When this author was interviewing for associate positions out of law school, more than one interviewer asked why one would want to get into estate planning with the prospect of increased exemptions eliminating much of the work. That was in 2006, when the federal estate tax exemption had just increased from $1.5 million to $2 million, and there was no portability. Those were Big Law interviews. Granted, the estate tax exemption was scheduled to increase to $3.5 million in 2009, but the exemption available for lifetime gifts remained $1 million. Further, for the same budgetary reasons that most provisions of the recently enacted Tax Cuts and Jobs Act, Pub. L. No. 11597, 131 Stat. 2054 (2017) (TCJA 2017), will sunset on January 1, 2026, the steady increase in the estate tax exemption (and corresponding gradual decrease in the estate and gift tax rate) put in place by the Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. No. 107-16, 115 Stat. 38 (EGTRRA 2001), was scheduled to sunset after 2010 (with a one-year repeal of the estate tax altogether in 2010). Nobody knew at the time what the exemption would be after 2010, and there was a real possibility that it would sunset back to $1 million. Regardless, one thought that even if the exemption stays at $3.5 million, surely there is plenty of work to be done. A couple with a $7 million estate is not just going to hand over all that money to their 20-something-year-old children if something happens to them, right?
Then, federal legislation in 2010 went further than extending the sunset provision contained in EGTRRA 2001. Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub. L. No. 111312, 124 Stat. 3296 (2010 Act). The 2010 Act increased the estate tax exemption to $5 million and reduced the rate to 35 percent for 2010, 2011, and 2012, yet allowed executors to opt out of the estate tax for decedents who died in 2010. The 2010 Act also increased the exemption available for lifetime gifts from $1 million to $5 million, indexed the estate and gift exemption amount for inflation beginning in 2012, and introduced the concept of portability, which allows a surviving spouse to use the estate tax exemption that was unused by his or her predeceased spouse. These provisions also were scheduled to sunset after 2012. Trusts and estates attorneys will recall the rush of activity toward the end of 2012 when a sunset to a $1 million exemption was again nearing reality.
But alas, the American Taxpayer Relief Act of 2012, Pub. L. 112240, 126 Stat. 2313 (ATRA 2012), signed into law on January 2, 2013, made permanent both the estate and gift tax exemptions of $5 million, indexed for inflation and the portability feature, yet increased the top rate from 35 percent to 40 percent. Surely, if there were concerns about the viability of an estate planning practice in 2006, those concerns were amplified by ATRA 2012. Then, effective January 1, 2018, the TCJA 2017 doubled the estate and gift tax exemptions to $10 million, adjusted for inflation, which for 2018 are $11.18 million. This provision is scheduled to sunset on January 1, 2026, when, without further congressional action, the estate and gift tax exemption amounts will revert to $5 million, adjusted for inflation, which is still estimated to be over $6 million per individual. With an estate tax exemption of $11.18 million, the Tax Policy Center estimates that only about 1,700 estates will owe federal estate tax in 2018, or less than 0.1 percent of all deaths.
It is hard to believe that anyone in 2006 could have forecast the current estate and gift tax exemption of $11.18 million, with the portability of unused exemption between spouses, yet even then estate planners were worried about their workflow. Since ATRA 2012 introduced the exemption amount of $5 million, one could hear screams from across the estate planning community that the practice will suffer, that there will be no more work to do, that we will have to seek other opportunities. These calls have only become louder since the enactment of the TCJA 2017. Email solicitations for a CLE program regarding alternative potential growth areas for trusts and estates practice have been common recently, since “the demand for estate planning is declining.”
In the article How to Ride the Coming Tidal Wave of Technology and Competition, published in this issue, the authors raise the fears of the fictional Peter that “technology, combined with the current $22.4 million estate tax exemption for a married couple, will reduce the need for lawyers to handle all but the most complex estate plans[.]” The authors discuss the fear of technology and the commoditization of certain legal tasks and the challenges we face moving forward on those fronts, concluding that there will be less all-around legal work in the future and offering ideas for what lawyers can do to position themselves for success in a changing legal environment. No doubt, attorneys in all practice areas will have to keep pace with technological advances in the practice of law or be left behind. This article addresses the concern raised by Peter over the impact of the current estate tax exemption and describes the immense amount of work that remains for trusts and estates attorneys.
