The battle over whether to repeal or reduce federal estate and gift taxes will probably be resolved this year. For the moment, however, the federal estate and gift tax system remains intact following former President Clinton's veto of Congressional legislation to repeal the so-called death tax and President Bush's proposal to phase out the death tax. But even if Federal estate taxes are eventually wiped off the books or dramatically reduced, that won't eliminate the need for estate planning.
Good estate planning is first and foremost a method for ensuring that your property, however much and in whatever form (cash, stocks, bonds, real estate, life insurance, retirement benefits, etc.), goes to the people and organizations you choose in the most efficient and cost-effective way. Even if you don't have an estate large enough to be vulnerable to the current Federal estate tax system (98 percent of the population does not), you still need to develop a sound estate plan, or the state will do it for you. Furthermore, estate planning involves the selection of a fiduciary (Personal Representative and/or Trustee) who will handle the management and distribution of your property. This has nothing to do with taxes. Either you select the person or persons to handle these tasks or you leave it up to a court to decide. The person or persons the court picks may be the person or persons least desirable to you. Finally, if you have minor children, do you want to pick the guardian for your children or do you want to leave that decision up to a judge? Also, do you want the same person or persons to manage your property as well as to raise your children? Without estate planning you could end up with the least desirable people raising your children and handling your property. Again, estate planning is much more than tax planning. Estate planning is the process by which you, and not a judge, determine what is best for your loved ones and your property after you are gone.
Probably nothing is more associated with sheltering estates from taxes than the use of trusts. It's true that some types of trusts might disappear, or at least lose their principal usefulness, if estate taxes were eliminated. But trusts serve many other purposes, as well. For example, a revocable or living trust doesn't save taxes, but it avoids the expense and hassle of probate. Furthermore, regardless of what your will or trust says, your retirement accounts and life insurance usually bypass probate and go to the beneficiaries named on those accounts, regardless of the age of the beneficiary. You may have avoided probate with your retirement accounts and life insurance proceeds but ended up handing a large sum of money in a lump sum to a child who is incapable of handling it properly. For example, some families use incentive trusts to encourage a beneficiary to take certain actions, such as doing certain philanthropic work or earning a certain level of income in order to receive distributions from the trust. Trusts may not parcel out money beyond basic support to a child until the child reaches a certain age. A trust can ensure that the trust's property is well managed for a beneficiary who is not financially mature. Special needs trusts are established for persons receiving public benefits because of special physical or mental problems. Also, by naming a trust as the beneficiary of a retirement plan or life insurance proceeds, you are able to control how and when the proceeds are distributed. Please note, however, that there are some very important income tax issues involved in retirement plan beneficiary designations so before one names a trust as the beneficiary of such a plan, some serious income tax planning should be undertaken.
Because of high divorce rates and remarriage another issue to consider these days is the use of trusts such as the qualified terminable interest property trust to ensure that property goes to your children and not children from another marriage of your spouse. Without such a trust and a properly written will, the current spouse, and even the spouse's new marriage partner or new children, could unintentionally end up with your assets.
Life insurance is another area of estate planning that will not disappear merely because Federal estate taxes do. Larger estate owners would no longer need to buy life insurance to provide the cash to pay for Federal estate taxes, nor would they have to employ strategies such as irrevocable life insurance trusts solely to keep the insurance policy out of their estates. However, they may still want life insurance to support surviving children and spouses, to help heirs pay potential capital gains taxes or to contribute at death to their favorite charity. Business owners will continue to have a need for life insurance. For example, they may want to pass on the family business to a designated heir while using life insurance to compensate the other heirs.
Actually, the elimination of the Federal estate tax would give reason to revisit existing estate plans. Because of the reduction or elimination of Federal estate taxes, many individuals may now seek to change their estate plans since many were structured primarily to shelter estates from Federal estate taxes. Many estate plans may soon be able to be simplified in structure and be implemented more cost effectively due to the elimination of the additional layers or steps that were required to avoid or minimize Federal estate taxes.
Additionally, estate planning is more than just the creation of wills and trusts. Living wills are needed to ensure that you are not given certain life-saving treatments you don't want should you be unable to make the decision yourself. A health care surrogate designation is needed to ensure that you are given certain life-saving treatments you do want if you are unable to make the decision yourself. A durable power of attorney is invaluable for allowing someone to step in legally and financially on your behalf to execute documents and make decisions if you are incapacitated. All three of the above documents can be incorporated into one long document however most people prefer to keep them separate in order to keep things simple.
It is very important to realize that the death of the Federal estate tax will not mean the death of all taxes. First, one must consider the impact that the elimination of Federal estate taxes will have on the states. In Florida, for example, in the fiscal year 1999-2000 the state of Florida collected approximately 780 million dollars in estate taxes through its share of the Federal estate tax. That number has increased on average by over 90 million dollars per year since 1995. Should the Federal estate tax be eliminated this will result in a budget shortfall for Florida which will presumably be made up by the enactment or increase of some other tax. Second, right now, when you die the cost basis of assets such as your stocks and your home are stepped up to the current market value (the so called "step up in basis"), so income taxes on capital gains are avoided when appreciated property is held at death. But if the Federal estate tax is repealed, this step up in basis may be eliminated. That means that, even as your estate tax worries wane, you may have to start fretting about those unrealized capital gains. Third, and finally, as was mentioned above, you will still have to cope with the income tax bills arising from retirement plan distributions. Even now, those income taxes don't disappear with your death.
In closing, estate planning goes far beyond Federal estate tax planning. Even if Federal estate taxes disappear, there are significant issues, tax and otherwise, that one still needs to grapple with in order to assure the most desirable outcome to life's most undesirable and unwelcome event. Though it is tough to talk about, planning for ones death will still be very necessary to assure.