Jan Peterson

Monday, 29 August 2005 05:08

Estate tax changes

The federal estate tax will expire, at least temporarily, in 2010, when phased-in reductions in the tax rate and increases in exemptions end. The changes have generated a great deal of discussion, pro and con, since they were announced in 2001, and it remains to be seen whether Congress will permanently repeal the tax after 2010.

In the meantime, it is important to note that the changes — which call for staged adjustments ending with an estate tax rate of 45 percent and a $3.5 million exemption in 2009 — will not in and of themselves sustain a business as it transitions from one generation or owner to the next. Included with the reductions are provisions that make it easier to qualify for valuation discounts on farms and business real estate and that provide extended tax deferrals at low interest rates if a family business comprises more than 35 percent of an estate, but even these cannot ensure continuity. Combine this with the reinstitution of estate tax on the state level, and transferring business assets from generation to generation has never been more complicated.

Equally worrisome is that the run-up in exemption amounts has created allocation problems in some existing estate plans. For plans created before 2001, when the federal tax changes began taking effect, a business owner with a $2 million estate may have devised an estate plan calling for the maximum amount to go into an estate-tax-free family trust.

Before 2001, that plan would have resulted in $1 million allocated to the family trust and the other $1 million allocated to a marital trust for the benefit of his or her spouse. Typically, that arrangement gave the surviving spouse broad flexibility to use the marital trust money as desired, and income only from the family trust without demonstrating need.

If that same owner died today without having adjusted his estate plan, the entire $2 million estate — the maximum exemption this year — would be allocated to the family trust. While the spouse would still benefit from the income of the family trust, he or she would not have the intended access to estate funds.

Those considerations and others make it critically important that owners of family businesses and farms review existing estate plans — or draw up plans for the first time — with an eye on the effect tax changes will have if they die before 2010.

A bank wealth management adviser can help. A seasoned banker who has the depth of experience to understand all the details surrounding estate planning, along with the federal and state estate tax changes, can provide the nuts-and-bolts analysis owners need to determine how best to allocate assets.

The banker who becomes acquainted with the business owner’s entire financial picture can walk the owner through the overall flow of estate assets. An attorney can then create the legal documents reflecting any changes that must be made.

Bank advisers who are experienced in trust administration and estate settlement can assist not only with planning for federal tax changes but also for the separate taxes that states have enacted in response to the phase-out of the state tax credit of the federal estate tax. Now estates that are not subject to federal death taxes may be liable for state death taxes, depending largely on where the business owner is domiciled at time of death. Bankers can help business owners who have business locations or homes in more than one state decide where to establish domicile.

Congress will ultimately determine whether the estate tax repeal is permanent or whether 2011 will usher in a return to some form of taxation upon death. Business owners can’t afford to wait and see, however — too much is at stake in the meantime. They must make their estate plans an integral part of their business plans today.

Jan Marc Peterson is vice president, client relations, in wealth management at MB Financial Bank. Reach him at (847) 653-2139 or jpeterson@mbfinancial.com.