Estate tax or not: Reasons your clients still need estate planning

The 2010 estate tax “repeal” has not gone unnoticed by most attorneys and certainly has been the subject of intense scrutiny, dialogue and debate among tax planning professionals. By way of summary, in 2001, the U.S. Congress passed legislation which put in place the current estate, generation-skipping transfer (“GST”) and gift tax law. Under this legislation, the estate and GST tax exemption gradually rose (and tax rates declined), reaching a peak exemption of $3.5 million and tax rate of 45 percent. The lifetime gift tax exemption remained constant at $1 million. The 2001 legislation also was scheduled to “sunset” in 2010, meaning that the changes to the transfer tax law that the 2001 legislation put in place would expire in 2010. Therefore, beginning January 1, 2010, the estate and GST tax are no longer applicable. However, the estate tax repeal is, at most, a temporary event which will end abruptly on December 31, 2010. As of January 1, 2011, without further action by Congress, the law as in effect prior to the 2001 legislation snaps back into place with an estate tax exemption and GST tax exemption of $1 million.

Practitioners have been inundated with queries from clients regarding the 2010 law and the media speculation surrounding a potential retroactive legislative fix. Currently, many, if not most, tax planning professionals are repeating the same phrase time and time again: the outcome of some tax planning strategies in the current environment is uncertain and therefore subject to increased risk. Many clients have happily seized upon this as a reason to defer the process of estate planning.

Practitioners should be wary of letting their clients continue to postpone the preparation of their estate plans pending enactment of new legislation. To aid practitioners in their attempts to prevent their clients’ inertia, this article reviews some of the benefits of estate planning which persist despite the uncertain tax environment.

Planning for Incapacity. As demonstrated by high profile media stories and television dramas, every adult should undergo basic planning for incapacity, including the execution of powers of attorney for property and for health care. These documents ensure that a client’s financial matters can be attended to without the costly process of a guardianship proceeding and ensure that an individual familiar with the client’s wishes is appointed to make critical health care decisions. In addition to these basic documents, individuals who are engaged in an unmarried relationship should take steps to ensure that their partner has access to residences, vehicles, and other property during the owner’s incapacity, if so desired.

Lifetime Gifting. The tax outcomes of certain lifetime gifting strategies in 2010 and beyond are still being debated. However, several gifting strategies remain viable and risk-free techniques to transfer significant wealth tax-free during an individual’s lifetime. Foremost among these techniques is outright annual exclusion gifting. Each individual may transfer up to $13,000 outright to another individual each year. When combined with a spouse’s annual exclusion gifting power, this means grandparents or parents can transfer up to $26,000 to each grandchild or child in a calendar year. The transfers may be outright, to custodial accounts, to 529 college savings accounts, or to certain trusts. Another powerful lifetime gifting technique is quite straightforward and largely under-utilized. Section 2503(e) of the Internal Revenue Code excludes from taxable gifts payments for tuition and medical expenses of any person. These payments include, but are not limited to, payments to educational institutions for tuition expenses and payments to an insurance company for the cost of health insurance. Treas. Reg. § 25.2503-6(b)(2) and (3). Practitioners should counsel clients interested in wealth transfer, but adverse to the risk inherent in the current tax environment, in these basic techniques which may yield considerable estate tax savings.

Property Disposition. The primary focus of any comprehensive estate plan is the testamentary disposition of the client’s property. If a client fails to execute any type of estate plan, the State of Illinois has provided one, referred to as intestate succession law. 755 ILCS 5/2-1. However, this plan rarely corresponds to a client’s wishes. For example, if a married client with children passes away, under Illinois intestate succession law, the property is allocated one-half to the surviving spouse and one-half among the surviving descendants. An explanation of the practical implications of this division of property subject to probate can be a useful tool to demonstrate the benefits of implementing an estate plan.

Probate Avoidance. “Probate” used to have a reputation as being long, arduous, and costly. Fortunately, this reputation is not always deserved. Unfortunately, many clients know this reputation is not always deserved or believe that their estates will not be subject to probate. Clients should be made aware that joint ownership of property and beneficiary designations work to avoid probate at the death of the first spouse; however, these mechanisms most likely will not be sufficient to avoid probate at the death of the surviving spouse while still accomplishing the couple’s dispositive goals. In addition, estate planning is essential to avoid the probate of real property located in a state other than the client’s state of residence. This type of probate, called “ancillary probate,” certainly will be costly and should be avoided whenever possible.