Whether working at Big Law, a smaller or medium size firm, or a boutique estate planning practice, there has always been much more to estate planning than planning for the avoidance of transfer taxes. A young trusts and estates associate might be exposed early and often to the sophisticated estate planning techniques reserved for only the wealthiest clients, and the work for them will remain so long as there is any estate tax, regardless of the exemption amount. But most associates might also have the opportunity to handle numerous issues for moderately wealthy and even regular people and gain experience in all aspects of a practice related to the trusts and estates world.
In addition to drafting numerous wills and trusts, both revocable and irrevocable, and otherwise putting in place transfer tax plans involving limited partnerships, LLCs, and all of those sort of things, a trusts and estates practitioner might also administer estates and trusts, handle estate and gift tax returns and fiduciary income tax returns, appear in probate court and handle fiduciary litigation (including guardianships), represent clients in IRS controversies, work with clients on family business succession (regardless of tax issues), prepare employment agreements for clients, and maybe even work on real estate transactions and IRC section 1031 exchanges. All of the work, however, generally emanates from the core estate planning work.
While avoidance of transfer taxes is no longer a driving force for many clients, the primary goal of transferring one’s wealth as the client desires, taking into consideration the varying needs of the next generation and other legatees, with minimum loss to waste and creditors and with minimal interruption to business operations and family dynamics, remains. After the passage of ATRA in 2010 (increasing the estate and gift tax exemption to $5 million), Lou Mezzullo, then president of ACTEC and past chair of ABA RPTE, sent an oft-cited letter to ACTEC Fellows reminding them of the many services that trusts and estates practitioners provide in addition to federal transfer tax planning. See, e.g., Ronald D. Aucutt, The Future of the Estate Planning Profession, Chicago Estate Planning Council, March 20, 2013; Steve R. Akers, Big Issues for Estate Planning Practices in the Current Environment (Oct. 29, 2015), https://jewishfed.org/sites/default/files/FULL_Outline_KEYNOTE_Big_Issues_for_Estate_Planning_in_Current_Environment.pdf.
That non-exhaustive list includes the following:
- Planning for the disposition of the client’s assets at his or her death.
- Identifying guardians for minor children, if and when needed.
- Planning for disability and incompetency.
- Planning for children with disabilities.
- Planning for spendthrift children.
- Planning for marital and other dissolutions.
- Asset protection planning.
- Business succession planning (without the estate tax to blame for the failure of a business).
- Using business entities to accomplish nontax objectives.
- Life insurance planning (other than to provide funds to pay taxes).
- Charitable giving (for its own sake and because income tax considerations are still relevant and techniques, such as lifetime charitable remainder trusts to facilitate diversification, would not be affected at all).
- Retirement planning.
- Planning for clients with property in more than one state, including ownership, asset protection, state taxation, and probate issues (and state estate tax).
- Planning for clients who are US citizens or resident aliens and who own property in other countries.
- Planning for nonresident aliens with assets in the United States or who plan to move to the United States.
- Planning for citizens who intend to change their citizenship.
- Planning for nontax regulatory issues, such as the Patriot Act, HIPAA, and charitable governance reform.
- Trust administration.
- Fiduciary litigation (perhaps more likely if there is more to fight over).
- Income tax planning.
- Planning for state death taxes.
All clients, regardless of wealth, will require work in at least several of the preceding areas, starting with the first six items above. Those items represent the most fundamental goals of all estate planning clients. This author cannot recall a client ever saying, “I want to avoid estate taxes regardless of how it affects my family.” Spouses and descendants come first, and every beneficiary is unique.
Everyone who has children should have a will, if for no other reason to properly name guardians and avoid family infighting after death. Clients are often unaware, and surprised to find out, what happens to their property if they do not have a will. Many assume their spouses will inherit everything, but in many states their children will inherit half of their assets through intestacy, regardless of their ages, and if any children are minors, such an inheritance will require a full-blown guardianship estate with court oversight. That is certainly an outcome all clients wish to avoid.
