Estate planning is sometimes a very difficult discussion with clients. instinctively, many people do not relish talking about their own demise, and Cpas equally dislike talking about anything that the client doesn't want to talk about. But for this topic, I feel that it is a part of the Cpa's core fiduciary responsibility to alert the client of what could or should be done regarding their estate plan to accomplish what they'd like to accomplish for the eventuality of their death.
There are a few ways that I'd like to slice up the topic of estate planning. First is the lingering discussion regarding the unified credit and the level of the tax rate. Last year we were worried about the expiration of the Bush tax cuts and what that meant for estate tax planning. This year, it is the repeal of Section 3 of the Defense of Marriage Act. There are the technical sides of the discussion, but also the personal side of this issue that either plagues or motivates clients. Second are the issues hidden in plain sight and under the nose of most CPAs that require a better estate plan now. And third are the plans themselves -- or the lack thereof -- for your clients.
As far as the estate tax code goes, we seem to be in a place now where the $5.25 million exemption is safe. This does, however, creep into the discussions of lawmakers as they wrestle with budget deficit and revenue-raising ideas -- so do not be cavalier or lazy about using it. The federal death tax provides less than 3 percent of the government's total income, so most of the jabbering is more political than substantive. For now, it makes sense to plan on utilizing the current exemption amount with future exemptions indexed upward for inflation.
In short, the changes to DOMA now give same-sex couples the same tax benefits for estate planning as traditional marriages as long as your state recognizes same-sex marriages. This means that the marital deduction, spousal transfers, portability of the $5.25 million exemption and the ability to make split gifts may be utilized by same-sex couples. This is a huge benefit for the LGBT community, and clearly a market that needs your help now.
GIFTS AND EXEMPTIONS
For those who obviously have more than they need, utilization of the $5.25 million gift tax exemption makes a lot of sense. The guaranteed avoidance of death taxes on that money and the avoidance of its future appreciation from your estate could prove to be a very beneficial tax savings and a beneficial family wealth transfer move.
For families whose wealth is so large that a $10.5 million dollar gift from a married couple does not save much in death taxes, you must consider leverage. There are several techniques to utilize leverage when planning for your wealthy clients' estate tax reduction.
The most basic form of leverage may be the use of life insurance in an irrevocable trust or some other protected entity. In today's low-interest-rate environment, the conservative client may be open to a life insurance solution because the internal rate of return on their death benefit may be as attractive, or more so, than some other sort of savings vehicle. The internal rate of return on death benefit simply shows what the annual rate of return on your premium investment would be from your life policy if you died in any given year. Obviously, if you pass shortly after purchasing the policy and have paid little into the policy, that IRR will be very high. Conversely, should you live to life expectancy, the IRR begins to look more like long-term financing. Many policies today have the potential to deliver an IRR on death benefit to exceed 4 percent per year at normal life expectancy. Compared to what their conservative alternatives look like today, this feels pretty good to those who have reduced confidence in other asset classes.
Wealthy clients may choose to contribute their maximum allowable gift to an entity, and use those funds to acquire a single premium policy or invest the money and use some of the income or principal from the investments to pay the premiums each year.
Another form of leverage may include discounting. Discounting can emerge from several popular techniques for wealthy families. The use of protected entities such as family partnerships and irrevocable trusts may allow for some moderate discounts on the valuation of gifted assets, thereby enabling a larger long-term gift. Installment sales and the use of charitable trusts also provide leverage. For purposes of this discussion, I'll avoid the details for the specific techniques, and get you to efficient and practical ways for you to serve your clients in the estate planning area.
CPAS MUST STEP UP
As the CPA financial planner, you are on the front lines of your client's financial life. You see just about everything no less than once a year. If you don't see just about everything at least annually, start asking deeper questions. I believe it is your job to recognize when help is needed. But alerting the client about things they need to do is not enough; you need to spring into action to help remediate the problem. Unfortunately, too few practicing CPAs are careful enough to be that proactive for their clients. It may be that they are too busy with their heads in the sand from audits or tax season to talk about estate planning. Or it may be that they lack the confidence in their ability to talk intelligently with clients about their estate plan. If it's the former, that may be OK if they audit public companies or run a tax sweat shop.
