The New World of Estate Planning

Introduction

Estate planning is rapidly moving away from the historical focus on bypass trusts and saving estate taxes. While many professionals have rightfully focused considerable attention on income tax considerations, there is more involved. The shift in focus is due to far more than changing tax laws. Everyone, clients and professional advisers alike, will need to rethink every aspect of planning. This article will explore many of these changes and suggest practical steps to better serve existing and new clients.

Changes

While each of the change factors cited below is obvious, the impact is not as clear and will require reassessment:

• Demographic changes are reshaping estate planning. While everyone knows that the population is aging, what does that mean to both traditional estate planning and the professional services you might seek out? The answer will profoundly change estate planning.
• High estate tax exemptions ($5,430,000 in 2015) make the minimization of the federal estate tax irrelevant for all but the wealthiest taxpayers. If you are ultra-high net worth tax minimization planning should proceed with haste since the permanent 40% estate tax is substantial and the proposals to restrict a myriad of planning techniques used by the wealthy continues to proliferate (e.g., minimum term for GRATs, restriction on uses of grantor trusts in note sale transactions, etc.). For the vast majority of people, however, that high exemption makes the federal estate tax, but not planning, irrelevant. Don’t be lulled into inaction (or just as bad or worse, simply obtaining internet or cheap documents).
• Higher income taxes have shifted the focus of estate planning to address income tax implications of planning. This is a true sea change. You must review and revisit all existing entities, trusts and planning techniques. It might be possible to modify existing planning to obtain better income tax results. Too often people have merely liquidated partnerships, terminated trusts, cancelled insurance coverage, and taken other imprudent steps, without evaluating all the consequences.

Tomorrow’s Estate Planning will be Different

There should be an increased focus on non-technical, qualitative “fuzzy” or human considerations of planning. Planning for aging, health issues that increase with age, non-traditional family relationships and more, are all at the heart of what “new” estate planning is about. Historically, estate planning focused on minimizing transfer taxes on wealth transmission to the next generation. As a result the bypass trust and insurance trust were the focal point of many if not most plans. Tomorrow’s estate plan is more likely to address wide-ranging concerns. For example, if you are a Baby Boomer who anticipates living for two or three decades into retirement,  you are likely to be more concerned about cash flow and health issues then estate (or even income) taxes. Will you have adequate cash flow for those many post-retirement decades?

Are you worried about the risks of Alzheimer’s disease and other dementias? Planning to address these concerns differ markedly. You will have to take your estate planning in new directions, seek different services from your professional advisers, and work with those advisers in different ways. For example, the role of your CPA will likely increase relative to that of your attorney as income taxes assume a greater role. The roles of your CPA and wealth manager will increase relative to that of your attorney as cash flow projections and planning become more important that minimizing estate taxes. The role of your estate planning attorney will also shift as he or she begins to address a wider range of more personal planning issues.

Tax Returns

Tax returns and filing requirements will be affected in a number of ways by the changing demographics, tax planning goals and other considerations.

• Estate Tax Returns, Form 706 – The filing reflect a rapid decline year by year of the number of estate tax returns filed. However, with the advent of “portability,” the ability of a surviving spouse to use the estate tax exemption of the first spouse to die, the number of returns filed each year should begin to rise significantly. Many more people will have to file estate tax returns as that will be required to preserve or “port” the first to die spouse’s exemption. But the nature of those returns, and who should prepare them, will change as dramatically. It has been common for most estate planning attorneys to prepare Forms 706. When there was a significant tax due, or at least the potential for a large tax, people were willing to incur the costs of attorneys completing these tax returns. However, if the vast majority of Forms 706 will be filed merely to secure portability of the exemption from the first spouse to the surviving spouse, with no anticipation of an estate tax ever being due, you might prefer to use the lowest cost and most efficient service to preserve the exemption. In many if not most cases this will be your CPA. Whatever is done concerning filing an estate tax return, you will need to collect data as to the fair value of assets on death in order to determine the income tax basis of those assets. So even if you opt not to file a return you should have your CPA prepare a schedule of assets and their date of death values.