Naming Guardians of Minor Children. The need to name guardians of minor children is one of the first reasons clients seek estate planning advice. The importance of this issue does not diminish in an uncertain tax environment. For clients who have a will in place which names guardians, these individuals should be reviewed every three years. Not only will the minor children’s needs change as they age, but the financial, family, and health circumstances of the named guardian may change, making such individual a less desirable choice for guardian.

Avoid Guardianship of Minor’s Estate. When a minor child inherits property with a value in excess of $10,000, the court may require the appointment of a guardian to protect the child’s inheritance. 755 ILCS 5/25-2. This also applies to the child’s receipt of the proceeds of a life insurance policy or retirement plan benefits. The appointment of a guardian and the concomitant court oversight likely will drain resources from the child, since all costs associated with the administration of the guardianship estate and the legal representation of the guardian will be paid from the child’s assets. Accordingly, it is preferable to avoid formal guardianship proceedings by providing for alternate methods of payment of the inheritance to a minor child through the estate plan, for example, payment should be made to a trust or custodial account for the benefit of the child.

Incentive Trust Distributions. Perhaps one of the most powerful arguments in favor of the use of a trust as a vehicle for wealth transfer is the ability of the grantor to control the terms of the distribution of the trust assets. Commonly, the terms of a trust agreement will provide for the outright distribution of or a right to withdraw trust property at specific ages. Practitioners also can suggest provisions which link access to the trust property with certain life goals. For example, a trust could provide that a beneficiary be given a right to withdraw the trust property upon completion of a college degree. This type of provision provides an incentive to the beneficiary to further his or her education, a common desire for the grantor-parent. Incentive distribution provisions are relatively simple to draft and administer, and provide clients with peace of mind that their hopes and goals for their children will be relevant after death.

Special Needs Planning. As diagnoses of special needs (which means for purposes of this article an individual who due to a mental, physical, or emotional disability is eligible for government benefits) increase, more families can benefit from additional planning to allocate assets for the benefit of a disabled individual in a manner which will avoid disqualifying the individual from receiving federal and state aid. This can be accomplished by creating a trust with provisions designed specifically for these purposes. A client who is primarily responsible for the care of a special needs child or individual also should ensure that his or her power of attorney for property permits the agent to make discretionary distributions to or for the benefit of the special needs individual and to create and fund a special needs trust for the benefit of the individual. It is imperative that the practitioner inquire whether any family members or other intended beneficiaries are disabled during the practitioner’s initial meeting with the client.

Creditor Protection. Although the creditor protection an individual can provide for himself or herself is limited, that individual can provide substantial protection for his or her surviving spouse and descendants. By transferring the beneficiary’s inheritance in trust, rather than outright, and limiting the distributions from the trust, a judgment against the beneficiary generally should not be satisfied from the trust assets while the assets remain in the trust. The use of trusts as a vehicle for transferring assets also is effective in keeping a beneficiary’s assets separate from his or her spouse’s assets, thereby reducing the likelihood that a divorcing spouse could receive a portion of the beneficiary’s inheritance through a property settlement.

Charitable Planning. Clients with charitable intentions should be encouraged to proceed with estate planning as well. Without clear direction in a testamentary instrument such as a will, trust or beneficiary designation, gifts to charitable organizations will not be completed upon the death of an individual. Most sophisticated charitable planning techniques, such as charitable lead trusts and charitable remainder trusts, remain largely unaffected by the tax law changes. In addition, with the recent crisis in Haiti, many clients already will be motivated to proceed with the charitable plans.

The above summarizes many of the benefits of estate planning separate from tax minimization goals. Practitioners should counsel their clients on these benefits in order to prevent the client’s postponement of planning due to the uncertain tax environment. When a more stable tax regime is in place, the practitioner can then propose appropriate tax minimization and wealth transfer strategies, with the knowledge that a proper planning foundation already has been laid. ■


Jodie E. Distler Hanzlik Practices at Thompson Coburn LLP, 55 East Monroe Street, 37th Floor, Chicago, IL 60603 and may be reached at 312.782.3660 or via e-mail at

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February 2010Volume 56Number 6PDF icon PDF version (for best printing)