SENATE FINANCE COMMITTEE’S 2007 ESTATE TAX HEARING
Four invited witnesses testified at a November 14 Senate Finance Committee hearing titled "Federal Estate Tax — Uncertainty in Planning Under the Current Law." But the hearing’s title doesn’t give the major story.
A more accurate title. True, a good part of the hearing covered the uncertainty and the complexity under current law. But a better title would have been: "Should the Estate Tax Be Permanently Repealed; if Not, What Should Be the Exemption and the Rates."
Warren Buffett, CEO of Berkshire Hathaway. He testified strongly in favor of retaining the estate tax, suggesting a gradual slope in rates above a $4 million exemption (indexed for inflation) with a top rate higher than the current 45%. He didn’t discuss this in his opening statement but in answer to questions from committee members.
Ranking SFC member Charles Grassley (R-IA) asked Mr. Buffett whether he thought the current laws on charitable spending requirements should be changed saying that, for example, colleges and universities have no spending requirements on their endowments. He mentioned the 5% minimum payout requirement for private foundations.
Mr. Buffett compared charities and endowments to private businesses when it comes to federal requirements. "It’s institutional economics," he replied. "Require them to spend 3% of their donations for charitable purposes and that’s what they will spend. Require 5% and they’ll spend that." Mr. Buffett noted that he imposed high payout requirements on the billions of dollars that he has given and will be giving to the Bill and Melinda Gates Foundation.
Conrad Teitell, Cummings & Lockwood. I discussed the complexity of planning under current law with a roller coaster exemption and total repeal for one year (albeit with a carryover basis for heirs instead of a stepped-up basis for that year).
In my opening oral statement, I said that the unlimited estate tax charitable deduction in the current estate tax law—and in the estate tax laws since the inception almost 100 years ago—should be retained under any revised laws. My written statement for the record details the estate tax ramifications of outright and split-interest charitable bequests. The statement describes the tax benefits for gifts of IRAs to charity at death and urged the Congress to extend the current law for IRA/charitable rollovers during lifetime. Further, I urged the Congress to expand the expiring law to permit tax-free IRA/charitable rollovers for charitable life-income plans such as gift annuities and charitable remainder trusts.
Dean Rhoads, a rancher and state senator from Nevada and Eugene Sukup, board chairman of Sukup Manufacturing Company, headquartered in Iowa. Both witnesses urged repeal saying that their families might have to sell the businesses in order to pay the estate taxes under current law.
The Independent Sector. Although a representative wasn’t a witness at the hearing, Independent Sector submitted a statement for the record.
OPENING ORAL STATEMENTS OF THE FOUR WITNESSES AND STATEMENTS SUBMITTED FOR THE RECORD
Statement of Warren Buffett
Thank you, Mr. Chairman. Mr. Chairman, Senators, I appreciate the opportunity to express a few views on the estate tax.
I will limit my remarks to three points.
The first relates to the intellectual dishonesty employed by those who use the phrase "death tax." This term is clever, it is Orwellian, and it is, if you'll pardon the expression, dead wrong.
More than 2.4 million Americans will die this year. About 12,000 of them will leave an estate that will be taxed when the exemption goes to $3.5 million, as Senator Grassley mentioned. It will be 9600 estimated and it's been 19,000 when the exemption was (lower.)
That means that 99-and-a-half percent of estates will be tax-free. You would have to attend 200 funerals to be at one at which the decedent's estate owed a tax. Indeed, far more people who die receive a large tax benefit. I don't think that's generally understood. Namely, a stepped up basis on appreciated assets.
If people insist on renaming the estate tax, it would be more appropriately labeled the "death present."
The second point I would like to make is that in a country that prides itself on equality of opportunity, it is becoming anything but that, as the gap between the super rich and the middle class widens in dramatic fashion.
Here are a few figures on the Forbes 400. Other people save their Playboy magazines, I save the Forbes 400 magazine.
Twenty years ago, 1987, it took $220 million dollars to make the list. Now it takes $1.3 billion, about a six-for-one increase. The total wealth of the list in 1987 was then $220 billion. Now it's $1.54 trillion, exactly a seven-for-one increase.
Tax law changes have benefited this group, including me, in a huge way. During that same period, the average American went exactly nowhere on the economic front. His income went from a median $26,061 to $48,201, almost exactly the increase of the CPI during the 20 years.
He's been on a treadmill while the super rich have been on a spaceship.
Dynastic wealth, the enemy of a meritocracy, is on the rise. Equality of opportunity has been on the decline. A progressive and meaningful estate tax is needed to curb the movement of a democracy toward a plutocracy.
Finally, I have a suggestion. Estate taxes now raise about $24 billion. It's one of the lowest percentages, incidentally, of total taxes in the history of the tax system.
As mentioned, that $24 billion will come from about 12,000 estates. Indeed, half of that sum will come from only about 1500 estates. The beneficiaries of each of those estates will receive millions, in many cases tens of millions or more. One point you never hear from proponents of estate tax elimination is whom they would get the $24 billion from if they didn't get it from the 12,000 large estates.
They just say, "Free us." They don't say who to further shackle.
Here's a suggestion: Keep the estate tax and its $24 billion, reshape it if you will, but keep the estate tax and its $24 billion. Then take a look at the bottom fifth of America. There are 23 million households in the United States with $20,000 or less of income. Many are paying payroll taxes that now total 15.3 percent. That 15.3 percent alone is more than the rate on dividends or capital gains. Let's give those 23 million households a $1000 annual credit. Every dollar of such a credit would affect real change in the lives of the 50-million-plus people residing in the 23 million households. Yet the cost of this would be less than getting rid of the tax on the 12,000 estates.
50-million people would be helped in a material way. The beneficiaries of the 12,000 estates would still receive what looks like a fortune to almost all Americans.
Leona Helmsley's dog, Trouble, reportedly is inheriting $12 million. If Mrs. Helmsley's estate is in the 45% tax bracket, Trouble could instead receive $22 million if the estate tax is removed.
