Personal Finance: Death and Taxes

One issue of particular interest to business owners and executives in the coming Presidential election is estate taxes. Currently they kick in on estates worth more than $675,000 (or $1.35 million for a husband and wife). The rates are confiscatory -- as high as 60%. Republicans have made repeal of death duties a key element of their platform, and a victory in November by George W. Bush could result in their elimination. Al Gore has offered a more modest adjustment of estate taxes, targeted at family-owned farms and small businesses, that would raise the $1.35 million exclusion to $4 million. So no matter who wins the election, the outlook is "very favorable for the closely held world," says Douglas A. Rothermich, an estate-planning consultant for TIAA-CREF Trust Co., St. Louis. He recommends holding off on certain estate planning tactics, but not on preparing a plan in the first place. "I think the more prudent course is to prepare appropriate tax planning as if death were to occur in the near term," he says, "but also to build flexibility into the estate-planning documents so that if and when radical changes in the estate tax code do occur, you haven't locked yourself into a position you will come to regret." The word to focus on is this: irrevocable. Until the dust clears, avoid it. The basic building block of an estate plan is often a living trust, which is revocable. With this strategy you transfer assets such as your home and automobiles and sailboat, as well as your business, into a trust, of which you are the principal trustee. These trusts have less to do with taxes than with avoiding probate. Not only is this an expensive and time-consuming process, but all the records, including business records, are put in the public record. Living trusts also allow you to name contingent trustees who can step in if you become incapacitated, likewise without the expense of legal proceedings. The standard tax-oriented trust is what is usually called a unified credit trust. The words refer to the amount excluded from estate taxes for any individual. In such a trust, the amount excluded from taxation for the first spouse to die is carved off into a separate trust, often called a bypass trust, thus preserving the unified credit of that person. The balance goes to the surviving spouse. Spouses are not taxed on such inheritances. Estate lawyers sometimes refer to these as A/B trusts: A is the unified credit portion, and B is the marital trust for the surviving spouse. The point of these trusts is to preserve the unified credit for each of the two spouses, but they max out at the combined credit, which this year and next is $1.35 million. Over the years the IRS has approved various schemes for protecting larger estates. The usual condition is that these more-sophisticated trusts be irrevocable. Some of the most common irrevocable trusts are tied to charities. Under current law, an estate can avoid taxes on the capital gain of the value of a business -- which tends to be extremely high, because many businesses are born in the founder's checkbook -- by leaving the business to a charity, which can sell it without paying capital gains. The charity in turn buys an annuity for the donor to provide income for his or her lifetime. But such a step might not be necessary if estate taxes are reformed. Rothermich says he recommends clients hold off on irrevocable trusts until Washington has acted.