Estate tax: a new beginning

Estate tax is fluid by nature, changing constantly as new social and fiscal policies emerge. Our country’s history of estate tax laws has been a veritable roller-coaster ride: reform followed by repeal followed by re-enactment.

Under the current law, the estate tax and the generations-skipping transfer (GST) tax will be repealed for one year in 2010 only to be resurrected the following year if Congress does not take action. However, this scenario is unlikely now that President Obama strongly supports retaining the estate tax and Democrats have taken control of both houses of Congress. A bill recently introduced in Congress (HR 436), if enacted, will finally remove a lot of uncertainties that clients face when planning their wealth transfer plan.

Smart Business learned more from Mouris Behboud of Gumbiner Savett Inc. about why waiting to conduct proper estate planning until the law changes “once and for all” is unrealistic and can prove to be very costly to you and your heirs.

What does the new proposed legislation provide?

In January 2009, a bill was introduced in Congress titled ‘Certain Estate Tax Relief Act of 2009.’ Under the act, the current $3.5 million estate tax exemption will become permanent. This means that if your entire gross estate is more than $3.5 million ($7 million for couples) your estate is subject to estate tax. This new proposed law will also freeze the maximum estate tax rate at 45 percent and, if enacted, will be effective for the estate of decedents dying after Dec. 31, 2009.

Why is this act any more important than prior estate tax acts?

There is a controversial section under this act. Generally, under the current law if a taxpayer transfers a partial ownership interest in his or her business to his or her children, the amount of the transfer can be reduced by application of valuation discounts, thereby saving a lot of money in transfer taxes. The use of discounts is a very popular strategy in transfer of wealth by business owners and high net worth individuals.

This proposed act will limit the use of valuation discounts only to transfers of ‘active business assets.’ It specifically states that ‘the value of any nonbusiness assets held by the entity shall be determined as if the transferor had transferred such assets directly to the transferee and no valuation discount shall be allowed.’

The term ‘nonbusiness assets’ means any asset that is not used in the active conduct of one or more trades or businesses. Examples of passive assets are: cash or cash equivalents, stock in a corporation, annuity, commodity and real property.

What are you recommending your clients do in light of these new developments?

With the effective date for this new proposed law as Dec. 31, 2009, time is of the essence. This leaves only a very short window of opportunity for people to revisit and update their estate plan to take advantage of the current valuation discounts in the context of transferring wealth to the next generation.

As a former IRS estate tax attorney, what are your recommendations for clients who want to minimize audit risks or even a potential IRS audit?

I have three pieces of advice: 1) Updating your estate plan on a regular basis can save you and your beneficiaries future headaches with court costs, taxes and attorney fees. In a recent survey, nearly one in every four wealthy individuals stated that their will and trust was last updated five or more years ago. High net worth individuals should revisit their estate plan at least once a year. If you do not already work with someone who is an estate planning specialist, you should spend time and find the right professional with expertise in this area. Not every accountant or attorney is qualified to prepare or to consult on estate and gift tax returns. Finding a licensed and qualified professional with years of experience will pay off with less time, money and effort being wasted by you and your heirs.

2) When making a gift or documenting estate assets, you should consider making full disclosures. Once you have made full and adequate disclosure, the IRS is barred from auditing you once the statute of limitation has expired on your gift or estate tax return.

3) The final and most important advice is that, in the unfortunate scenario that you are subject to an IRS estate and gift tax audit, remember the Three Golden C-Rules: cooperation, communication and compromise (though the IRS may want you to think concede, rather than compromise).

Currently, there are about 300 attorneys working for the IRS’s estate and gift tax division. Now that the repeal of estate tax is unlikely, the IRS has been aggressively recruiting attorneys to audit more estate and gift tax returns. The latest IRS annual data book for fiscal 2008 shows that 8.1 percent of all estate tax returns filed in 2008 were audited, which is significantly higher than the prior years. Almost one-third of all estate tax returns filed in the nation come from California. Therefore, I will not be surprised to see more audits coming our way in the near future.

Mouris Behboud is a principal-attorney at law for Gumbiner Savett Inc. Reach him at [email protected] or (310) 828-9798.