Alternatively, just from Trouble's share of the Helmsley estate tax, 10,000 families making less than $20,000 annually could receive $1000 each to make their lives a bit better. Even though Trouble probably heard Leona say, quote, "Only the little people pay taxes," end-quote, I don't think he would mind the estate paying $10 million in order for him to get his $12 million.
We need to raise about 20 percent of GDP to fund the programs the American people want from the national government. Further shifting of this requirement away from the super rich is not the way to go.
Statement of Conrad Teitell
Mr. Chairman, Mr. Ranking Member, Members of the Committee:
I am Conrad Teitell, an estate planning lawyer with Cummings & Lockwood in our firm’s Stamford, Connecticut office.
Over 50 of our firm’s lawyers are involved in estate planning.
And I teach this stuff at a law school.
InGone with the Wind, Margaret Mitchell observed that death, taxes and childbirth never come at a convenient time. Nor, she might have added, at a time certain.
This Committee has asked me to talk about the uncertainty in estate planning under current law — the one that Congress gave birth to in 2001. As all but troglodytes know, that law has a roller coaster estate tax exemption: $2 million this year and next; increased to $3.5 million in 2009. Then there is no estate tax whatsoever in 2010. But the estate tax is scheduled to reappear in 2011 and thereafter in all its glory. And the exemption will be limited to $1 million.
So, the only convenient time for death and taxes is 2010 — at least for the heirs.
We have complex tax laws because those laws reflect our complex society. However, it’s not the complexity that presents the problem with the current estate tax rules, but rather the uncertainty. And to cope with that uncertainty, we lawyers must often make complex plans even more so.
As I said a moment ago, I’ve been asked to talk about the complexities in planning under the current law — not whether estates should be taxed and if so with what exemption and at what rates.
My written statement for the record details the many problems under the current law that individuals face when trying to plan their estates. To name just a few:
Complicated trusts often have to be created to deal with the moving-target-estate tax exemption. And we have to draft for the contingency that there won’t be an estate tax in 2010;
Life insurance planning to pay for estate taxes and provide liquidity is difficult; and
Putting off decisions until Congress acts can be hazardous to your wealth.
Before I get back to the negatives, let me accentuate the positive — charitable bequests. This is the one area where it is easy to plan and draft under current law. The estate tax charitable deduction is unlimited, as it has been under our estate tax laws for almost 100 years.
Thanksgiving is just around the corner. Every year my family has a marathon Monopoly game — over the entire holiday weekend. This year, to make the game more realistic for my grandchildren, I’ve indexed the game for inflation.
If you buy Park Place, it will cost you $5 million.
The card that formerly said "Pay Tax Collector $200" will now say: "Pay $20,000 if you land at 7:00 or 8:00 o’clock; pay $15,000 if you land at 9:00 o’clock; and pay nothing at all if you land at 10:00 o’clock. But if you land at 11:00 o’clock or later, pay $40,000."
That’s analogous to the changing estate tax exemption over the next couple of years, complete repeal of the tax in 2010, but a return of a $1 million exemption in 2011 and beyond.
My version of the rules will surely make our Monopoly game more interesting. But our nation’s estate tax rules shouldn’t be a roll of the dice!
[For Conrad Teitell’s written statement for the record, see page 11.]
Statement of Dean Rhoads, rancher from Nevada
Good morning, my name is Dean Rhoads. I am a rancher from Tuscarora, Nevada, which is 60 miles northeast of Elko, Nevada. I have been involved in livestock industry activities my whole career as a rancher.
I have also been a state senator since 1984. My state senate district is the largest in the United States outside of Alaska and stretches over 73,000 square miles. My district is larger than 34 states and accounts for over two thirds of the land area of Nevada. Prior to serving as a state senator, I served three terms in the Nevada State Assembly.
I am the past Chairman of the Public Lands Council, an affiliate of the National Cattlemen’s Beef Association, and also the past Chairman of their Public Lands Committee. Today I am here on behalf of all the ranches, farms and small businesses in my district, as well as those throughout the State of Nevada. Although I am going to tell you the story of my family, there are many others like me who have been greatly impacted by the estate tax.
Since shortly after my wife, Sharon, and I graduated from college, we have lived on the ranch that was established by her parents in 1943. We now own the ranch.
Our daughter, her husband, and our two teenage grandsons all work on the ranch. We also have a 9-month old grandson who lives on the ranch. Our other daughter, her husband, and our granddaughter live on a ranch in southern Oregon.
My father-in-law came to Elko County in the 1930s when he was 15 years old. He worked as a cowboy and a ranch hand, saved his money, and eventually bought his first property over 60 years ago.
My father-in-law became a good friend of Bing Crosby when he owned ranches in Elko County, including one adjacent to my father-in-law’s ranch that we purchased in 1966. My wife and family lived there for 18 years.
We operate on a combination of private and public land, which is common for Western ranches of our type and size. The capacity of our ranch is approximately 10,000 Animal Unit Months or AUMs, which is how ranches in our part of the West are measured and valued.
I believe, if we had a willing buyer, our ranch would be valued at about $2.5 million in today’s market, assuming it was not broken up or sold for water.
My mother-in-law died in 1976. My father-in-law paid a total estate tax of over $300,000. To do this he could not afford to keep the ranch where my wife and I and our two daughters lived—the old Bing Crosby ranch.
Losing this ranch and our home was not only a personal blow, but it was devastating to our operation. This was our primary hay ranch, and at 6,000 feet in elevation we need every bale of hay we can produce. Losing this ranch meant we were forced to buy hay almost every year since 1985.
When my father-in-law died in 1995, there was no more land left to sell if we wanted to survive in the ranching business. Based on the ranch’s value, the tax we now owed, with interest added, was over $340,000.
Therefore we have been paying $18,000 in estate taxes, plus interest, every year; which we are continuing to pay. We have had to borrow money to make these payments. We pay this money back through the revenues produced by our ranching business.
