MB Couple Needs Help to Navigate Federal, State Estate Tax Maze

Jun 05, 03:33 PM

Current Headlines: David and Joann Wolz, a Manhattan Beach couple, worry about present and future estate taxes.

They are planning a family meeting on these issues this coming Father's Day, which is within a week of David's 73rd birthday. He and Joann have three grown children, all of whom are married, and seven grandchildren.

One family lives in Southern California; two families live in other states.

* A son and his wife live in Laguna Beach with their two children. They work in the real estate brokerage business, own their own home, and own several fixer-upper homes in the Laguna area. Their income is about $375,000, with a net worth of about $6 million.

* The Wolzs' daughter, her husband and their two children live in New York. Both are physicians with combined earnings of about $800,000. The couple owns its home and has an apartment building in Long Island. Their total net worth is about $4 million and growing.

* The couple's second son and his wife live in Kansas. He is a teacher and his wife is a homemaker who home schools their three children. Their income is about $50,000. Their home is valued at $250,000 with a $140,000 mortgage. The family subsists on a tight budget, and both parents worry about future costs of college educations for their children.

David and Joann established a Living Trust about 10 years ago, but understand many issues have changed since then. They have a sizable estate, mainly due to real estate appreciation. Their home for which they paid $310,000 in 1986 is now valued at $3 million. The mortgage is paid off, and the couple plans to continue living in it.

Due to their impending family meeting, they write asking for clarification and suggestions on reviewing their trust and overall estate planning.

For starters, the basic provisions of federal estate tax law, expiring in 2010, which families must factor into existing and new estate plans include:

* A gradual increase in the portions of estates' values that are exempt from the federal estate tax from $675,000 for those of people who died in 2001 to $3.5 million for those of people dying in 2009.

* A gradual reduction in the maximum tax rate from 55 percent to 45 percent for estates of people dying in 2007, 2008 and 2009.

* The uncertainty as to whether such changes will be made permanent, be amended under some future law, or be undone in the improbable, but not impossible, absence of any new legislation applicable to 2011 and beyond.

The exemption from the federal tax rose to $2 million for estates of those dying in 2006 (and as its maximum rate falls from 47 percent to 46 percent). Remember this exemption is per individual, so a couple who both were to die this year would have a joint exemption of $4 million on their community held property.

But consumers also must cope with the increasing changes at the state level resulting from the act; California now does not recognize the exemption.

Why? Since 1926, states have been able to piggyback on the federal estate tax, enacted in 1916, by adopting state estate taxes for which they siphoned off a limited share of the revenues collected from their deceased residents' estates in accordance with the federal tax's provisions -- without raising estates' total tax bills.

The limit: 16 percent of taxable estates' values, equal to the maximum for which estates could claim credit for state taxes on their federal tax returns.

The 2001 act affected this pattern in three major ways:

1) It repealed the credit for state estate taxes in 25 percent increments over a 4-year period ending this year, raising revenue going to the Treasury and leaving states -- of which 37 relied on the pick-up tax exclusively by last year -- scrambling for a substitute source of funds. In the aggregate, all forms of state wealth transfer taxes accounted for only 1.2 percent of all state tax revenues in 2003.

2) It precipitated a flurry of activity in state capitals to decide how to make up the lost revenue. States without estate taxes were encouraged to adopt them. States with estate taxes were encouraged to raise their rates and/or otherwise raise more funds.

The result: a varied pattern with differences in maximum estate tax rates and exemptions among the states and between the states and the federal government, even leading to cases of states taxing estates whose values are too low to be taxed by the feds, now that exemptions are higher.

State governments have not been alone in being engaged in a flurry of activity to deal with estate tax reform. With the changes in state taxes and a decline in their uniformity, financial planners have had to scurry to develop suitable estate plans for clients in a wider range of circumstances, giving unprecedented attention to state estate taxes.

3) It allowed estates to deduct state estate taxes on federal estate tax returns, starting this year.

With estate tax credits and the pick-up tax becoming only a memory, will the same fate be in store for other state wealth transfer taxes, relieving financial planners from having to deal with them? The remaining states with wealth transfer taxes will come under pressure to repeal them.

For individuals, couples and families concerned about estate planning, all should take several steps this year remembering that the whole picture of taxes on estates could change radically in 2010.

The U.S. budget has a huge deficit so it seems unlikely that Congress would repeat the tax totally. It could be capped or not.

Additionally, there is talk of reducing the "step up in basis" which means that assets such as real estate and stocks that were bought long ago at a very low price are valued at market value at death and, therefore, could be sold without paying a capital gains tax.

This tax should not be confused with the estate tax which is based on the total value of all the holdings in the deceased persons ownership at death. It does not relate to what the original cost was.

All these estate (federal and state) tax issues will have major effects on families living in different states.

Because David and Joann's family has such a disparity in wealth, they must decide as a family how they will distribute their assets both to children and grandchildren. As well, they need a Family Legacy approach to their living estate planning. How can the family as a group do well and do good, too?

They should investigate retaining a fee-only planner, a sophisticated estate attorney and knowledgeable CPA who can address current tax planning and estate planning for each state of residence and each income bracket. They then can create a living, ongoing plan to benefit every family member for years to come.

Stephanie Enright owns Enright Premier Wealth Advisors of Torrance. Write to her at the Daily Breeze, 5215 Torrance Blvd., Torrance, CA 90503-4077. If you need financial advice, include a stamped, self-addressed envelope so you can receive a confidential questionnaire to return. Questionnaires are also available at the Daily Breeze. Only letters chosen for publication will be answered; your real name will not be used.

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