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Rethinking Estate Planning with Proposed Tax Reform

On January 17, President Obama proposed a new plan for the tax code that could have implications on estate planning. He proposed a revamp of the tax code that would include bumping up capital gains and dividend rates to 28%, treating bequests like realization events such as making beneficiaries pay tax on assets that have appreciated in value, and blocking contributions and accruals in qualified plans and IRAs once the account reaches $3.4 million. These ideas are forcing people to rethink their current estate plan and look ahead to the future.

Response to the Plan

The response from advisors, Republicans, and tax experts was not favorable to this new plan. It has also been noted that the chances of this proposal going through a Republican-dominated Congress are low However, legislators are telling people to pay attention because it gives an insight to where legislation may go in the future. Experts have noted that this type of legislation has been proposed before, and can give people planning their estates now a potential look into the future.

Contingency Planning the Estate

Experts are looking to charitable giving, donor-advised funds and charitable remainder trusts as the tools that estate planners can use to help contend with the potentially higher tax rates. Life insurance policies can also be a way to shield assets from higher taxes, especially if there is a cap placed on qualified account balances. What would typically go to a qualified plan or IRA could instead be invested in a life insurance policy. A cash value life insurance policy would combine the benefits of a tax-advantaged accumulation of funds along with tax-free withdrawals from the policy.

Another option for avoiding negative tax consequences in an IRA would be to cut the balance of an IRA reaching the maximum contribution limit and using the funds cut to make a Roth IRA conversion. Alternatively, you could use outside funds to pay the income tax on the Roth IRA conversion, which would allow you to preserve the value of the account and still receive tax-free withdrawals.

Current Trends in Estate Planning

If the tax reform is a success, many estate planners would be undoing years of work based on the current trends in estate planning. Most of the change would be tied to the proposed change in stepped up basis for appreciated assets. This is because currently, if a beneficiary inherits an appreciated asset, such as stock, the asset will pass to the heir at the value it was at the time of death. The heir receives the asset without having to pay capital gains tax on the appreciated value. Under the proposed tax reform, the stepped up basis will still be allowed, but the appreciation will be recognized and the heir will have to pay.

Another issue is that with the federal estate tax exemption now at $5.43 million, many estate planners are focused on taking advantage of stepped up basis to mitigate income taxes. One expert noted that “the planning has moved from getting assets out of the estate to keeping appreciated assets in the estate . . . Maybe they’d have to go back to getting property out of the estate and shifting the burden to beneficiaries in lower brackets. People would really have to revisit their estate plan from the ground up if any of this found its way into law.

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