Estate planning - proposed tax bill changes the rules?

The Bush administration's proposed tax bill has attracted attention largely because it reduces income taxes. But the administration's proposal also presents the most serious threat to the federal estate tax since its enactment.

Not only would the proposal repeal the federal estate tax, it would also throw out the federal gift and generation-skipping taxes. Under current law, these taxes combine to assure that gifts and bequests above certain threshold amounts are taxed once in a generation at rates as high as 55 percent.

The proposal to repeal the estate tax may have you thinking you can forget about planning forever. After all, a major incentive for planning is to minimize transfer taxes. But with the estate tax dead, why bother?

Before you reach that conclusion, there are a few things to keep in mind: There are no guarantees that the administration's tax bill will be enacted. Democrats in Congress have offered a proposal that instead of repealing the estate tax increases exemptions for small business owners. Many believe this proposal has a better chance of becoming law than the administration's proposal.

That's good news for small business owners, but even for them it doesn't eliminate the need for planning to minimize estate taxes in excess of an increased exemption. Even the administration would not eliminate federal transfer taxes immediately.

Under the administration's plan, taxes are phased out over 10 years. That makes planning for the interim as important as ever. It may make planning for the future even more difficult. Your estate plan must be flexible enough to accommodate the possibility that the repeal will not fully phase in, or that the federal transfer tax will be reenacted before the repeal takes hold.

At a minimum, this suggests it would be risky to surrender life insurance policies intended to provide estate liquidity. Furthermore, it would be imprudent to ignore estate planning documents during the phase-in period.

Many existing wills and trusts tie the amount of the marital and family trust bequests to amounts allowed under the federal estate tax. A phased-in repeal requires scrutiny of these provisions. Many have pointed out that repeal of the federal transfer tax does not eliminate state death taxes. In fact, some have suggested that repeal of the federal estate tax may encourage state lawmakers to increase state death taxes and fill the state's coffers with revenues that would have otherwise gone to the federal government.

Repeal of the federal estate tax has a subtle but troubling affect on capital gains taxes. Under current law, a capital asset included in a decedent's gross estate receives a "stepped-up" basis at date of death. If the federal estate tax is repealed, the basis steppe is lost.

For example, remember that stock you bought for $20. No one thought that company was going anywhere, but now it's trading at $100. Under current law, estate taxes as high as 55 percent may be imposed on the stock at its fair market value of $100 when you die. However, the stock's basis is stepped-up to $100. So, when your heirs sell it for $150, their capital gain is only $50.

Under the proposed bill, there is no estate tax, but your heirs receive a "carryover" basis of only $20. If they sell at $150, their gain is $130. They pay a 20 percent capital gains tax on the gain. Of course, if the heirs choose not to sell, no capital gains tax is payable.

Viewed in this light, the administration's proposal isn't so much of a repeal of taxes as it is a reduction in effective tax rates and a tax exemption for assets that your heirs retain rather than sell. Finally, repeal of the federal estate tax does not eliminate that aspect of planning that has nothing to do with taxes, the part that relates to who gets what, how much, and when.

Only proper ownership of assets, proper beneficiary arrangements on life insurance and benefits, and properly drafted wills and trusts assure that your assets are distributed to those you love in the way you want them distributed. Even if the estate tax is repealed, there remains the need to protect minors and spendthrifts with special trusts, provide for the long-term care of a disabled loved one, or replace the loss of a person key to a business or family's financial stability.

And that's the part of estate planning that made it worth doing and doing right all along, the part that shows you care about your family, your employees and your favorite charities. That's the part of planning you would have done even if there had never been a federal transfer tax.

Sharon Stanley is a representative of Prudential Insurance Co. in Cape Girardeau. (334-2603)