Postpone Estate Tax Repeal Celebrations

Physician's Money Digest, November15 2003, Volume 10, Issue 21

While proponents of the estate tax"repeal" tout recent legislation as arelief for those impacted by estatetaxes, the reality of the new law fallsshort of that claim. The extreme complexity and temporarynature of the repeal along with its ever-changingprovisions, greatly reduces any relief. Timing provisionsfurther complicate the rules; some changes areretroactive, some are immediate, and some don't takeeffect for years.

Perhaps the law's biggest problem is that it "sunsets"in 2011. This means that in 2011, the estate taxlaws revert back to 2001 standards—unless Congresssteps in. Add to that the inevitable changing face ofCongress, their propensity to tinker with legislation,and increasing budget demands, and you've got aplanning nightmare. Finally, because of budgetaryconstraints, some states are adopting estate andinheritance taxes.

Estate Tax Traps

The tax law contains traps that can cost you andyour heirs dearly if you don't take appropriate steps toavoid them. Let's assume the current tax law remains ineffect until 2010. That year, your wealthy uncle dies andleaves you real estate. Because he died in the best yearpossible (ie, 2010), his estate would not be subject totaxes. However, unlike today's provisions that allow fora step-up in basis to fair market value for most inheritedproperty, the cost basis for your property will remainat your uncle's original basis.

If you sell, you may be responsible for capital gainson the value of the property in excess of your uncle'soriginal basis. The tax burden shifts from the estate tothe beneficiary—from the estate tax to the capital gainstax. It's even more complicated because the law, withinlimits, allows a modified step-up in basis for assetsworth $1.3 million. The executor must select this, andthe assets must be specifically identified.

Unified Credit Woes

The unified credit is a credit against estate taxes.Property qualifying for this credit does not incur an out-of-pocket estate tax. For example, at the death of aspouse, an amount of property equal to the unified creditexemption is transferred to a trust, usually called abypass or credit shelter trust. The balance of the estateis then transferred to the surviving spouse. No federalestate tax is due upon the death of the first spouse.

This remains an effective estate planning technique.However, due to the incremental increase in theunified credit under the new tax law, depending on thesize of the estate, a credit shelter trust may now geteverything. This would effectively prevent the estatefrom going directly to a surviving spouse, if the otherspouse died before 2010.

Protective Measures

What can you do to minimize risk and protect yourheirs? Design (or redesign) your estate plan with a greatdeal of flexibility. Flexibility is key. Your advisor canhelp you make sure the provisions of any trust documentsallow your trustees to distribute assets as theysee fit. Your advisor can also review your holdings, suggestingvarious options for your assets so that yourheirs aren't caught in 1 of the bill's expensive traps.

Future security:

Review your existing estate plan today. Consult witha trusted advisor to help you sort through the tax lawchanges and assess their effect on your situation. It's agood idea to review all your estate planning documentsand determine whether assumptions in place at the timeof their drafting are still applicable. Planning now will allow you to control the transfer ofyour assets based on your values and objectives.

James Douglas Mattern is a financial representativewith the Northwestern Mutual FinancialNetwork based in Philadelphia, Pa, for theNorthwestern Mutual Life Insurance Co,Milwaukee, Wis. He welcomes questions orcomments at 215-569-1222 ext 2778 or atjames.mattern@nmfn.com.