Will Power: Estate Planning & Retirement

Staff Writer
Columbus CEO

Wealthy or not, most people want to ensure that any inheritance, gifts or assets in their estate plan can be conveyed easily, and with as small a tax bite as possible.

However, that’s sometimes easier said than done, given that the federal estate and gift tax exemptions and rates have been a moving target for several years. The same holds true as 2012 turns to 2013.

Financial planners and estate planning attorneys are fielding many questions about how exemptions are changing and what actions people should take to limit their tax liability so their heirs—not Uncle Sam—receive the bulk of what’s been designated for them.

Professional advice isn’t always cut-and-dried, of course. It depends on the individual client, his or her wealth (or lack thereof) and the use of tax-saving tools such as credit shelters and other trusts.

For 2012, the individual federal estate tax and gift exclusion is $5.12 million, up from $5 million in 2011. However, both are set to drop to $1 million as of Jan. 1 unless Congress takes action, which it had not done as of early December. Also set to end is the portability provision, where a surviving spouse can inherit the unused portion of the husband or wife’s exemption and add it to his or her own exemption.

“There are a host of vehicles available for those clients for whom the use of the exemption makes sense,” says Joseph Chornyak Sr., managing partner and Certified Financial Planner at Chornyak & Associates, in an email interview. “Which vehicle makes the most sense depends upon each client’s individual circumstances.

“The fundamental question for most clients, however,” Chornyak adds, “is whether it makes sense at all.”

In recent years, trying to predict the federal estate tax exemption has been an exercise in futility. New York Yankees owner George Steinbrenner was one of several billionaires who died in 2010, the year there was no federal estate tax. In 2009, the exemption was $3.5 million.

Given the uncertainty, some professionals have taken to giving very basic advice to their clients: “I always tell them to try their best to live till next year,” says attorney James Bownas, a partner at Lane, Alton & Horst whose practice areas include income, estate and gift tax law.

Transfer Tools

Estate and gift tax exemptions are important planning tools to maximize the amount of money transferred to the intended recipients. “The estate and gift taxes are taxes levied on the transfer of wealth from one person to another,” Chornyak writes.“There are a number of exemptions from the taxes. For instance, U.S. citizen spouses can transfer an unlimited amount of wealth between themselves, either while living as a gift or at death, without any tax.”

Gifts or inheritances given to other individuals are taxed at the prevailing federal and state rates in place at the time of the gift or the time of death. For 2012, the portion of any estate or gift that exceeds the exemption threshold is taxed at a federal rate of 35 percent. That rate is scheduled to jump to 55 percent as of Jan. 1, barring Congressional action.

Forgive financial planners and attorneys if they’re muttering, “Here we go again.”

“The last time this happened, in 2010, Congress did act,” Bownas says. “But they did it at the end of the year, did it retroactively and nobody knew what to do in the meantime.”

Consensus among the professionals interviewed for this story is that Congress is likely to agree to raise the estate tax exemption from $1 million to around $3.5 million, with a maximum tax rate of 45 percent—what President Barack Obama prefers.

Amid the uncertainty, financial planners are seeing clients with more urgency to make gifts, create trusts, consider capital gains moves, or maybe even transfer shares of their business to their children at the 2012 exemption level. At the same time, they’re trying to keep enough money to live on for the rest of their lives.

Fiscal cliff politics and the debate about raising taxes for those earning more than $250,000 annually also have been cause for concern. “A lot of clients, the news is scaring them,” says Kristen Moosmiller, a Certified Financial Planner with PDS Planning, an investment advisory firm.

Moosmiller says many of her clients are worried about getting pushed into a higher tax bracket. “We review their tax return with them and see what their income actually comes from … assets versus income. For a lot of the clients, it’s an educational concept.”

