1 Comment

How to Handle Clients with Estate Tax Issues: A Financial Planner’s Guide

Clients with estate tax exposure have become the unicorns of the financial planning industry. For 2019, individuals with taxable estates greater than $11.4 million are subject to a federal estate tax of 40 percent. To put this into context, according to the IRS, only about 2,000 estate tax returns are filed per year for estates of $11.4 million or more.

Despite these statistics, if you practice in parts of the United States where wealth is more concentrated, such as New York, Los Angeles and the San Francisco Bay Area, you may very well have clients with taxable estates. It is important to prepare your practice to understand the particular needs of these clients.

The Basics: Sources of Wealth

Many clients in areas where housing is expensive, such as New York and San Francisco, may hold most of their wealth in real estate. In areas where tech companies are the main economic engine, including Seattle, San Francisco/Silicon Valley and Austin, Tex., your clients’ wealth may be tied up in the stock of their employers. Regardless of the source, clients with estate tax exposure are often very concerned about having to pay taxes. This concern may overwhelm other non-tax issues that are sometimes more important. Proper planning includes the ability to contextualize taxes in relation to other issues that are important to the client.

The Conversation: No Free Lunch

Contextualizing taxes often requires educating the client. Many clients do not understand even the basics about how estate taxes work or about how the tools of financial and estate planning affect estate taxes. Most people overestimate the impact of estate taxes and believe it affects most, if not all, estates. The majority also overestimate what the tools of tax planning can do, believing these tools can be used to eliminate any estate tax liability. It is important to explain to these clients that estate and financial planning can, at most, reduce or delay an estate tax liability, but not eliminate it entirely. It is important for the client to understand that if an estate is taxable, the IRS will eventually get its share.

What might this conversation look like? First, there is the technical explanation of the estate and gift tax. Every individual is subject to a unified exemption from estate and gift tax. The Tax Cuts and Jobs Act (“TCJA”), which became effective on Jan. 1, 2018, doubled the estate and gift tax exemption from $5 million to $10 million, adjusted for inflation from 2011. For 2019, the exemption is $11.4 million. In addition, every individual has a gift tax exclusion of $15,000 each year per donee. Any gift to a donee in excess of $15,000 in a given year is applied against the unified exemption. For example, if your client gives $215,000 to their child to help them buy a home, $200,000 of that gift is applied against their unified exemption, which would reduce the available exemption in 2019 to $11.2 million. If the client later died in 2019, they would have $11.2 million available as an exemption from estate tax liability. The TCJA’s estate tax provisions are set to expire at the end of 2025 and revert back to the $5 million unified exemption, adjusted for inflation, which is estimated to be about $6 million for 2026. Your client may ask how to plan for this change in the laws. A good response is advise that they plan for the current law and not speculate on what it might be in the future. You can always adapt the plan once the new law known.

The Tools: Reducing or Avoiding Estate Tax Liability

If your client is married, and both spouses are United States citizens, they already have the most effective method of avoiding estate tax liability, at least when the first spouse dies. Transfers of wealth between spouses who are both U.S. citizens, in any amount, are not subject to estate or gift tax. The combination of the estate tax exemption and the unlimited marital deduction is a potent tool for avoiding estate tax liability on the death of the first spouse. This can be accomplished by dividing the deceased spouse’s estate between an irrevocable trust that is funded up to the amount of their available estate tax exemption (known as a “Credit Shelter” or “Bypass” trust), and then funding their remaining estate to a Qualified Terminable Interest Property (“QTIP”) trust. The QTIP trust is an irrevocable trust for the support of the surviving spouse that is includable in the estate of the surviving spouse. The transfer to the QTIP is treated as a gift to the surviving spouse and takes advantage of the unlimited marital deduction.

Take the example of a married couple with each spouse having a taxable estate of $20 million ($40 million total). For a deceased spouse in 2019 with a $20 million taxable estate and the full $11.4 million in available estate tax exemption, $11.4 million would be funded to the Bypass Trust, and the remaining $8.6 million would be funded to the QTIP trust. The surviving spouse, as a result, now has a taxable estate of $28.6 million. Use of the marital deduction does not eliminate estate tax liability, it only transfers it from one spouse to another.

