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Back to Fundamentals in Estate Planning: A Long Term Perspective

March 11, 2015

Article by C. Arthur Robinson, II

It has always been the case that one size does not fit all when it comes to estate planning.  However, recent changes emphasize why we cannot simply use the standard plan from years past, and expect that we will achieve optimal and appropriate results for our clients.  Here, a bit of history is helpful.

In the early 1980s, there was a sea change in estate taxation with the introduction of the concept of the Unified Credit which unified the estate and gift tax[1].  The then-exemption of $600,000 in 1982 dollars put a great many people in a situation where estate taxes were not a concern.  Gradually, over the next 20 years, with the growth in our economy and the burgeoning of wealth at a great many levels, our planning became more and more focused on the fixed $600,000 lifetime unified credit amount, often to the exclusion of other concerns.

By the late 1990s, many of our clients had estates well above the $1.2 million limit, and planning for creating assets outside of the transfer taxable estate had become very prevalent with techniques as simple as the Irrevocable Life Insurance Trust and as complex as Grantor Retained Annuity Trusts and Charitable Lead Trusts of various sorts.

Because the avoidance of tax was a significant and primary goal for many clients, at least in the minds of estate planning practitioners, the planning was often driven by tax concerns.  Other concerns of our clients were often dealt with as an adjunct to the goal of saving taxes.

Recent changes have modified the estate planning environment in a drastic fashion.  Subsequent to the change in estate taxes in late 2010, we now have a lifetime credit equivalent which shelters $5 million adjusted for inflation from the date of enactment[2].  As of 2014, that exemption equivalent as adjusted for inflation is $5.34 million and will be indexed for inflation each and every year going forward.  In addition, in the turbulent years between 2001 and 2010, with increasing exemption amounts and the possibility that an estate tax would be not be a permanent part of the landscape, estate planners learned the hard way that one size does not fit all, and it was necessary to draw documents with increased flexibility as well as suggesting new approaches.

The focus of the Trust and Estate professionals on tax and taxes, while necessary as a practical matter, was often not the primary issue for clients.  In our current federal tax regime, taxes are very often not an issue for our clients[3].  In fact, almost always, other issues will dominate the discussion with an estate planning client.  Because those issues are paramount to the client, they should be very carefully considered and ultimately, should be the primary focus of the planning.

Estate tax at the federal level is a concern in Virginia for only a fraction of 1% of households, i.e. households whose taxable estates exceed 10.68 million for a married couple[4].  For the vast majority of our citizens, well over 99%, estate taxes are no longer a primary concern even for the practitioner.  This requires a significant adjustment in the way we think about estate planning.  Until a very few years ago, it was true that estate taxation was almost always in the mix, certainly for our clients who had acquired $3-4 million.  That is no longer the case.

Because the technical ins and outs of doing planning on a tax sensitive basis were both interesting and presented a significant technical challenge, whereas other more mundane considerations were less technically interesting, much of our training and continuing education has been focused on a relatively small group of issues.  It has always been the case that we should focus on our clients’ intent.  In fact, good estate planning professionals learn very quickly to focus on the clients’ intent in addition to taxes.

In the current planning environment where estate taxes are far less of a concern, a focus on client intent should be redoubled.  And so, the question becomes what are the proper concerns for us to raise with our clients and make sure that we discuss when we do estate planning.  To distill conversations conducted over nearly thirty years, the client focuses which seem to be central in my experience are: asset preservation , carrying out the intent of the client and ensuring that their intent has the highest possible probability of being implemented after their death.  Dealing with family issues which increasingly arise in families where there may be more than one marriage and children from several marriages, second and third spouses with differing amounts of wealth, and other blended family issues are also increasingly a part of this mix as the number of blended families has risen sharply in the last twenty years.

Protection of assets from creditors and predators has, likewise, always been a concern for our clients.  Lastly, our clients have been and continue to be concerned with privacy and transmission costs with respect to their estates.

