REAL ESTATE TACKS: PLANNING SAILS YOU THROUGH THE LEGAL MAZE
Business North Carolina
May 2005
With President George W. Bush back in the White House, and Republicans holding a majority in the House and senate, are the days of estate tax numbered? The topic has become charged with emotion, often along political lines. The stakes could be huge.
The Heritage Foundation, a Washington, D.C.-based think tank, says the tax makes it nearly impossible for some families to transfer a business to the next generation. In 2001, Congress passed a compromise that did not repeal the estate tax, as some had hoped, but allowed for gradually increased individual estate-tax exemptions, lower tax rates and a one-year moratorium in 2010. Many believed Bush, if he won re-election, would kill the tax or make the increased exemptions permanent.
But North Carolina estate planning lawyers aren’t holding their breath waiting for permanent repeal. "Nobody knows what’s going to happen between now and 2011," says Penn Craver, Jr., a partner with Kilpatrick Stockton, PLLC in Winston-Salem.
Bill Culp, Jr., a partner with Culp Elliot and Carpenter PLLC in Charlotte, says taxpayers should pin all their hopes on repeal. "For a lot of people, the estate tax is really a voluntary tax. If you start planning, you can avoid the estate taxes that would otherwise apply. Every year, we have people who die and pay estate taxes. Right now, those who wait are running the risk of an untimely death and having to pay."
So what do people need to know about estate tax laws? A lot depends on their assets and objectives. The estate tax didn’t become part of the tax code until 1916. Since then, the tax has been mercurial. The top rate has ranged from 10% to nearly 80%. Individual exemptions have been as low as $50,000. And it wasn’t until 1948 that marital deductions were part of the law. By the 1970’s the gift tax and estate taxes were unified. By the 1980’s, exemptions were raised, rates dropped and unlimited marital deductions added. In the 1990’s, exemptions were raised again, this time to $1 million.
Once Bush came into office, estate tax rates dropped below 50%. The current exemption is $1.5 million. It is scheduled to rise to $2 million in 2006 and $3.5 in 2009 before the tax temporarily disappears in 2010. In 2011, the tax will return with a $1 million exemption and a top rate of 55%. That is, unless the law is revisited. "Our economy is coming back up, and we don’t need the revenue. Now, I think it’s more about out national policy and whether we should allow vast amounts of wealth to accumulate," says Craig Dalton, partner and head of Poyner & Spruill LLP’s estate planning section in Raleigh.
Adam Shealy, lawyer and certified public accountant who specializes in estate planning and probate law, says estate planners eagerly await the release of the first report of the PResi9dent;s Advisory Panel on Tax reform, due July 31. "I think what they’ll come back with this reform or revision of the estate tax, "says Shealy who practices in the Hendersonville office of Asheville-based Van Winkle, Buck, Wall, Starnes and Davis, PA.
But any major change to the tax code would require 60 votes in the Senate, where Republicans hold 55 seats. "It’s not clear if they’ll be able to pull it off with Social Security reform on the table, the deficit... there’s just an awful lot that got to be done," he says. "Still, a few years ago, before the 2001 Act, most estate planners probably would have laughed at you if you said estate tax was going away. I’ve learned never to say never about anything."
What this means is that estate planners expect continued change. "You plan for a static environment when we’re anything but static," says Bill Nicholson, advanced planning specialist with Raleigh-based Capital Investment Cos., and director of Capital Insurance Affiliates. He recommends re-examining estate plans every three years -- more often if tax laws change.
There could be something else to worry about. Most states have never levied an estate tax because they receive a portion of the feral levy. Whispers of permanent repeal have caused states to review their policies.
This could become particularly expensive in North Carolina, where, Culp notes, there is a state gift tax. "There have been many proposals to repeal the gift tax, but the state needs the money and hasn’t done it," he says. "North Carolina has been pretty aggressive in interpreting estate tax and gift tax law. In certain cases, it makes a big difference."
Record keeping also could be affected by tax law changes. One feature of the federal estate tax is known as a "step-up in basis," which means that increases in the value pf an asset that occurred while it was owned by the decedent aren’t charged against the inheritor. The step-up in basis is scheduled to go away along with the estate tax in 2010, which leads many estate planning professionals to speculate that the federal government may use the capital gains tax to make up for the revenue lost through the estate tax.
To show how this works, Dalton uses an example of a client whose grandmother leaves him stock. She purchased it for10 cents a share many years ago, but now it’s worth much more. The client wants to sell the stock. The step-up in basis means that the client, when she decides to sell the stock, would pay capital gains only on the increase in value from the time he inherited the stock. If the step-up is no longer in effect, the client will be liable for all the gains since it was originally purchased. And, Dalton says, "The burden will be for the client to find out what she paid for it and prove it."
Another question that is yet to be answered is how estate tax law affects charitable giving. "Many charities have been endowed at death because it’s a good alternative to the money gong to Uncle Sam," Nicholson says. "If the estate is large, [removing the estate tax] may curtail some gifts.
He says charitable impulses, fear of capital gains tax and potential loss of a stepped-up in basis have crated more interest in charitable-remainder trusts, where a donor gives an asset to charity but is allowed continued use of the asset -- including the ability to income from it. A beneficiary -- in many cases, the donor -- receives the income, and the charity gets the principal at the termination of the agreement. "It can turn into an income producing asset. Alongside that could be a life insurance trust as wealth replacement for your children. It helps everything that [the grantor] likes. The only person who feels left out is Uncle Sam."
When it comes to estate planning, those who lead family-owned businesses and farms are among those with the greatest need. Yet they often are reluctant to revisit estate plans. Stephen L. Smith, a lawyer with Horack Talley Pharr & Lowndes PA in Charlotte, and David Bosworth, a tax and investment counselor who often works with Smith, say there are many opportunities for planning.
"In almost every instance where we talk to people with significant assets, a big concern is the in-laws," Bosworth says. "With any kind of assets there is near 100% chance that somebody’s going to go through a divorce and the assets will end up in the hands of a person you don’t want. With an LLC or a family limited partnership, no one else can own and control the assets. You can’t become a partner without others agreeing."
The bottom line? If you suspect you need estate planning or should revisit your plan, it can’t hurt to ask. "the rule of thumb is to revisit you plan if there is any significant change in your family or financial state. But you also need to dust it off every five years or so to see where you are," Smith says. "The fact that we are in an uncertain tax environment is not an excuse for not dealing with it."
Nicole M. Sikora is a free-lance writer based in Charlotte.
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