Because of this, I can say without a doubt that we have not made very many capital improvements to our ranch nor have we been able to take advantageof some expansion opportunities to plan for the future when our grandchildren might want to continue the tradition started by my wife’s parents 66 years ago.
The other thing we have not been able to do is put aside any extra money to build up a fund to help our daughters with their own estate tax burden when my wife and I pass on.I appreciate the Senate Finance Committee holding this hearing to investigate problems caused by the uncertainty of current law. But my family is a good example of what happens when the law does not offer solutions. Hopefully any future solutions will provide my family and other families like us, some relief down the road.
A current estimate of the value of our cattle would be about $1,100 to $1,300 per mature pregnant cow with a calf at her side. Understanding that the cattle market is not constant, we own about $2 million worth of production units in our ranching business, in addition to our yearlings, a horse herd and the land value.
Let me illustrate the uncertainties of planning. Under current law, if my wife and I were killed in a common accident in December of 2009, our family ranch would be valued at around $7 million, counting all the land and all the animals. Because my wife and I have tried to do some estate planning to divide our ranch assets between us, my daughters should have a $3.5 million exemption on my estate and a $3.5 million exemption on their mother’s estate. They would not have to sell any land or cattle to pay the federal government, assuming the ranch does not continue to increase in value and also assuming that the ranch was not broken up for its water rights.
But, if they were faced with dealing with our estates in January of 2011, they would owe nearly $2.5 million within 9 months of our death. That would be in addition to the over $640,000 we have already paid in estate taxes to the federal government.
So, how do we plan without some certainty? Let me tell you, that potential tax bill represents a whole lot of pregnant cows at $1300 a pair.
Everyone in my family wants to continue our ranching business. Ranching is a tough way to make a living, but we can do it and make a profit over time.
It is difficult, but we can deal with the variables of weather, drought, labor shortage, market conditions, and day-by-day business expenses such as the increasing price of fuel. But, if you continue to add the specter of the burden of this unfair tax -- if we have to pay this much a third time as a family for one ranch -- I do not have much optimism for our future.
In closing, I urge the Committee to pass legislation reforming the estate tax by either eliminating or reducing the burden this tax places on families, ranches, farms, and small businesses in Nevada and throughout the United States.
Whether the solution is to eliminate the estate tax altogether or to increase the marital exclusion and lower the tax rate I leave up to the wisdom of Congress. But whatever you decide, I hope you will take action to help my family and others like us.
Thank you for the opportunity to testify before you today.
Statement of Eugene Sukup, Sukup Manufacturing Company
I’d like to thank the Chairman and Members of the Committee for offering me the chance to speak here today. My name is Eugene Sukup, and I’m the founder and Chairman of the Board of Sukup Manufacturing Company. We’re a small manufacturer located in Sheffield, Iowa. My company also is a member of the National Association of Manufacturers, the nation’s largest industrial trade association representing small and large manufacturers nationwide.
I started Sukup Manufacturing Company 44 years ago, while still working on the farm. I had bought my first grain bin to dry and store shelled corn. But, the process didn’t work quite right. So, I came up with a new design that worked better. Today, I’m proud to say that forty years after our first item was patented and manufactured, my sons, Charles and Steve and I have expanded a single idea into a worldwide company, employing over 350 workers in seven states. We now hold over 70 U.S. patents and produce a broad line of grain handling and storage systems.
In addition to our plant in Sheffield, Iowa, we operate six distribution centers in Arcola, Illinois; Aurora, Nebraska; Defiance, Ohio; Jonesboro, Arkansas; Cameron, Missouri; and Watertown, South Dakota. We sell products all over the United States and to 50 foreign countries.
I firmly believe that one of the keys to our company’s success is our ability to hire and retain top notch employees. Over 30 percent of our workers have been with us for more than 10 years. We provide exceptional benefits, including health insurance coverage at no cost for our workers, and only $60.00 per month for their families. In addition, we offer a 401K Program, Dental Health Plan, and a Profit Sharing Program that was started in 1973.
As the largest employer in Franklin County, Iowa, we’ve watched the community grow around us. Today, we have a health clinic, a dentist office, a chiropractor, a drug store, a bank, a grocery store, a restaurant, and a golf course. The growth of the town can be seen by new homes that are being built and a church that has overgrown its capacity and is making plans for a new one.
We believe in giving back to the community, which is why my company is a major donor to the Sheffield Care Center for Senior Citizens. We helped build a local swimming pool and a playground. We also gave a million dollars to help fund a child day care center that cares for over 100 children in Hampton, Iowa. Sukup Manufacturing Company contributes 10% of its taxable income for charitable contributions for local charities and contributions to the Sukup Family Foundation, which also contributes to area charities.
The family foundation does not build up a large balance but uses the money for charitable gifts. The foundation balance is over $1 million dollars with over $500,000 have been contributed from the foundation in 2006.
I’m not bragging when I tell you that businesses like Sukup Manufacturing are the backbone of our economy. By the same token, when a business like ours is sold off or shuttered, the loss to the economy is great. If Sukup closed today, 350 people would lose their jobs. But, that’s just the beginning. Without jobs, there’s no reason for a child care center. As people move on to other places, the restaurants and stores close down, the dentist moves to a bigger city with more customers. The loss would be felt in Iowa, in Arkansas, in South Dakota.
Now, to be clear, we’re a growing company. So, why would we close down or sell off? I’m here today to tell you that one of the greatest threats to our family-owned business is the estate tax. If my wife Mary and I died today, we estimate that our estate tax liability would be somewhere between $15 and $20 million dollars. The only way for my sons to pay that tax would be to sell off the business.
Folks will tell you that you can "avoid" the tax. Well, maybe that’s true in some cases, but it also involves extremely high financial planning costs including expensive life insurance policies that businesses pay year in and year out. Money that we put into life insurance policies and other financial planning tools to avoid the tax is money that we could have been putting into the business – hiring more employees and expanding into other states.
