Resting in peace just got tougher.
In June, after months of rancorous debate, the U.S Senate voted not to abolish the sunset provision of the death tax (also known as the estate tax). The vote, which split down party lines, all but killed hopes for a permanent repeal of the death tax.
Granted, the estate tax is scheduled to be gradually rolled back over the next few years, then disappear entirely in 2010. But thanks to the Senate vote, the tax will merely be dormant, not dead: it returns in full force in 2011.
For high net-worth executives, that bizarre bit of scheduling makes for some extremely complicated estate planning. As the law stands, the estate tax exemption of $1 million in 2002 gradually rises to $3.5 million in 2009. The top estate tax rate, which is 50 percent in 2002, gradually declines to 45 percent over that time. In 2010, the death tax disappears. But get this: once the death tax comes back from its one-year holiday, it reverts back to the 2002 exemption, or $1 million at a 55 percent rate.
Congress’s unusual approach to estate planning — that is, creating a moving target — has financial planning experts flummoxed. Says Craig Janes, national director of estate gift and trust services at Deloitte & Touche: “You now have to have documents that are sufficiently flexible that handle death right around 2009 and what happens if the estate tax that we knew last year springs back into existence.”
At the very least, financial planners say estate owners should review and update the language of their will — repeatedly. And they say high-net worth individuals should evaluate trusts to take into account the tax law changes.
Consider, for example, a happily married CFO with an estate of $5 million. The finance chief wants to leave his wife at least $3 million, but also doesn’t want his issue (also known as children) to have to pay any federal estate tax. If the CFO happens to die in 2002, those heirs would get $1 million (the full death tax exemption), while his wife would get $4 million and avoid taxes because of the unlimited marital deduction. This implies our executive hasn’t made large gifts in the past because that will eat up the $1 million exemption, too.
If our CFO dies in 2009, and his will still says that he wants his children to benefit from the full estate tax exemption that the law permits, the progeny would get $3.5 million. But his spouse would only receive $1.5 million from the estate — well below the $3 million the CFO had intended to leave his loving wife. Maybe she could go work for the kids.
Formula clauses, which take into account changes in rates and exclusions, may be one fix for the problem. For instance, as the death tax exclusions rise, the children’s contribution could be capped at $2 million. “But because there’s such variations in what the law will be in the next nine years and what it will be after 2011,” notes Janes, “it’s becoming incredibly difficult to accurately draft formula clauses, and they have become extraordinarily complicated.”