What makes a person “wealthy” is open to interpretation, but Bownas says it’s not unheard of for someone to be a millionaire and not be aware of it. Assets such as a home, a growing 401(k) account, perhaps a vacation home with increasing value can help elevate an individual into millionaire status. The reaction, Bownas says, often is, “What? How did that happen? It’s good, but how did that happen?”

If Congress fails to act, or votes to leave the 2013 exemption at $1 million, the estate and gift tax net would catch many more Americans than the $5 million break. And they would all be paying 55 percent rather than 35 percent on the amounts that exceed the exemption.

Count Chornyak among those who doesn’t expect that to happen. He estimates the exemption will remain in the $3.5 million to $5 million range. “If people began to believe that the $1 million exemption currently on the books to become effective Jan. 1, 2013 would be the actual exemption going forward,” Chornyak says, “urgency might give way to panic.”

He adds: “Without getting into discussion of who is ‘really wealthy,’ it is clear that the drop in the exemption to $1 million will affect a large number of people, including both business owners and hard-working employees who have saved and invested.”

Other Options

Jeffrey Smith, senior wealth planner for PNC Wealth Management, says he’s telling clients to consider options that go beyond the exemption changes and to plan a course of action to minimize tax losses.

Taking advantage of low interest rates may help. Smith says it’s possible to make low-interest loans to relatives that limit tax liability. “That’s a way to help out family members or make transfers to them.”

Another option, Smith says, is a GRAT, or Grantor Retained Annuity Trust. The trust is taxed when it’s established and assets are transferred into it. Annual payments are then made to the grantor, based on interest earned on the trust’s assets or a percentage of their value. When the trust expires, if the grantor survives the term of the trust, the beneficiary receives any remaining assets tax-free.

Other individuals may set up a Roth IRA or a tax-saving trust that allows Mom and Dad to name their kids as beneficiaries without giving them an outright gift, says Bownas—such as to transfer stock as part of an exit strategy for business owners who expect their company will grow in value.

It’s all enough to keep financial advisors and estate planning attorneys busy. “A lot of [clients] are being driven to us by their financial advisors. There’s so much going on they can’t even process it,” Bownas says.

There’s also a big change in store at the state level. Effective Jan. 1, Ohio’s estate tax will disappear. Municipalities with many older residents stand to lose the most, since they will no longer receive revenue from estate tax collections. But individual taxpayers could save a bundle. Before the repeal, those who inherited an estate valued at $338,333 or more paid a flat tax of $13,900, in addition to 6 percent on the excess. The bill jumped to $23,600 for estates valued at $500,000 or more, plus a 7 percent rate on the remainder.

However, the repeal doesn’t necessarily mean that Ohio won’t ever have an estate tax again. “It would be a politically very easy tax to reinstate some day,” says Bownas.

Chornyak calls the expiration of the Ohio estate tax a “pleasant surprise” for most clients. “Few people are changing their plans based upon the expiration, but it does reduce the family wealth transfer cost of remaining an Ohio resident,” he says.

Regardless of the approach that individuals take, there’s a lot of decision-making tied to the pending federal changes. Even if Congress agrees to keep the exemption at $5.12 million, or lowers it to any amount above $1 million, the debate about a permanent solution is likely to continue. “It will be a patch like it was the last time, for a year or two. It won’t be a long-term solution,” Bownas says.

“For those older clients with a net worth close to the exemption amounts and all clients with a net worth significantly in excess of the exemption amounts, December 31, 2012, may well mark the end of a unique opportunity to make a sizable gift,” Chornyak says. “For the rest of our clients, it is just another annoying uncertainty.”

Moosmiller agrees. “It’s kind of a sit-and-wait situation,” she says. For her clients, many of whom are retired, estate planning has a clear-cut mission. “They want things to go to their children, and it’s not too complicated.”

For now, at least, they’ll have to wait a little longer for a simpler solution.

Debbie Briner is a freelance writer.

Reprinted from the January 2013 issue of Columbus C.E.O. Copyright © Columbus C.E.O.