Furthermore, it’s nearly impossible to plan for a tax that changes every year. Under current law, the exemption for the tax is $2 million with a top rate of 45 percent. In 2010, the tax is repealed. But, in 2011 the top tax rate goes back up to 55 percent and the exemption drops back down to $1 million. The uncertainty of the tax means that we have to plan for the worst case scenario, costing us even more money.
Even if my sons are able to somehow keep the business after we pass on – my grandchildren will have to pay the same tax again when they take over the company. There’s no limit to how many times our company will be taxed.
We are truly a family owned business. I’m fortunate to have two sons working with me who are graduate engineers, two grandchildren that have returned to the company fulltime, and two grandchildren who are still attending Iowa State University. One of my grandsons is disabled and has been working at the company running the robot welder. I can’t tell you how much it means to me to be able to provide him a job that allows him to make a real contribution to the company and to society.
I built this company, my sons helped me build it and my grandchildren want to carry it on. Isn’t that the kind of entrepreneurship that our government should encourage? This tax discourages entrepreneurs, it destroys family businesses and it’s unfair. I hope that you will all work together to permanently end this unfair burden on family-owned businesses like mine.
Independent Sector’s Written Statement for the Hearing Record
The role of charities and foundations, which now number 1.4 million, is far too valuable in American civic life to be overlooked in the national conversation about estate tax reform. From hospitals to homeless shelters to art museums and little leagues; from religious congregations to universities, the charitable sector manages to reach every aspect of American life. Therefore, on behalf of Independent Sector, a coalition of charities, foundations and corporate giving programs, we ask that the impact on nonprofit organizations be kept in mind as this Committee considers the implications of reforms to the federal estate tax.
The federal government and the charitable sector share a unique partnership in addressing many social concerns. Repeal of the estate tax would cost about $1 trillion in federal tax revenues in the first ten years, once the added interest on the federal debt is taken into account. Revenue losses this big would significantly worsen the already severe federal budget problems the nation faces. Many charitable organizations serving the most vulnerable among us, particularly health and human services organizations, rely on state and federal government funding to support community programs. Those revenues are already at risk, and a full repeal of the estate tax will only serve to further dry up funding for these critical services.
Americans have always supported a strong and independent charitable sector. Policy makers have long recognized the vital role tax incentives play in encouraging Americans, particularly wealthy taxpayers, to give back to the community. According to the Internal Revenue Service, in 2006 almost two-thirds of charitable bequests came from estates valued at over $10 million, and three quarters of bequests came from those valued at over $5 million. In this context, it is clear that a repeal of the estate tax would be very disruptive. The Congressional Budget Office has estimated that if the federal estate tax had not existed in 2000, charitable donations would have been reduced by a stunning $13 to $25 billion that year. This massive potential loss in donations is more than the total amount that all corporations gave to charity in 2000. The CBO study, like a number of earlier studies, found that the estate tax leads affluent individuals to donate more than they otherwise would, because such donations – whether made during life or as bequests at death – sharply reduce estate tax liability.
If the estate tax were retained in a smaller form, the CBO study indicates that the drop in charitable giving would be much smaller. An exemption of the first $2 million to $3 million of an individual's estate (and twice that amount for couples) would have reduced charitable giving by just $1 billion to $6 billion in 2000. Again, this is compared to a drop of up to $25 billion if the tax were entirely eliminated. Tax incentives are a basic part of the nation's charitable infrastructure, and the estate tax has for decades been one of the most important of these incentives. Retaining a smaller, reformed estate tax would be a sensible way to preserve charitable donations and protect federal and state budgets, while responding to the criticism the current estate tax has engendered.
Permanent repeal or irresponsible reform of the estate tax would benefit the few at the expense of the many. Repealing the estate tax would seriously damage the power of hundreds of thousands of individuals who work with the nonprofit community to improve the public good through charitablecontributions, volunteering and advocacy. The solution is to protect family farms and small business owners while also ensuring adequate federal revenues and encouraging charitable contributions that help nonprofits implement, complement and enhance services provided by government and business. We urge you to protect individual legacies while safeguarding the legacy of a better future for all.
We ask that you give serious consideration to the impact on charitable giving of each estate tax proposal. Both the federal government and the charitable sector need sufficient resources to meet the diverse challenges of the 21st Century. Careful and reasonable reform of the estate tax will make that possible.
Patricia Read, Senior Vice President, Public Policy and Government Affairs, Independent Sector
Teitell’s Written Statement for the Hearing Record
Death and Taxes Are Certain — the Estate Tax Shouldn’t Be Arbitrary
The arithmetic. An individual who dies on December 31, 2008 leaving a $5 million taxable estate to his or her children will pay an estate tax of $1.35 million. If the same individual survived one more day — until January 1, 2009, when the exemption from the estate tax is scheduled to increase from $2 million to $3.5 million — the tax on the same estate will be $675,000. But if the individual had survived for another year — until January 1, 2010, when the estate tax is scheduled to be eliminated — the estate would not pay any tax. Finally, if the estate tax exemption returns to $1 million in 2011 and beyond the estate would pay a tax of approximately $2 million.
To paraphrase Rodney Dangerfield. The fact that the same size estate can have four different tax liabilities — depending solely on dates of death that could potentially be separated by only a few minutes — is not lost on taxpayers. This creates a lack of respect for a tax system and strikes taxpayers as arbitrary. And a lack of respect for the estate tax system can also breed disrespect for the gift and income tax laws.
Basic Estate Planning Is Mind-boggling for Married Couples and Families
The estate planning process. In helping clients plan theirestates, we first discuss their wishes and their needs, capabilities and other information about the desired beneficiaries; and, of course, the client’s assets. That’s the easy part.