This is where tools that actually reduce estate tax liability are helpful. The goal is to move assets out of the client’s taxable estate to those other than the surviving spouse. This typically consists of the client’s children or other family members, or charities. With the exception of charitable gifts, these transfers of wealth utilize the gift tax exemption to move assets to donees. Once these assets are transferred, they become part of the taxable estate of the donee. Ideally, you will transfer assets that are expected to increase in value over your client’s lifetime, so the effect on the client’s estate and gift tax exemption will be lower than if the asset remains in their estate until the client dies. Grantor-Retained Annuity Trusts (“GRATs”), Intentionally-Defective Grantor Trusts (“IDGTs”), Qualified Personal Residence Trusts (“QPRTs”) and other similar tools can be used to move assets that are expected to grow over time out of the client’s estate. The advantage to the client is that the asset is valued at its present value, and in some cases is discounted from its present value. Any subsequent gain would not affect the taxable estate of the client.

A simple example is a QPRT. A client transfers her personal residence worth $1.5 million to a QPRT that names her three children as remainder beneficiaries. This is a $1.5 million gift to the four beneficiaries. By the time of the client’s death, the residence is worth $6 million. The client has removed $6 million from her estate with only a $1.5 million reduction to her estate tax exemption. The three beneficiaries’ estates will have increased by $2 million each by the time of their mother’s death. These are sometimes known as “asset freeze” techniques because they, in effect, freeze the value of the asset at the time of the gift from the donor’s taxable estate.

It is important to emphasize to the client that these techniques come at a cost. They require the client to give away property, which may reduce liquidity or cash flow available to the client. For a QPRT, the client is giving away their personal residence, in most cases, to their children. QPRTs are commonly structured so the donors will rent the property from the donee after it is transferred to the QPRT. Many clients might not be willing to rent their home from their own children. The client must understand that reducing their taxable estate means reducing their wealth.

Tax Obsession Versus Sound Planning

Estate planning attorneys have their spin on an old phrase: “don’t let the tax tail wag the estate planning dog.” Sometimes clients must be reminded that it may be impossible to avoid taxes entirely, and the benefits of lower taxes must be compared to the cost, complexity and risk involved with implementing the tools to lower their taxes. The cost involves not only giving away wealth, but also the costs of hiring lawyers, accountants and even financial planners to develop and implement the tools and techniques of reduced tax exposure. The complexity involves setting up and maintaining the trusts, partnerships, LLCs and other tools commonly used to reduce estate taxes. The risk stems from the heightened scrutiny by the IRS and the risk that any of these tools, not properly carried out or maintained, can fail in their intended purpose of tax reduction (e.g., when the value of the asset decreases over time).

Communication is Key

Educating your client requires explaining the costs, complexities and risks of the tools explained above so the client can balance the tax and non-tax goals of their plan. Achieving that balance helps ensure the success of a carefully crafted financial or estate plan.

The conversation with a client who is fortunate enough to have a taxable estate must take into consideration the client’s relative sophistication and their motivations. In having the conversation, the financial planner better understand who their client is and the client better understand what it is they want.


David D. Little is Certified Specialist in Estate Planning, Trust, and Probate Law and an attorney with Hartog, Baer & Hand. He can be reached at dlittle@hbh.law.

1 Comment

Are You and Your Clients Making These Estate Planning Mistakes?

A recent survey by Caring.com found that only 42 percent of U.S. adults have estate planning documents in place.

The survey asked participants why estate planning documents hadn’t been established yet. Twenty-nine percent said they have no one to leave assets to, and 47 percent said they simply hadn’t gotten around to it yet, according to the AARP article, “Haven’t Done A Will Yet?”

Not Having a Will

“The biggest estate planning mistake I see people make is not having a plan at all,” Eric Roberge, CFP® professional, founder of Beyond Your Hammock, told U.S. News and World Report.

About 52 percent of U.S. adults have not made a will, according to BMO Wealth Management. A will is essential to an estate plan, but it’s not enough, writes Bob Carlson in the Forbes article, “7 Big Estate Planning Mistakes.”

Only Having a Will

In addition to a will, other documents need to be in place for an estate plan to be thorough. These include power of attorney, trusts and advanced medical directives.

