A fundamental rule for success in sports is to “keep your eye on the ball.” This advice has applications far beyond the sports world, however. It also applies to business and estate planning. Too many people sign planning documents, wills, trusts and corporate shareholder agreements and, thinking they have taken care of everything, never think about them again. That’s a mistake.
Let’s take a couple in 2002 with a combined estate of $2 million, mostly in the husband’s name. They know they can leave their entire estate to each other tax free, but that would impose a hefty estate tax for the children when the survivor of them dies.
On the death of one of them, they would like to make as much of their estate as possible available to the survivor, without increasing the estate taxes. The maximum federal estate tax exemption is $1 million. The couple goes to their lawyer who proposes a will creating a trust to hold “the maximum amount that can pass free of federal estate tax,” and leaving the balance of their assets to the survivor outright. The trust income would be paid to the survivor, and an independent trustee could have the right to invade principal for the survivor’s health, maintenance and support. This is good advice. The survivor gets a million dollars outright, and income from the million dollars in trust.
On the death of the first to die, the money in the trust wouldn’t be taxed, because it is equal to the maximum tax exemption. The remainder of the decedent’s estate wouldn’t be taxed because it would qualify for the marital deduction. On the death of the second to die the survivor’s money wouldn’t be taxed because it is within the million-dollar exemption. The money in the trust wouldn’t be taxed because the trustee owned it, not the survivor. Thus $2 million can go to the children tax free. The couple leaves the lawyer’s office feeling good that they have secured their children’s future.
Keeping in mind Mark Twain’s observation that “No man’s liberty or property is safe while the legislature is in session,” let’s fast-forward a few years. It is now 2011. The House and Senate have been busy, and the federal estate tax exemption has been raised four times. It is now $5 million. Our couple has paid scant attention except to be pleased they can provide such a nice inheritance for their children tax free.
They have lived on the income from their $2 million, and at the death of the husband in 2011, they still have the net worth they had in 2002, but there is a problem. He still owned most of the assets. His will leaves “the maximum amount that can pass tax free” to the trust. He and she accumulated $2 million during their lives, and she will get almost none of it outright. It will all go into the trust because of the increased tax exemption. This was not the intent when the plan was made in 2002. She will get the income from the trust, but if she wants to use any of the trust principal, she will need to convince the independent trustee that she needs it for her health, maintenance and support.
The necessity for review doesn’t relate just to estates with tax plans. Many wills leave assets to a surviving spouse, and then to children. Years later, one of those children may need public assistance. Receipt of their inheritance may disqualify them from public assistance that may have provided more benefits than their inheritance.
There are situations in which business partners sign an agreement to purchase a deceased partner’s share from his or her estate for a fixed dollar amount. Years later, the value of the business may have multiplied many times over, but the price to be paid by the surviving partner(s) may never have been increased because the plan wasn’t reviewed and updated.
Some small businesses have no plan at all because “We trust each other.” That’s fine, but you may not always be dealing with each other. Do you trust your partner’s ex-spouse after a bitter divorce? Do you trust his or her trustee in bankruptcy? How about the IRS agent who seizes part of your partnership because your partner fell behind on his taxes? You can’t predict the future.
The point is a business or estate plan isn’t a one-time, forever fix. It should reflect the law, your needs and wants when it is written, but as the law and those needs and wants change, so should the plan.
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