For lawyers, estate tax incomplete puzzle

By Albert Turco and

Kimberly Atkins

Dolan Media Newswires

With little chance of long-term federal estate tax reform passing any time soon, attorneys are again trying to plan as best as they can, not only for their clients, but also for themselves.

"Nobody has a clue what's going to happen," said Richard H. Gregory III, a Providence attorney who specializes in estate planning.

In his fiscal 2013 budget proposal, President Barack Obama proposed an increase in the estate tax that would drop the gift tax exemption from $5.12 million to $3.5 million, and raise the tax rate from 35 percent to 45 percent.

That plan, like the rest of the budget measures proposed by the president, would have to be approved by Congress to take effect, something that is far from certain. So in the meantime, lawyers are preparing for anything.

They have had a lot practice in dealing with uncertainty around the estate tax. The tumultuous state of federal tax law stems from a complicated tax scheme that saw the estate tax rate gradually decrease from 2001 to 2009.

Gregory said he is surprised that Congress has yet to establish a long-term policy.

In 2010, lawyers and estate planners watched inaction from Congress cause the estate tax to be repealed. During that year, lawyers feared the possibility of a retroactive reinstatement of the tax, which did not happen. They also prepared for the possibility that the tax would return in 2011 with a vengeance, reset at the high rate of 55 percent with only a $1 million exemption. That did not happen either; in the 11th hour of 2010, lawmakers and the White House agreed to the current short-term measure that set the 2011 exemption at $5 million ($10 million for married couples) and the estate tax rate at 35 percent.

Predicting the law and protecting assets

The current rate is set to expire at year's end and will revert back to the highest rate of 55 percent with a mere $1 million gift tax exemption, unless a new measure is signed into law.

But because this is an election year, lawmakers probably are not going to address tax reform until after the November polls.

So the fate of the estate tax could be decided in a six-week window. Or Congress could act later in 2013 and make the law retroactive to Jan. 1 of that year. The uncertainty does not make lawyers' jobs any easier.

Gregory said the "least likely outcome" is that the law returns to a $1million gift exemption and 55 percent estate tax rate and remains that way. He said he expects Congress to take up the issue sometime in early 2013 and reach some compromise.

But he is advising clients who can take advantage of the current $5 million gift tax exemption to do so now.

Providence attorney F. Moore McLaughlin IV said most of his clients are small business people whose wealth is tied up in their businesses. They will feel the impact of any reduction in the exemption but cannot afford to give away millions of dollars today, he said.

"I heard about someone, not a client of ours, who gifted 90 percent of his wealth to an irrevocable trust because he believed he'd run his business until the day he died," McLaughlin said. "Then a great offer to buy came along, but he only owned 10 percent of the business."

Although estate tax liability under any possible plan would affect only those with million-dollar estates, many middle-class clients, including small business owners and elderly clients could meet that threshold more easily than they think.

Here are some of the examples of situations in which clients require careful planning:

* Couples who have remarried and have children from prior marriages;

* Elderly clients who purchased homes decades ago that are now valued well above the exemption limit;

* Couples whose joint assets clear the exemption amount but who have not planned because they do not feel very wealthy; and

* Professionals and small business owners -- including attorneys at small firms -- who are looking to protect their assets.

"Every lawyer reading this [article] should be looking for asset protection," said Martin M. Shenkman, a New Jersey attorney specializing in estate and corporate practice.

Some planning tools in peril

Although Obama's plan is only the starting point in the tax law negotiation process--lawmakers will release their own plans and the debate will progress from there -- it is worth noting that the White House proposes eliminating some frequently used estate planning methods.

For example, the president proposes dropping the lifetime federal gift tax exemption from $5 million to $1 million, a move that would strip estate planners of one of their most basic tools. Such gifts can be particularly useful in states like Rhode Island, which have no state gift tax, but lawyers nationwide rely upon this strategy.

"Consider the same-sex couple, where one partner is wealthier than the other," Shenkman said. "And the wealthier partner wants to have some jointly owned property with the other partner."

Typically, the wealthier partner could take advantage of the large gift tax exemption to convey property that is likely to appreciate in value over time in order to minimize estate taxes, Shenkman said. Under Obama's plan, however, a gift of $1 million or more -- the cost of many homes in the country -- would incur immediate tax liability.

Shenkman said it is not just the "ultra-wealthy" doing this type of planning. "This happens in a lot of scenarios."

In addition to changing the gift tax exemption, Obama's proposal would eliminate certain forms of grantor trusts and dynasty trusts. It also remains unclear whether any new tax law will include a portability provision, which allows surviving spouses to benefit from the unused exclusion from their spouse's estate.

Several attorneys predicted that portability would remain in the law, noting that the provision had not been a point of dispute in previous wrangling between Republicans and Democrats, but nothing is certain.

Erring on the side of caution, many lawyers are utilizing a number of mechanisms, including certain types of irrevocable trusts, domestic asset protection trusts and other measures that allow the grantor to retain some control of the assets during his lifetime.

Lawyers said they do not expect the situation to get any clearer soon, particularly not in an election year.

Entire contents copyrighted © 2012 by The Dolan Company.

Published: Thu, Mar 29, 2012