• Trust Income Tax Returns, Form 1041 –  As you age the benefits of using trusts to protect wealth you have accumulated, and using trusts to protect yourself and your loved ones will become more common. The aging population should be accompanied by an explosion of revocable living trusts (all taxed as grantor trusts) since that is a prime tool in protecting clients from the challenges of dementia and aging generally. The increasing use of trusts will result in more income tax reporting implications. The search for income tax basis (the amount on which gain or loss is determined when an asset is sold) has resulted in many, perhaps most, irrevocable trusts being structured as grantor trusts. These are trusts that, while out of your estate, the income on which is taxed to you. Most of these grantor trusts include “swap powers” that permit you, as the grantor/settlor of the trust, to swap or substitute assets in your name, for highly appreciated trust assets. Swapping will bring those assets back into your estate so that on your death those assets will be included in your estate so that they will qualify for a basis step-up.
• Notifying the IRS of Trust Relationships, Form 56 – With the increasing use of trusts, and the need to replace aging individual trustees, Form 56 which has too often been ignored, should be given more attention. This form is used to properly inform the IRS of changes in trustees and terminations of trusts. If you are a trustee of any trust and this form has not been filed, file it now. If you were a trustee of a trust that has been terminated file the form to inform the IRS of that fact.

Tax Planning

You tax planning will be affected in a number of ways by changing goals and the new tax environment.

• Monitor swap powers – The importance and growing use of swap or substitution powers in trusts was noted above. But merely including of these powers in a trust is not sufficient. They have to be planned for, monitored, and used when appropriate. Protecting assets will continue to be an important goal for clients. You (really the trustee of your trusts) need to monitor the use of these powers so that as you age, or if you become ill, appreciated assets can be swapped back into your estate before death to realize a basis step-up. Monitoring these powers should be a regular item on every irrevocable trust annual (or more frequent) checklist.
• Evaluating grantor trust status – The adage “too much of a good thing” can apply to grantor trust status as well. The tax “burn” on your estate will result from your personally paying income tax generated on assets held in an irrevocable trust you created. While this can be a powerful wealth shifting and asset protection tool, at some future stage you may tire, or not be able to afford, the continuation of that tax cost. Monitor the status of grantor trust powers and identify when they might become counterproductive so that action can be explored to turn off grantor trust status if feasible and if appropriate.
• Powers of appointment to capture basis step-up – A mechanism that is growing in use to secure the elixir of basis step-up by estate inclusion is the use of general powers of appointment. Historically these had been used to avoid the undesired incurrence of a generation skipping transfer (“GST”) tax by forcing the assets involved into a beneficiary’s estate to avoid the GST tax. With the high $5,430,000 2015 exemption few clients face or care about GST taxes. But these same powers can be harnessed to increase basis. For example, if you create a spousal lifetime access trust (“SLAT”) (analogous to a credit shelter trust for spouse and descendants but created during your lifetime) this technique can be modified to provide incredible income tax benefit. Perhaps a poor relative, e.g., a parent or mother/father-in-law lives in a non-decoupled state and has modest wealth. If the SLAT is funded with $2 million perhaps this elderly mother-in-law could be given a general power of appointment over the trust assets. This should cause all trust assets to be included in her estate. There will be no estate tax since her estate is well below the exemption amount but the inclusion will cause all assets in the SLAT to receive a step-up in tax basis savings tremendous capital gains during your lifetime. Planning for, monitoring, and reporting the use of general powers should be a new and regular component of your estate planning reviews.

Additional Planning Considerations

The “new” estate planning will bring with it expanded issues to address:

• Monitoring services – As you age increasing physical and cognitive frailty will ensue. Creating checks and balances to protect you and your loved ones through this process. For example, arranging for your CPA to receive monthly statements and to input all data into Quicken or another program can provide valuable monitoring. If a child is named agent under a client’s durable power of attorney, monitoring the accounting of what is being done in that role may be vital to protect you and preserve family harmony. Similarly, with the increasing use of revocable trusts to protect you as you age, monitoring children and other non-professional successor trustees, even monitoring your conduct as you age, will be a valuable protective step. Little has been done historically to fill these needs.
• Budgeting and financial planning – Traditional financial planning, budgeting and forecasting services should be a growing component of what estate planning is about to assure you remain on target for your goals over what may well be decades of later life.

Fiduciary Roles in the Post-Cleaver Age

The typical American family doesn’t resemble the Cleavers. For many, it is difficult with families geographically dispersed, wracked by divorce and other disruptions, to identify trusteed and capable persons to serve in various fiduciary capacities. Different approaches are required It might be advisable to name a corporate trustee, perhaps in appropriate cases a trusted professional adviser with whom you have a long term relationship. For example, using a funded revocable trust with a corporate successor trustee may be an ideal approach to providing protection when close (in relationship and geographically) family is not available.

Conclusion

Estate planning will be a new world with new goals and new solutions. Many of these will be different then the historical estate tax-minimization focused solutions that have been so commonly the focus of planning. To best protect yourselves and your loved ones, be proactive and think in broad humanistic terms.