Revocable trusts have been trumpeted for years due to their ability to allow for the management of the trust’s assets in the event of the settlor’s own disability, without having to rely on powers of attorney and without adult guardianship proceedings. At the same time, powers of attorney for property and health care are essential estate planning documents that all clients should execute.
Revocable trusts are also useful, if properly funded, for avoiding protracted probate court proceedings after death. Any assets held in the trust at the time of the settlor’s death will be disposed of in accordance with the provisions of the trust and will not be subject to probate administration and public disclosure. A trust is also easier to amend than a will. Clients are comforted by this planning, regardless of any transfer tax issues involved for any particular family.
Placing assets into trusts for a spouse or descendants offers plenty of advantages even if no transfer tax issues need to be addressed. For one, it allows for professional management of assets. A spouse who has had no experience with financial management or investment decisions may be better off as a trust beneficiary than carrying such a burden. Placing property into trust for a spouse (particularly for a not-first-marriage spouse) can also protect the expectancies of children from diversion by the surviving spouse.
Using trusts to transfer property can allow the client to determine the circumstances and for what purposes a beneficiary will receive the property or its income. A trust for a spouse or children also provides a level of asset protection, from creditors ranging from tort plaintiffs to future divorcing spouses. Many clients also have children with disabilities or who are merely spendthrifts. For children with disabilities, establishing a third-party special-needs trust for such children can be a crucial part of the estate plan, again without consideration of tax issues. A trusts and estates practitioner would be wise to become familiar with state laws regarding benefits that may be available from public agencies and to be able to advise on establishing trusts to provide supplemental benefits for the beneficiary without the trust’s assets being subject to reimbursement for such benefits.
Concerning spendthrift children, if a married couple with $7 million presumably would not want to simply leave that amount of assets outright to their children, would a couple with $22 million want their children to inherit their estate outright, particularly if one child would likely dissipate the assets? Large outright distributions may spoil children and eliminate their incentive to be productive and self-supporting. Regardless of transfer tax issues, the use of trusts upon a client’s death remains extremely important to many clients for various reasons.
Asset protection comes in many shapes and sizes, and many attorneys practice within the asset protection niche of estate planning. Techniques range from establishing offshore trusts or trusts in states that have enacted self-settled creditor spendthrift trust statutes, allowing for Domestic Asset Protected Trusts (DAPTs)—there are currently 17 states with such statutes, with varying levels of protection and varying exceptions—to complex webs of limited liability entities. While these techniques may still be reserved for the wealthy clients who are likely subject to transfer taxes and will require complex planning, other clients who work in particular fields (i.e., physicians), may also benefit from these techniques.
More often, asset protection arises in the context of the spouse or children of the client, with the client’s concern being potential creditors or divorcing spouses down the road. Using trusts created under a well-drafted revocable trust at death goes a long way to alleviating the concerns clients often have for their spouses and children. The attorney must also be mindful in advising clients regarding beneficiaries’ potential future creditors of the states’ rules on the availability of life insurance proceeds and retirement plan benefits to satisfy creditors, to ensure that beneficiary designations are properly completed.
Business Succession Planning, Using Business Entities to Accomplish Nontax Objectives, and Life Insurance Planning
Closely held business owners will need competent estate planning advice regardless of transfer taxes, even if there is no estate tax. Experts estimate that 85 percent of the crises faced by family businesses focus around the issue of succession. Charles D. Fox IV, Estate Planning Without an Estate Tax, Washington, DC Estate Planning Council (Feb. 16, 2017) (citing Bernard Kliska, Planning for Business Succession, Chi. Bar Ass’n (Apr. 16, 1996) at 1). Conflicts between family members regarding the succession of control and ownership create more crises than transfer taxes, by far. The problem can be as simple as having no succession plan at all. A client who owns a business at death without a succession plan leaves the client’s family, business, and wealth in peril. Questions abound about what should be done with the business, and the business is left open to attacks by those who want to take control or believe they are entitled to do so. This is an area of the practice in which it is particularly important for the attorney to work in concert with the clients’ other advisors, such as accountants, financial advisors, and family business consultants.