In recent years, we have seen a renewed focus on these issues as the exemption has risen, but we are now in an arena for planning where a new set of concerns as a result of recent changes have arisen on the tax and non-tax fronts.  It is important to realize, that often estate planning was done in the context of tax planning where an estate tax rate was greater than the income tax rate.  For the first time in many years, when you combine the highest federal income tax rate and income tax rate in Virginia or elsewhere, you will arrive at an answer for marginal tax rates which makes it very important in current planning to focus on income taxes.[5],[6]

One of the most pronounced features of our federal estate tax law is the step-up in basis which occurs to assets that pass through an individual’s estate.[7]  Arranging for the step-up in basis is important to all of our clients, and with the exemption equivalents being as high as they currently are, it may be possible in many situations to get not only one, but two steps up in basis at the death of the first and last member of a couple. In addition, for the first time we have portability of the Deceased Spouse Unused Exclusion (DSUE) which can be used in certain circumstances.[8]

How does this translate into changes in the planning process?  The answer is that traditional credit shelter planning is almost certainly of less utility and generates more complexity for most of our clients.  Among their alternatives in a current planning environment are to use various techniques which pass property either by operation of law or under a third party beneficiary theory using everything from transfer on death deeds and transfer on death accounts to beneficiary designations in retirement plans.  It is possible to use titling of assets and an extremely simple estate planning instrument, nothing more than a very simple Will, to transfer very large amounts of property with great efficiency under current Virginia Law.

However, the practical difficulties with this approach should be carefully explained to the client.  They should understand that when beneficiary designations or transfer-on-death designations are made, those techniques need to be carefully monitored so that as facts and circumstances changes, changes can be made to the specific titling of assets.

Oftentimes, clients wish to benefit their surviving spouse but want, after the death of that person, to control the property.  This is certainly the case in many blended family situations and is also the case when family concerns about financial responsibility of children and grandchildren, potential threats or contingent liability threatens the intent of our clients.   So we find in many cases that, notwithstanding the current environment where a simple Will and a combination of these techniques will get the job done with great efficiency, it is nonetheless desirable to use a trust for estates greater than $750,000.  We do this to provide privacy, to provide an overarching, self-executing strategy, and to accomplish a variety of objectives which are connected to our clients’ assets but will change based on the fact pattern which changes over time.

Trusts in Virginia still enjoy significant creditor protection for non-settlor beneficiaries in virtually every instance where the trust is properly designed with spendthrift trust provisions and can provide a significant and ongoing safety net for downstream beneficiaries.[9]  The type of trust that can be used has been simplified in many cases, so that a single trust focused first as a marital trust which is “QTIP-able” and is thereafter focused on children and their descendants can be used in a great many cases.

For larger estates, a two trust instrument which uses disclaimer trust structures can also provide for greater flexibility and can serve multiple purposes in conjunction with a “QTIP-able” marital trust.  For wealthier clients whose net worth exceeds $12 million, traditional credit shelter planning continues to be a viable structure and is one that should be examined carefully.  We should also consider more advanced techniques such as ILITs as explored in our feature article.  The questions of whether or not to use a trust, its structure, whether or not to use transfer-on-death and other beneficiary designations to transfer significant assets, how assets should be titled, and when access on the part of beneficiaries should be unfettered are all decisions that should be carefully thought through and should be actively discussed with our clients.  Because we have more degrees of freedom than has ever been the case, as we are free from the specter of significant estate tax for those estates less than $12 million, more thought and analysis is a necessary part of the planning process.  There is no substitute for modeling the results of an estate plan, running the numbers is critical.

This puts us in a position, however, where for the first time in many years, we can sit down with a client, discuss with them what they really wish to do, and add significant value by addressing a multitude of potential concerns and threats with greater freedom than we have enjoyed than at any time in the last thirty years.  Whenever the choices become difficult or the number of potential courses of action multiplies, a thoughtful and knowledgeable estate planning attorney who wishes to spend the time and energy to tailor a plan to the specifics of a client’s situation and their intent and to address their concerns provides an increasingly value-added service.

Whether you draw one estate plan per year or hundreds, the client focus should be paramount in the planning process.  Our current situation presents problems and opportunities for estate planning lawyers as professionals.  However, if we rise to the challenge, we can accomplish a great deal more than our clients might suspect and provide a service to them that is virtually irreplaceable.  I encourage all practitioners to spend the time and energy to think through these issues for their clients.

[1] TaxReform Act of 1976 Pub. L. 94-455 (unification fully phased in by 1981); Economic Recovery Tax Act of 1981, Pub. L. 97-34
[2] Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010 Pub. L. 111-312
[3] “State-by-State Estate Tax Figures Show Why Congress Should Enact Senator Sanders’ Responsible Estate Tax Act” Citizens for Tax Justice, available at CTJ.org/pdf/estatetax2014.pdf
[4] See footnote 3
[5] Virginia Code 58.1-302, 320
[6] IRS Pub. 17 “Your Federal Income Tax” (Nov. 26, 2013)
[7] IRC §1014
[8] I.R.B. 2012-28, T.D. 9593 (July 9, 2012)
[9] Sheridan v. Krause, 161 Va. 873 (1934)