Then the talk turns to the federal estate tax exemption.The amount that a client can leave to his or her beneficiaries without incurring estate tax is a cornerstone of many estate plans. We explain that the amount has increased over the years, that it was only $600,000 ten years ago, but has gradually increased to its current level of $2 million. We also describe the future scheduled changes in the estate tax: an increase in the exemption to $3.5 million in 2009; repeal of the estate tax in 2010, and then the estate tax’s rebirth in 2011 and thereafter with an exemption of $1 million.
We explain the conventional wisdom among estate planning lawyers is that the changes to the estate tax scheduled to occur in 2010 and 2011 are unlikely to occur, but that we must assume that they will in our planning.
Uncertainty about the amount of the estate tax exemption can have unfortunate consequences:
Estate plans for married individuals with combined estates between $1 million and $2 million currently are far more complicated than may be necessary. Take the case of a married couple with combined assets of $1.2 million. Given the current value of the couple’s assets and the current estate tax exemption of $2 million, those clients should have the flexibility to leave their estates to whomever they choose in whatever manner they wish without paying any federal estate tax. However, the possibility that the exemption from the estate tax might be as low as $1 million in 2011 and thereafter means that the Wills for this married couple must be designed to preserve the estate tax exemption of the first spouse to die by segregating the exemption in a trust for the benefit of the surviving spouse which will be exempt from the estate tax on the death of the survivor. Otherwise, if the property were simply left outright to the surviving spouse, an estate tax of 45% will be incurred on the survivor’s death on the portion of the estate that exceeds $1 million, resulting in a federal estate tax bill of $90,000. Yet if we could inform the same couple with certainty that the exemption from federal estate tax is unlikely to return to an amount lower than its current $2 million level, we could advise them that a trust for the benefit of the survivor is unnecessary. In short, many couples are receiving more complicated — and costly — estate plans than they are likely to require.
Because of the uncertainty in the exemption amount, couples must constantly update their estate plans, and incur additional legal fees, to respond to the scheduled changes.
The expectation of the average estate planning client is that he or she can sign a Will and related estate planning documents, title assets in accordance with the plan, and return to their estate planning lawyer in five to ten years to assure that the plan remains appropriate in light of then-owned assets and any changes in family circumstances. However, the changes scheduled to occur over the next few years require many individuals to review their estate plans yearly. For example, a married couple with $2 million of assets in the husband’s name and only modest assets in the wife’s name would need very simple Wills to assure that they pass their entire inheritance tax-free to their children in 2007. However, if that same couple does not revisit the manner in which they hold title to their property in 2011 when the exemption from the estate tax is scheduled to return to $1 million, and the wife predeceases the husband during 2011 without using her $1 million exemption from the estate tax, their Wills drafted in 2007 could result in an estate tax of over $500,000. Sometimes as estate planning lawyers we can, by drafting "disclaimer" provisions in the documents, enable a survivor to take some post-mortem tax-saving actions.
It is unfair to create this trap for individuals who have conscientiously tried to create tax-efficient estate plans, but haven’t kept abreast of the complex changes to the estate tax exemption over time.
Confusion Regarding the Role of Life Insurance
Life insurance has traditionally played an important role in estate planning. The uncertainty regarding changes in the estate tax makes it difficult for taxpayers to accurately evaluate the role that life insurance should play in their estate plans.
The proceeds of a life insurance policy are includable in the estate of the policy’s owner. Thus when a client is selecting an asset to give to children during his or her life, life insurance is a desirable asset. It is generally not very valuable during the client’s life, but will be highly valued at the client’s death. A common estate planning technique involves placing a life insurance policy on the life of a taxpayer into an Irrevocable Life Insurance Trust. That trust enables a taxpayer to take advantage of his or her ability to make annual tax-free gifts of up to $12,000 to each member of his or her family each year by making gifts to the trust for their benefit, and thereby provide funds to pay the premiums on the policy owned by the Insurance Trust. That trust’s insurance proceeds will pass to the family members at the taxpayer’s death without being exposed to the estate tax in the taxpayer’s estate.
Life Insurance Trusts have been an important tool in estate planning not only because they can be coordinated with the gift tax rules, but also a life insurance policy that is payable to a Life Insurance Trust for a taxpayer’s family provides an excellent source of liquidity at the taxpayer’s death. This source of liquidity can prove helpful to a family needing funds that can be used to replace lost income, pay estate taxes or give the family a source of funds that can be used while a home or business is being sold.
Under the current $2 million estate tax exemption, a married couple with $5 million of assets can assure that the first $4 million of their assets pass to their children without exposure to the estate tax by having properly drafted Wills that take advantage of both of their $2 million exemptions from the federal estate tax. The remaining $1 million will be subject to the federal estate tax, resulting in a tax of $450,000, and a total inheritance of $4.55 million for the children. This couple might decide to purchase a $450,000 life insurance policy that will be payable upon the death of the survivor of them and place that life insurance in a Life Insurance Trust for their family. This way, if both spouses die at a time when the estate tax exemption is still $2 million for each individual, the $450,000 of life insurance proceeds would replace the $450,000 of estate tax due, resulting in the children receiving $5 million.
This planning, which has been very common, is often a victim of uncertainty. A married couple with $5 million and properly drafted Wills would not need a Life Insurance Trust in order to maximize the inheritance of their children in 2009. The individual exemption of $3.5 million that year will mean that a married couple can protect up to $7 million using simple Wills. A Life Insurance Trust would also prove unnecessary for this couple if they both die in 2010, when the estate tax is scheduled to be repealed. However, in 2011 and thereafter, when the estatetax exemption is scheduled to return to $1 million, a married couple will only be able to protect the first $2 million of their estates using their exemptions. If this comes to pass, a much larger life insurance policy might have been advisable.
Certainty regarding the future of the estate tax would eliminate the confusing variables that currently face a taxpayer who is evaluating the role of life insurance in his or her estate plan.