Even with a properly prepared estate plan, leaving business interests in shares to children or to certain children could lead to conflict. Buy-sell agreements are a common mechanism to assist in the successful transition of a family business, especially in circumstances where one or more members of the next generation are involved in the business and others are not. Buy-sell agreements arise in other contexts as well. For example, entrepreneurs may be required by outside investors to have a buy-sell agreement in place, funded with life insurance, as a condition of outside investment in the company. It is difficult to blame those investors for wanting a plan in place so they do not end up at the behest of the business owner’s spouse or other family members, who may not be familiar with the business at all. As start-up owners tend to take on outside investments at younger and younger ages, these arrangements will be necessary even when estate planning is otherwise nowhere on the radar for the client.
Drafting buy-sell agreements for business owners should be within the bailiwick of all estate planning attorneys. These agreements give the owner control of transfers of interests. They typically include a right of first refusal for either the owner or the entity to purchase interests, subject to proposed transfers. This protects business owners and their families from becoming business partners with a child’s spouse (or ex-spouse) or with other undesirable third-party owners. The buy-sell agreement can also provide liquidity for family members who are not involved in the business. This is often accomplished with life insurance (not primarily for transfer tax planning).
Creating different classes of interests that have the effect of separating control of the business from the economic interests in the business can also be helpful in eliminating family strife. It may also permit the client to feel comfortable making gifts of interests, either to transfer control while retaining an economic benefit or to transfer economic benefits to family members. Clients with businesses that may be successful but do not rise to the level of creating taxable estates under the current exemptions tend to like the idea of transferring interests to their children while retaining economic benefits from the business.
For business owners and executives or other self-employed clients, planning for retirement benefits is critical. For some such clients, retirement benefits will be their most significant asset. Ownership and transfer of retirement benefits will involve significant income tax considerations regardless of transfer tax issues. Clients often seek advice on the distinctions among the multitude of available plans, qualified vs. nonqualified benefits, and the advantages and disadvantages, for example, of Roth IRAs and traditional IRAs.
Clients who own S-corporation stock require significant planning, regardless of value, because of the restrictions on permissible shareholders of S-corporations under the IRC. Voting trusts, grantor trusts, estates of deceased shareholders, or grantor trusts that become nongrantor trusts after the death of the grantor for a period of two years after death can hold S-corporation stock, but other trusts are not qualified S-corporation shareholders unless they are qualified subchapter S trusts or electing small business trusts. Clients who own S-corporation stock will need strong guidance in ensuring that their businesses continue to qualify as S-corporations.
Even outside the context of operating family businesses, limited partnerships and limited liability companies have become popular vehicles for managing and controlling family assets, and, as several cases have demonstrated, must have a legitimate and significant nontax purpose in order to provide a transfer tax benefit. “A significant purpose must be an actual motivation, not a theoretical justification.” Estate of Stone v. Commissioner, T.C. Memo. 2012-48 (Feb. 22, 2012). Although there have no doubt been abuses of LPs and LLCs to achieve estate tax savings, most of them do have legitimate and significant nontax purposes. One purpose could be providing an additional layer of asset protection for beneficiaries. Or, the purpose can be as simple as central management of various family assets. Another purpose often desired by clients is the ability to restrict further transfers of assets owned by the LP or LLC. Increased transfer tax exemptions diminish none of these purposes.
The death of a loved one is a highly sensitive and emotional time for family members, who may not want the responsibility for administrative matters. At the same time, clients without significant net worth may not like the idea of any corporate fiduciary. Acting as an executor or trustee (or co-executor or co-trustee with a family member) is one of the most appreciated services we provide to clients and a great value-add for the firm. Unfortunately, many law firms do not condone this practice. Of course, a firm that does provide this service should make sure provisions are included in its malpractice policy to cover these roles.