Neglecting health care power of attorney is also a common estate planning mistake. A health care power of attorney is “all about you, before you die. A will is only about dividing up your property when you’re not around,” lawyer and author Sally Hurme said in the AARP article.

Without determining the person who can make decisions upon incapacity, or stating your wishes in a legal document, state or local law will determine who gets to make these decisions.

Not Updating Beneficiaries

Estate planning mistakes aren’t reserved only for clients, as Nancy L. Anderson, CFP® professional, wrote in Forbes. Anderson shared how she had divorced her husband when her children were ages 2 and 4, and changed her IRA beneficiary to her father. Twenty years later, she realized she hadn’t updated that, despite her kids being grown.

“If I’d passed away before making a change, it could have been a disaster for my family,” Anderson wrote.

Neglecting Digital Assets

This has been on the radar for a few years, but recently came to the forefront when the CEO of QuadrigaCX, a Canadian crypto exchange, died in December without giving the password to offline cryptocurrency wallets to anyone. Customers with $190 million in cryptocurrency stored with QuadrigaCX might not see their investments again. While neglecting digital assets likely won’t cause your clients’ heirs millions, this is a reminder to not ignore them.

Ana TL Headshot_Cropped

Ana Trujillo Limón is senior editor of the Journal of Financial Planning and the editor of the FPA Practice Management Blog. Email her at alimon@onefpa.org, or connect with her on LinkedIn

Leave a comment

Digital Assets 101: How to Account for Digital Assets in Estate Plans

Digital assets are a popular topic and an ever-important aspect of estate planning with today’s digital age. Even simple accounts such as Facebook and Twitter have tremendous transferable value to beneficiaries. However, beneficiaries and clients alike believe that merely sharing a password or access gives the beneficiaries the rights to the account. Ironically, this may constitute a violation of the law if this is how a digital asset is handled in an estate. It is important to understand the transferability, the value and how to provide instructions for transfer.

When planning for digital assets in an estate plan, it is important to help your clients identify their digital assets. Certainly, the best place to start is with an inventory. Try asking them if they have some of the popular digital assets and explaining the intrinsic value to the beneficiaries. Once they have a comprehension of the value, they are more likely to identify digital assets they own. While they may not initially see value in digital asset planning, photos, videos and stories go a long way in legacy planning. Helping clients realize the value of legacy planning can assist with digital asset planning.

After taking inventory, you will have to familiarize yourself with some of the policies of a particular digital asset. Digital assets can be transferred in similar ways to normal assets. Some will allow the account holder to appoint a legacy person and some need specific language in wills or trusts to transfer the digital asset. The only caveat is that some assets (unlike liquid and tangible assets) are not considered property and simply cannot be transferred. Most of this occurs in loyalty reward programs.

One of the most popular digital assets is Facebook. The reason for its popularity is because of the memories it holds. A user can appoint a legacy sponsor to handle the account once someone has passed. The user can also choose to delete the account. The challenge here is similar to that of a beneficiary designated account, someone must be chosen prior to death. Once someone dies and Facebook finds out they memorialize the account. This basically freezes the account and provides no access. Just like setting beneficiary designations (and revisiting them), digital assets that have legacy access should have those designations set and revisited periodically.

Loyalty reward programs are equally as popular. While most are not that friendly within an estate, some have clauses that can be accounted for in legal documents. Let’s take American Airlines. American Airlines has some language in its AAdvantage program terms and conditions which does not specifically allow transfer after death, but the airline gives itself a “loophole” to transfer the miles after approved legal documents have been submitted. Accounting for specific language in estate documents can be vital in transferring a specific digital asset with significant value. This is an excellent example accounting for digital assets within a will or trust document.

Digital assets can be tricky when accounting for them in an estate plan. The key is to take proper inventory, gather some familiarity or help and account for transfer. The great news is, this is an excellent conversation starter, a differentiator in practice and a way to provide great value to your clients. In the digital age we are in, digital assets are becoming more important in estate planning. Take the time to learn how to account for them in estate plans, it will be well worth it.


Scott Huff_Updated

Scott Huff is the CEO of Yourefolio.