Potential Incapacity and Delay Results in Unfair Tax Exposure for Taxpayers
"Let’s see what happens" — the under-planning trap. While some individuals may end up over-planning their estates due to the uncertainty in the estate tax laws, many others under-plan. They defer important estate planning decisions until there is more certainty about the size of the estate tax exemption and the applicable rates. This failure to plan today may result in a significant and unfair future tax bill.
The current planning environment. Some married couples with less than $2 million in combined assets conclude that the exemption is likely to remain at or above its current $2 million level so that they can leave all their assets to the surviving spouse without estate tax exposure on the death of the survivor. But, as already discussed, any married couple with a combined estate in excess of $1 million is at risk of paying estate tax under the current tax regime when the property passes to their children. Estate planners, even if they have the opportunity to meet with those couples, are caught between Scylla and Charybdis when deciding whether to risk over-planning clients’ estates or under-planning the estate and hoping for the best.
Lifetime gifts. A common estate tax reduction strategy is giving property away during the taxpayer’s life so that it is not part of his or her estate at death. Giving to reduce estate taxes and to benefit family members and others before the giver’s death is recognized and encouraged in the Internal Revenue Code. The law allows individuals to make the following gifts without incurring any gift tax: unlimited gifts to charity; unlimited gifts to U.S. citizen spouses; limited gifts to non-citizen spouses; annual exclusion gifts of $12,000 per year per donee; gifts to pay medical and educational expenses; and gifts of up to $1 million during the lifetime of the taxpayer.
While giving has always been a popular strategy for the wealthy, it can also benefit individuals with more modest estates. However, the current estate tax environment has caused individuals who would otherwise engage in appropriate giving programs to forego or postpone giving, thereby potentially losing the benefit of reducing their taxable estates by both the value of the gifted property and the future appreciation on that property.
Of particular import is the decreased use of the $12,000 annual-per-donee-gift-tax exclusion for taxpayers who are on the border of having taxable estates. Annual exclusion gifts can be made each year to the same individuals, or to certain types of trusts for their benefit.
The failure to make the annual exclusion gift in a particular year has a significant opportunity cost associated with it. For example, a single taxpayer can give $12,000, and a married couple $24,000, to a child each year. If the married couple fails to make this $24,000 combined annual exclusion gift to just one child in just one year, the opportunity cost of this failure could be as much as $12,000 in federal estate tax, assuming an estate tax rate of 50%.
Gifts beyond the annual exclusion. Wealthier individuals are postponing the decision to make larger gifts which may result in the payment of significant federal gift tax because they have concluded that they do not wish to pay a gift tax now if the property may not be subject to estate tax in the future. In the meantime, family members may be deprived of gifts that could enable them to buy homes or start businesses before the parent’s death.
Future planning may be impossible.The understandable decision to defer planning for the estate tax (waiting to see what happens) assumes that the taxpayer will have the capacity to plan in the future. A client who postpones making important changes in his or her will in order to avoid the expense of having to redo it after the estate tax law is revised will not have an opportunity to make those changes if he or she loses mental capacity before Congress finally acts.
Uncertainty regarding future estate tax laws is creating two classes of families who will be punished for their failure to act while waiting for Congress to act. First, the families of taxpayers who became mentally incapacitated and, as a result of their incapacity, are unable to implement estate planning techniques that would minimize the impact of the estate tax on their inheritance. Second, the families of taxpayers who wanted to see the future of the estate tax law before engaging in a giftingprogram and, as a result, missed opportunities to make gifts that would have minimized the exposure of their assets to the estate tax.
Outright charitable bequests. Fortunately, this is one area where it is easy to plan and draft under current law. The estate tax charitable deduction is unlimited. So for outright bequests to qualified charities, no estate tax is payable regardless of the size of the bequest. Thus whether the estate tax exemption is $2 million, $3.5 million or higher is irrelevant. Donative intent, of course, is crucial.
IRAs to charity at death. Many individuals give all or part of their IRAs and other pension plans to charity at death. Those gifts qualify for the unlimited estate tax charitable deduction.
Retirement plans payable to individual beneficiaries (instead of charity) at death. The changing estate tax exemption (and estate tax repeal for 2010) must be taken into account in planning and drafting. There can be a double tax (even triple tax if the generation-skipping tax is involved) if a retirement plan is given to a beneficiary other than a charity. In addition to the estate tax (and the generation-skipping tax in some cases), the beneficiary must pay income tax on so-called income in respect of a decedent. However, if the IRA or other pension plan is given to charity, the estate tax (and the generation-skipping tax if otherwise applicable) and the income-in-respect-of-a-decedent tax are avoided. This benefits charities and those that they serve.
Before 2006 an individual who used funds from his or her IRA to make lifetime charitable gifts was taxed on the funds payable to charity. For nonitemizers, there was no offsetting charitable deduction. And for generous higher-income donors, the income tax charitable deduction was often limited or unavailable because of the adjusted gross income ceilings on deductibility—even taking the five-year carryover into account.
For 2007 (and last year) an individual age 70½ or older can make direct charitable gifts from an IRA (including required minimum distributions) of up to $100,000 per year to public charities (other than donor advised funds and supporting organizations), operating private foundations and "conduit" foundations and not have to report the IRA distributions on his or her federal income tax return.
The Public Good IRA Rollover Act of 2007 (S. 819) with lead co-sponsors Senator Byron L. Dorgan (D-ND) and Senator Olympia J. Snowe (R-ME) has bipartisan co-sponsorship on the Finance Committee and in the Senate. An identical House bill (H.R. 1419) has bipartisan co-sponsorship in the House and the Ways and Means Committee.
Those bills would expand the current IRA/charitable rollover provisions in a number of ways, the most significant for many charities and their supporters would allow a tax-free rollover for a life-income plan (e.g., gift annuity, charitable remainder unitrust) for individuals age 59½ or over. The tax-free direct charitable rollover (as under current law) would be available for individuals age 70½ or over.