Representation of fiduciaries in the administration phase provides a steady source of revenue for the firm, one that likely exceeds the revenue from drafting documents and putting the plan in place. Family-member executors and trustees are often lost without trusted advisors. Questions often arise regarding the funding of various trusts under the estate plan and valuation issues for purposes other than taxes, standards for discretionary distributions of principal, and proper accounting for a trust’s receipts and disbursements. When family businesses are involved, correctly transferring interests to the intended beneficiaries and complying with governing documents for business entities are crucial. Unfortunately, mistakes are often made as a result of bad advice.
Administration services for higher net worth clients typically include preparation of estate tax returns; these services almost always include fiduciary income tax advice. Fiduciary income tax returns are required in nearly all estates, regardless of overall value.
Although attorneys who focus on planning generally would not, for example, handle a will or trust contest involving capacity issues, reams and reams of medical records, serious discovery, and ultimately a trial, there are several types of lighter litigation matters that estate planners—or trusts and estates practitioners—should be capable of handling. These include claims against estates that arise in the ordinary course of administration, beneficiaries and fiduciaries who argue about accounting issues, spouses who renounce wills, and will and trust construction matters. In addition, court proceedings are often necessary to reform trust documents, to comport with a settlor’s intent in light of drafting errors, or to comply with federal tax laws. Occasions also arise requiring the handling of matters such as nonjudicial settlement agreements where court approval is necessary or desirable. Having the ability to handle such matters can significantly increase the amount of work for the traditional estate planner.
In addition, recent articles have described the great wealth transfer on the horizon as the baby boomer generation will pass down $30 trillion in assets to the next generation. Increased transfer tax exemptions only leave more for family members to fight over. An across-the-board increase in fiduciary litigation could lead to increased work for trusts and estates lawyers as expert witnesses, mediators, or arbitrators.
Planning for State Death Taxes
Clients in states with state estate taxes will continue to need tax planning to avoid state death taxes, which can be significant in some cases. In Illinois, for example, the state estate tax exemption is $4 million, with no portability between spouses. Although the top nominal rate in Illinois is 16 percent, once a decedent exceeds the $4 million exemption amount, the tax tables are applied to the entire estate, not just the excess over $4 million. For a client with an estate of $4.5 million at death in 2018 (without the availability of a marital deduction or other proper planning), the estate tax bill would be $142,857 (28.6 percent of the $500,000 above the exemption amount). For a 2018 decedent with an estate of $11.18 million, the Illinois estate tax would be $1,082,431. These are outcomes to be avoided, and, particularly with portability not available for the Illinois exemption, planning to avoid the Illinois estate tax remains a priority for clients with assets exceeding $4 million.
Income Tax Planning
Even if the estate and gift tax is repealed in its entirety, clients will still need advice with respect to federal and state income taxes. This has been in the spotlight this year, with many clients calling to ask questions about the income tax provisions contained in TCJA 2017: Should I convert my S-corporation to a C-corporation (given the reduced 21 percent C-corporation tax rate)? Does my business qualify for the qualified business income deduction for pass-through entities? If not, how can I make adjustments to qualify for the deduction? I own many partnership and S-corporation interests; how can I ensure that they collectively qualify for the maximum allowable deduction? How can I get around this $10,000 limitation on deductions for state and local taxes? An estate planning attorney cannot respond to these questions by saying, “I don’t know, but I know someone else who might be able to help you.” Changes in the laws, such as the income tax changes in TCJA 2017, cannot just be ignored by an attorney because he or she is “only an estate planner.” Rather, such changes present a tremendous opportunity to develop new client matters and to expand your practice.
Advising clients on fiduciary income tax issues has been and remains an important aspect of practice, which ties in with estate and trust administration as discussed above. Asking a surviving spouse whether or not a trust should elect to be taxed as part of an estate, or whether the estate should file on a calendar year or fiscal year, is likely to produce more confused looks than actionable answers. That surviving spouse is looking to us for those answers. Many CPAs, who may have prepared thousands of individual income tax returns, are unfamiliar with many of the rules governing fiduciary income taxes. Clients will need assistance with issues such as section 645 elections, determining the best taxable year for reporting distributable net income, and the proper computation of the deductions available to estates and trusts for distributions made to beneficiaries, timing distributions to the advantage of beneficiaries, and the limitations on deductibility of trust expenses. Preparation of fiduciary income tax returns also fits squarely within a trusts and estates practice.
