lower – $600,000 (and the rates were much higher – 55 percent). As the imposition of the death tax becomes less of a factor, the liquidity afforded by life insurance may lose its luster in light of the premium outlays. These policies may not be needed, may be deployed in some other fashion (e.g., gifted to children or grandchildren to pay the ongoing premiums), or even possibly sold to the highest bidder in the life settlement market.

Family limited partnerships (commonly referred to as FLIPs) have been created by many families to help facilitate lifetime gifts. In light of the change in the death tax landscape, many families are re-evaluating the continued use of the FLIP. There are many income tax issues to consider with unwinding a FLIP, depending on the current owners: the duration of existence, whether property contributed had a built-in gain, and whether liquidating distributions are made pro rata under the treasury regulations, among other factors. Competent tax advice should be sought prior to liquidation.

One of the more interesting income tax issues to be managed and understood is the interaction between death taxes and income taxes in light of the “step-up” in basis rule. This rule says that most assets receive a change in basis at a person’s death. The new basis becomes the value on the date of death. Assume a person owns Eli Lilly & Co. stock that has a $0 basis. If the person sells the stock there would be capital gains tax on the sale proceeds. If the stock were gifted during lifetime to children and the children sell the stock, the children would have the same capital gains tax (gifted assets have a “carryover” basis to the donee, meaning that the donee receives the donor’s basis). By contrast, if the stock is left to children after a person’s death, and the children sell the inherited stock the day after death, there would be no capital gains tax. While this rule is commonly referred to as the “step-up” in basis, it can also result in a “step-down” in basis (e.g., publicly traded stock purchased for $100,000 during life but only worth $50,000 at death will result in a new basis of $50,000, and the possible income tax “loss” will vanish).

Assessing assets in light of changes

Out of fear of the death tax, most laypersons (and appraisers) assume that assets are to be valued at the lowest possible value after a person’s death. However, in light of the high exemption amounts and the step-up in basis rule, that may not be the case. Most people should want assets to be valued at the highest possible value as long as it does not exceed the death tax exemption amount. Thus, for hard-to-value assets (real estate or business interest), assuming a person’s estate will not exceed the exemption amount, most should want the value to be as high as reasonably possible so as to minimize future income taxes (or increase current depreciation expenses for depreciable assets). Most appraisers recognize that there is a range of reasonableness, and it may be necessary to educate appraisers to understand the issues or to merely state that you do not want the lowest possible value. Many are not familiar with these scenarios, and understanding these rules is critical to advising families on which assets to gift or sell during lifetime and advising estate administrators in order to minimize future income tax.

While the estate tax laws are great for our clients, there is still much work to be done. Estate plans or techniques that are dated by five years or more should be reviewed with a fresh perspective in light of the changes that have taken place over the last two years.•

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Greg J. Duncan is a partner in the Indianapolis office of Bingham Greenebaum Doll LLP. He practices in the areas of estate planning, probate and trust administration, estate and gift tax planning, estate litigation and nonprofit planning. He is a certified trust & estate lawyer by the Indiana Trust & Estate Specialty Board. He can be contacted at gduncan@bgdlegal.com. The opinions expressed are those of the author.

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