Charities are grateful. I am the pro bono legal counsel for the American Council on Gift Annuities (an organization of 1,200 charities nationwide). Those charities are grateful to the Congress for the existing IRA/charitable rollover law and that Congress is considering extending that law. Adding the ability for an individual to roll over part or all of an IRA to charity and receive life income (fully taxable) from a life-income plan would enable millions of taxpayers of modest and average means to benefit our nation’s charities and the people they serve. Instead of getting income from their IRAs, they would get income from a charity’s life-income arrangement. Currently, about two-thirds of the taxpayers take the standard deduction. This would give them a tax incentive to benefit charities and still provide them with retirement income.
Testamentary charitable remainder unitrusts and charitable remainder annuity trusts (CRTs). Under current law, where a testamentary CRT provides income payments to a survivor for life with a remainder gift to a charity, the charitable gift element is fully deductible under the unlimited estate tax charitable deduction. The value of the life-income interest for a survivor is potentially subject to estate tax. So it is often a challenge to plan not knowing when death will occur and what the estate tax exemption will be (or whether there will be an estate tax).
Testamentary charitable lead unitrusts and lead annuity trusts that make payments to a charity for a period of time with an eventual gift to family members. The remainder gift of the lead trust to family members is subject to the estate tax. Thusthe changing estate tax exemption (and whether there will be an estate tax at the time the lead trust is created by an individual’s will) has created planning and drafting challenges.
Putting all this in context. An incredibly large number of generous Americans — of modest, average, and wealthy means—include charities in their estate plans. I know this from my law practice (working with both charitable institutions and individuals in their estate planning) and my work with a number of national umbrella organizations of charities. And, of course, published statistics show the magnitude of charitable giving. From the very beginning of our income, gift and estate tax laws, almost 100 years ago, those laws have encouraged charitable contributions. Any new estate tax law should continue to provide for an unlimited estate tax charitable deduction.
The Impact of Changing a Taxpayer’s Domicile
Our firm advises hundreds of clients who have residences in both Connecticut and Florida. Connecticut has decoupled from the federal estate tax system and created a separate Connecticut estate tax, while Florida has no state estate tax. Our attorneys often meet with clients who have residences in both states and we discuss the estate tax advantages of establishing Florida as their domicile.
Many clients have taken the steps required to transfer their domicile from Connecticut to Florida. Although it is usually clear when a client should consider changing domicile to reduce the estate tax burden on his or her estate, it is a decision that comes with collateral consequences. A taxpayer who decides to move his or her domicile to Florida to avoid the Connecticut estate tax at death is no longer going to pay Connecticut state income taxes or sales taxes. Because a person’s domicile is based on many factors, the domicile claimed by the executor of a decedent’s estate may be disputed by one or more states taking a contrary position in order to collect state death taxes. The huge dollar amounts that will be at stake as a result of domicile disputes will undoubtably lead to costly litigation.
Complexity as a Result of States "Decoupling" from the Federal Estate Tax System
Intertwining of federal and state tax laws — the problem. My office at Cummings & Lockwood is located in Stamford, Connecticut, where the Connecticut estate tax exemption is $2 million — the same as the current federal estate tax exemption. Our firm also has two Florida offices. That state does not have a state estate tax. The states which border Connecticut and in which some clients have vacation homes all have a state estate tax system. The exemptions from the state estate taxes of New York, Rhode Island and Massachusetts are, respectively, $1 million, $675,000 and $1 million.
When Congress revised the estate tax law in 2001, that revision gradually eliminated the "state death tax credit." That credit effectively created estate tax revenue sharing between the federal government and the states. With the repeal of the credit, the states lost that revenue source. The states responded to this lost revenue in a number of ways. Some states, like Florida, have elected against implementing a state estate tax. Other states, like my home state of Connecticut and the other states in the area, have "decoupled" from the federal estate tax system, creating an independent tax system with an exemption amount which may match the federal exemption (as in Connecticut), but frequently does not (as in New York, Massachusetts and Rhode Island).
This "decoupling" from the federal estate tax system has had unexpected and significant tax consequences for our clients whose estate plans were designed to avoid federal estate tax. When the federal and state estate tax systems worked together, a Will designed to avoid federal estate tax would also be effective to avoid state estate tax. Not anymore.
Because of this significant change, our law firm contacted every one of our estate planning clients to bring this change to their attention. Our lawyers spent literally hundreds upon hundreds of hours figuring out how to revise our documents to take into account that the state exemption from the state estate tax might be lower than, higher than or equal to the exemption from the federal estate tax. And we have familiarized ourselves with the estate tax systems of other states, and encourage our clients to retain attorneys in other states to determine whether assets outside of our client’s primary state of residence will be exposed to a state estate tax.
This is a challenge for our law firm even though we have more than 50 estate planning lawyers. We have the person power to familiarize ourselves with the estate tax systems of other jurisdictions, coordinate our response to our clients and update our firm’s drafting system. It is difficult to imagine how a solo practitioner who does some estate planning could adequately understand all of the planning issues that arise out of a state’s decision to decouple from the federal estate tax system, communicate all of those issues to his or her estate planning clients and help a client with a vacation home in another state plan for the estate tax system in that state.
The response of the various states to the 2001 changes to the federal estate tax system has made effective estate planning drastically more complex — and costly.
The Repeal of the Estate Tax for 2010 May Not Be All Good News for Taxpayers: Carryover Basis (Not Stepped-up Basis) at Death
A ticking tax bomb. In 2010, carryover basis applies to assets having over $3 million of appreciation inherited by a decedent’s spouse, and assets having appreciation of more than $1.3 million inherited by others. The $1.3 million is the amount for all heirs combined, not for each heir. Inheritances below those amounts are governed by the current stepped-up basis rules. These carry-over-basis rules apply for 2010 only; in 2011 and beyond the current stepped-up basis rules will apply.