Continuing Tax Issues and Flexibility in Planning
The above discussion describes a wide variety of services that an estate planner, or trusts and estates practitioner, can provide to create a practice that thrives rather than withers in the face of less onerous transfer tax laws. The discussion assumes, however, the continuation of very high transfer tax exemptions, such that even if a sunset occurs in 2026 the estate and gift tax exemption will exceed $6 million per individual, with portability. ATRA 2012 did provide permanent provisions in the transfer tax laws, creating some level of stability that did not exist from 2001 to 2012, and the Tax Cuts and Jobs Act made transfer taxes irrelevant for most of the population, but there is always the possibility of a future decrease in the estate and gift tax exemptions or an increase in the transfer tax rates.
Many clients who do not have taxable estates under the current laws may have had taxable estates the last time their estate planning documents were executed, perhaps as recently as last year. Clients may have made irrevocable transfers to trusts or engaged in other transfer tax-saving techniques that are not necessary under the current law. Many clients may be interested in undoing some of their previous transfer tax planning, given the current higher exemption amounts. Other clients must revisit their estate plans to ensure that funding formulas will work properly and continue to be appropriate (especially in states with a decouple exemption amount). All of this certainly creates work for estate planning attorneys.
On the other hand, clients should not be too cavalier about the possibility of a future tightening of the transfer tax rules. Clients who may not have a taxable estate now have an opportunity to use the increased gift tax exemption amount before it possibly sunsets in 2026 or is otherwise decreased by an act of Congress. Forgiveness of existing debt is the prime example here, whether the debt arose from an intra-family loan or a sale to an irrevocable trust. Disclaiming income interests in QTIP trusts to cause a current gift under section 2519 is a possibility, as is giving the remaining portions of family entities to the next generation.
Flexibility in planning is going to be crucial. The needs of clients on the issue of transfer taxes will vary significantly based on net worth. High net worth clients will continue to engage in the same estate planning techniques in which they have engaged for years. However, the convergence of the estate and gift tax rates (40 percent) and the capital gains rates (23.8 percent) requires planners to be more mindful with respect to assets used for lifetime gifts, in trust or otherwise. Obtaining a step-up in basis upon death may be more important than estate tax exclusion, especially for families with assets right in the $20 – $30 million dollar range, and planning for maximum tax savings when considering both transfer taxes and capital gains is no easy task.
Structuring trusts and careful trust design will be imperative for future flexibility. Statutes are sweeping the nation, allowing such things as trust decanting and instructing parties such as trust protectors, investment advisors, and distribution trust advisors. Taking advantage of these statutes, the selection of trustees, the use of powers of appointment, including springing or formula powers, and even coordinated planning with less wealthy family members are all critical in the current estate planning environment.
Finally, the Personal Touch
In the article Size Matters: How Big Should a Law Firm Be?, published in this issue, the authors describe several potential market niches that focus on clients who want personal attention, niches in which clients will continue to seek a personal relationship with a trusted advisor. That article also relates the transition of Beth Wood from Big Law to her own firm, recounting how clients were willing to follow because of the intensely personal nature of trusts and estate and that they cared more about the individual lawyer who would take care of them and their families than they did about the firm name. The article concludes that to “thrive, and sometimes even to survive, all lawyers will need to be the resource for what even advanced cookie-cutter technology cannot provide—deeply personal service and surgical solutions to their clients’ problems.”
In conclusion, this author could not agree more with that sentiment. The successful trusts and estates practitioner will not only have the knowledge base and expertise to create the legal work product but will give priority to the client relationship. More and more, clients do not merely want to retain an estate planning attorney who can produce documents for them, but who will become a trusted advisor. Many clients also come with several other advisors. Practitioners should welcome opportunities to become part of a team. Overlapping work with multiple advisors is okay. Opportunities abound, and immense amounts of work remain for the estate planner who has concentrated on transfer tax planning but who is willing to expand into a broader trusts and estates practice, foster long-term, personal client relationships, and work well as part of a team of advisors.