Even in a year of no federal death tax, top estate planners warn that marital trusts can cloud the issue. Not even billionaires may be able to pass on their wealth tax-free.
While even Forbes is grousing about how billionaires like John Kluge are cheating the IRS by dying during the federal death tax holiday, executors are still working overtime to get the heirs the best outcome no matter what happens in Washington.Kluge, for example, amassed about $6.5 billion in his lifetime, making this self-made media baron the 35th richest man in America when he died on September 7.
Although the details of John Kluge’s will haven’t been made public, his lawyers would have at least thought about putting some or all of his taxable wealth into a qualified terminable interest trust (QTIP).
A QTIP is a form of marital trust that gives executors up to 15 months to choose whether to pay the prevailing estate tax liability -- currently zero -- or deferring the bill until the surviving spouse dies.
These trusts are traditionally favored in complex situations like Kluge’s (four wives, three kids) because they also limit the surviving spouse’s access to the underlying assets, but their flexibility has also made them popular tax planning vehicles.
“The control part is very important, but even totally harmonious families were using QTIP trusts purely for tax purposes,” explains Donna Barwick, a senior fiduciary officer at Wilmington Trust’s Atlanta office.
As far as harmonious families go, Kluge’s fellow billionaire George Steinbrenner was happily married to the same woman since 1956. But based on published reports, he probably put most of his $1.1 billion estate into a QTIP trust -- not to keep Joan from spending their children’s inheritance, but for the tax treatment.
Smart planning in any other year?
Far from being the cut-and-dried billion-dollar windfall that Forbes and other publications are fretting about, the one-year repeal of the federal estate tax actually creates new headaches for blue-chip estate planners.
A lack of guidance from Washington is at the top. Unless Congress acts this year to change the rules, the estate tax is set to return January 1 at a maximum rate of 55% for all assets over $1 million.
Dan Rubin, a top estate planner at New York City law firm Moses & Singer, agrees that QTIP is probably the way for billionaires to go, but the details can be tricky
For one thing, no one knows for sure if the benefit of having no estate tax will in 2010 will be passed on when the spouse dies.
And the Kluge or Steinbrenner lawyers may not be able to defer the liability even if they wanted to.
“Normally in order to get the deferral, an election would need to be made on the estate tax return,” he notes. “With no estate tax on the books this year, there’s some question whether you can even make that election.”
Getting the better basis
Estate tax elections aside, simply having the assets in a QTIP-capable trust shields billionaire heirs from a bit of their future capital gains burden.
Although there’s no 2010 federal estate tax, the current basis rules mean that beyond a certain threshold ($1.3 million plus $3 million extra for spousal property) inherited property no longer “steps up” on the previous owner’s death.
A QTIP trust gets that spousal exemption while other forms of trust do not, Dan Rubin explains.
“If you rewrote a billionaire’s will in 2010 to exchange a QTIP trust and put in a credit shelter trust instead because you thought you no longer needed the marital election, you would be wasting $3 billion in basis allocation,” he says.
Rubin also notes the persistence of state estate taxes. As a Palm Beach resident, Kluge wasn’t worried about Florida taking a piece of his fortune, but George Steinbrenner’s lawyers did need to deal with New York’s tax code.
“Steinbrenner’s attorney is a close friend of mine,” says Donna Barwick. “My guess is that Steinbrenner’s estate was so well planned that this was not an issue. You could say that about any billionaire, no matter what the exemptions are in any given year.”
Visibility still hard to come by
For estate planners who are working with slightly smaller clients, the sad fact is that it’s already late September and nobody really knows whether the estate tax will reset 2-1/2 months from now with an exemption of $1 million, $5 million or somewhere in between.
Senator Mitch McConnell (R-Kentucky) has introduced a bill that would “patch” the tax code and reset the estate tax (and the capital gains treatment of inherited assets) at 2009 levels.
But McConnell aide Don Stewart tells The Trust Advisor he isn’t holding his breath for any progress on the bill before the November election.
A lame duck Congress may go either way. On one hand, a $1 million exemption will generate extra revenue for a cash-starved government. But on the other, exposing upper-middle-class families to an added tax burden is still extremely controversial in Washington.
However the new rules end up, the prospect of making them retroactive to the start of 2010 looks slim. Every billionaire that dies only raises the odds that any attempt to tax these huge inheritances will end up in years -- maybe decades -- of litigation.
If so, even the best executors have a lot of work ahead of them.
Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and reporting.