Tax Reform Act of 1976—the ancient history. That law provided for a carryover basis instead of a stepped-up basis at death. Apart from the dissatisfaction with a rule that imposed a new tax (capital gains when an heir sold inherited assets), myriad outcries were heard by Congress that it was impossible to comply with the new rules. Congress retroactively repealed the carryover-basis rules to the date of The Act’s enactment.
Back to the present estate tax law — added complexity and costs to client. It is possible to draft estate plans to maximize the limited step up in basis (described earlier) and bequeath — if death occurs in 2010 — the most highly appreciated assets to charities (if one is planning charitable bequests). For charities, basis is generally irrelevant because only in rare cases do they pay capital gains taxes on the sale of appreciated assets. The least appreciated assets are bequeathed to family members. Planning becomes more difficult in determining which heirs will get the lower basis assets and which heirs will get the higher basis assets. The heirs will pay differing capital gains taxes on subsequent sales of their inheritances. Some of them will have bad heir days.
What’s happening on the ground? Most planners, I understand, are ignoring the issue. They believe that the carryover basis rules will never come to pass. Thus the general attitude is "wait and see." Of course, if the client is mentally incompetent in 2010, planning opportunities could be lost if carryover basis becomes a reality.
Planning for Interests in Qualified Retirement Plans: IRAs, 401(k)s, 403(b)s and SEPs
The estates of many individuals are comprised of interests in retirement plans and those plans represent a large percentage of their overall net worth. As a result, estate planners must consider those assets when preparing a tax-efficient estate plan. The use of trusts are often involved to hold an individual’s estate tax exemption amount and in planning for minor beneficiaries. As the size and importance of those retirement assets increases, so does the complexity in planning for their disposition under the current IRS regulations and rulings. They impose onerous requirements and seemingly arbitrary restrictions. The rules have become so complicated that trust planning with qualified retirement plans, which is absolutely necessary for spouses and minor children, is so complex that even the most sophisticated estate planning lawyers struggle with them.
High-net-worth Individuals: Estate Tax Concerns and Planning Techniques
Initial observation. While the amount of the estate tax exemption is of some interest, the overwhelming concern is the tax rates for the estate and generation-skipping taxes.
Testamentary planning techniques. The starting point is a testamentary estate plan that efficiently utilizes the estate and generation-skipping transfer tax exemptions, the marital deduction and the charitable deduction.
Lifetime techniques. Once the testamentary plan is in place, estate planning turns to lifetime giving strategies to remove assets from the estate and reduce the value of assets that will be in the estate.
The use of lifetime gifts up to the annual exclusion amount is one way to give assets to various family members thereby reducing the assets in the individual’s estate. Beyond that, any gifts (other than charitable donations) will either use the individual’s $1 million lifetime gift tax exemption or generate a gift tax. Thus the strategy is to focus on ways to make lifetime gifts using as little of the exemption or generating the smallest amount of gift tax possible in each transfer; and also to leverage the gifts to remove as much value as possible from the taxable estate for each dollar of exemption used or tax paid.
Estate planning for high-net-worth individuals focuses on identifying assets that have a lower value now than the individual expects them to have in the future, then transfer those assets now to the intended beneficiaries before the expected appreciation. Those gifts can be outright or in trust, and can employ strategies to further reduce the gift tax cost, such as making gifts to Grantor Retained Annuity Trusts.
Gift transactions are structured so that for gift tax purposes the taxable value of the gift is less than the liquidation value of the gifted asset. A common technique is a Qualified Personal Residence Trust.
Tax-efficient lifetime gifts are made by identifying assets that qualify for a valuation discount because of the nature of the assets’ ownership — e.g., establishing a valuation discount based on a fractional interest, minority-interest, or lack of marketability.
When the tax man cometh. Depending on the nature of a high-net-worth individual’s assets, estate planning can be as much about how to pay the taxes as how to avoid or minimize them. Because the estate tax is tax inclusive while the gift tax is tax exclusive, the same asset can be given during lifetime or at death with different total tax results. For some individuals, paying a gift tax now may be more tax efficient than having the estate pay an estate tax later. An estate planner’s job is to identify the individual’s ability to (1) make large taxable gifts, (2) pay taxes on those gifts and (3) structure those gifts in the most efficient way to limit the gift tax exposure.
The fly in the ointment. With the current uncertainty in the estate tax law, many individuals are reluctant to pay a gift tax now in order to avoid a larger estate tax later. They believe that there may be no estate tax when they die or if there is, the rates will be much lower. They fear that paying a gift tax now could be a foolish decision.
How to pay the estate tax. For some families, the issue is not when to pay the tax, but how. An estate that is high in value but lacking in liquidity can cause serious problems for the heirs who will be faced with a large tax due but difficulty paying that bill. This can lead heirs to sell estate assets quickly, with little ability to obtain fair market value for the assets. In those situations, the estate planner must work with the family to both reduce taxes and create strategies for liquidity at death. Those strategies may involve life insurance, buy-sell agreements, and complex structures.
Conclusion of Teitell’s Statement for the Hearing Record
A fable by the late Ambrose Bierce, American journalist and satirist, may be instructive:
An Associate Justice of the Supreme Court was beside a river bank when a Traveler approached and said:
"I wish to cross. Will it be lawful to use this boat?"
"It will," was the reply; "it is my boat."
The Traveler thanked him and, pushing the boat into the water, embarked and rowed away. But the boat sank and he was drowned.
"Heartless man!" said an Indignant Spectator. "Why did you not tell him that your boat had a hole in it?"
"The matter of the boat’s condition," said the great jurist, "was not brought before me."
When Congress enacted the current estate tax law in 2001, the matter of the uncertainty in planning that would result was apparently not brought before it.
Now that the matter has been brought to the Congress’s attention by myriad taxpayers and their advisers, it is time to enact corrective legislation — and soon.
Taxwise Giving & Philanthropy Tax Institute
PO Box 299, Old Greenwich, CT 06870-0299
©©©©2008 Taxwise Giving® All Rights Reserved