But if your firm is like the bulge in the bell curve -- a fairly small practice serving closely held businesses and high-income taxpayers -- you must make the time to pay attention to the issues looking you in the face every day. To get over your knowledge gap, align yourself with a subject matter expert on estate planning and look for the following signals that you bump into each and every day in the ordinary course of practicing accounting.
Start at the top of the 1040, with dependents. Are there children or elderly parents claimed? If children, simply ask who is named in their will as the guardian of any minor children should both parents pass prematurely. If you get the vacant stare, you are one for one and have identified someone in need of basic estate documents. If there are elderly parents being claimed, ask about the asset structure of the parent: Will they be able to pay for any long-term-care issues they encounter? How current are their estate documents? What role are you intended to play in the settling of your parents' estates? These all seem like easy questions, and they are. Simply asking these thoughtful, caring questions places you in a category of service far higher than the practitioner who does not ask these questions. Yet not enough CPAs ask them.
Now drift down the 1040 to their income. Does it come from a job or do they own the company that generates that W-2? If they control their own W-2, what is their succession plan for the company? Do they have key-man insurance? Is there a clear plan regarding who takes over the roles vacated by the deceased owner-operator and funding for the transfer of ownership to either the next generation, partners or some of the key employees? Don't accept general answers from the client regarding corporate succession. Handshake agreements or undiscussed expectations from second-generation family employees could also upset the apple cart pretty easily. Insist on seeing the documents, and reviewing the valuation formulas and the life policies that may be in place. Conduct this review as if the client passed yesterday and use this as the basis for any services or recommendations you can deliver.
ON TO THE SCHEDULES
Now look at their Schedule B in a different light. Rather than question the merit of the underlying investment, for estate planning purposes you need to know how that asset is owned. If your client gets flooded with 1099s from joint accounts, there is a strong likelihood that there is not a strong estate plan implemented. A properly implemented estate plan would have most, if not all, 1099s flowing into a trust. It may be a pass-through trust not requiring a separate tax return, but from an estate planning perspective the trust is a far more efficient entity to hold and pass title upon death. Unless the estate falls under your state's probate limit, property passing from one individual to another due to death must go through probate. This can be expensive and time-consuming.
Even people who have done estate plans with trusts frequently fail to fund the trusts while they are living, and by default end up relying on the probate process to fund them. Most of the new clients I see who have already formed trusts are not properly using them. Your annual glimpse of their 1099s can save the family time and money upon their passing if you look beyond the numbers now.
Take a closer look at Schedule E for more estate planning opportunities. Are trusts flowing through on Schedule E already? Were these formed by the client or are they inherited? Does the client know where the assets are? What are their rights with respect to the trust corpus and investment decisions? Who is the trustee and do they have the power to change that?
Schedule E will also tell you about any flow-through business interests. Have you ever inquired about the succession plans for these S corps, LLCs or trusts? Get copies of any buy-sell agreements, salary agreements or any other written document that your client may be subjected to as an owner of the entity. It's way too early to offer solutions; just ask the right questions to ascertain if the situation is under control and pointed in the right direction.
Real estate also shows possible estate planning needs through the Schedule E. Learn if the real estate is owned individually or in an entity, then ask about the documents behind the scenes. Real estate owned with someone else that is not held in a protected entity can pose problems. The classic case is a home inherited by two siblings and owned as joint tenants in common. Won't your client's sister-in-law be surprised to find out that she does not inherit your brother's share of that property due to the joint form of ownership? You can help them retain family harmony and prevent tax problems by offering a solution based on what you already know.
The last part of finding out where your clients stand with their estate plans is to ask. You should ask them when you see them. You should ask them in your firm newsletters. You should ask them in your tax organizers. Because of the natural tendency of clients to procrastinate in the estate planning area, you need to ask these questions with regularity. The most common answers will be no, no and no. Clients need your help, and if you don't believe me, ask these questions of yourself and your partners ... then fix yours first.
John P. Napolitano CFP, CPA, PFS, MST, is CEO of
