Estate Planning Without Estate Taxes?

Like the rumors of Mark Twain’s death, reports of the federal estate tax’s demise were greatly exaggerated.

Late last year, Republicans in the United States House of Representatives proposed the repeal of the 102-year-old “death tax,” but ultimately Congress passed the U.S. Senate’s less aggressive proposal to double the estate tax exemption for a period of eight years beginning in 2018. President Trump signed this measure into law on December 22, 2017, as part of comprehensive tax reform. The federal estate tax, then, will live on, but only for estates larger than $11.2 million for individuals (indexed for inflation) and $22.4 million for married couples, reducing, if not eliminating, the tax for all but the wealthiest families.

Families not subject to the estate tax might assume that the absence of federal estate tax liability means they need not create an estate plan. That is not the case. For one, the exemption will be cut by half in 2026, making estate taxes a reality for families currently not subject to them. The exemption has been changed multiple times, and it could be reduced in the future under a different Congress and administration, even before its scheduled reduction in 2026. Families may want to account for the potential reduction of the exemption by including provisions in wills and other testamentary documents that cover multiple estate tax scenarios.

Another reason to create an estate plan in the absence of estate tax liability is to address threats to bequests that have nothing to do with estate taxes. Many conflate estate planning with reducing estate tax liability because of the high toll estate taxes can take on bequests. Left unchecked, the tax can consume 40% of the value of estates exceeding the exemption. Factor in state-level estate taxes or inheritance taxes applicable in about 20 states and the District of Columbia, and roughly half of a bequest can be lost to estate taxes. Onerous as they may be, estate taxes are but one of many challenges to transferring and preserving wealth. Federal income and gift taxes can erode gifts and inheritances, as can non-tax threats, such as litigation and divorce. A well-structured estate plan can address these obstacles to transferring and preserving wealth.

Achieving Non-Tax Benefits

For many families, the main purpose of an estate plan is to protect loved ones by securing their inheritances. Mitigating transfer taxes is integral to achieving that goal, but estate planning is not synonymous with tax planning. A sound estate plan may offer benefits that have nothing to do with containing the damage from estate and other taxes, including:

• Protecting assets from creditors. Divorce settlements and other legal judgments can be more detrimental to the preservation of wealth than estate taxes. As such, many estate plans incorporate trusts to protect bequests from potential creditors of the beneficiaries. Assets placed in irrevocable trusts might be held for the benefit of a spouse or child, but they are owned by the trust. By severing beneficial ownership from legal ownership, these trusts can put assets out of reach of creditors, whether they are an estranged spouse or disgruntled business partner.
• Addressing the complexities of blended families. Today, many families include stepchildren. This can complicate estate planning because, while many people love their spouses’ children like their own, they also want their biological children to enjoy the benefits of their hard work. That might not happen if your assets pass directly to your spouse after your death. The spouse might favor his or her biological children over yours when deciding how to distribute their estate, or your spouse might create a new family through a subsequent marriage. Again, trusts offer a solution. By creating a trust for your spouse and naming your children as beneficiaries upon your spouse’s death, you can help ensure your children will be protected.
• Helping heirs manage their inheritances. If a child lacks the knowledge or maturity to manage substantial wealth, an inheritance can be eroded in short order by poor investment decisions or excessive spending. These threats can be addressed by holding and managing a child’s inheritance in trust until the trustee determines the child has the knowledge and maturity to manage the assets on his or her own. A parent might instruct the trustee to distribute the assets in increments, giving the child full access to them only when he or she reaches a certain age.

For many people, estate planning is strictly about mitigating the impact of estate taxes, but viewing estate planning solely as a tool to minimize taxes can be costly because other obstacles to the transfer and preservation of wealth might not be addressed. Taxes that are unlikely to disappear — the gift tax and capital gains tax, for example — can deny loved ones the fruits of your labor, as can non-tax-related threats like divorce or litigation. A strong estate plan can mitigate threats to wealth that arguably are more insidious and potentially more damaging than the federal estate tax, which is why the need for estate planning will live on whether or not your estate is subject to estate taxes.