This excerpt comes from an email from Jeff Reed at KestlerFinancial about the possibility of a capital gain tax replacing the estate tax. My gut reaction is to respond with an argument on the impact of these taxes on social policy but that clearly misses the point of the discussion. He is absolutely correct in pointing out that no matter what path we take, the best tax planning approach is to boost the amount of life insurance on wealthy clients. The underlying report titled “Cost and Consequences of the Federal Estate Tax: An Update” issued on July 25, 2012 is well worth reading.
“It could happen. At least, if the Republicans have their way. In a rather surprising move in an election year, the Republicans released a study arguing that the Estate Tax actually generates less revenue than would be generated by the repeal of estate taxes and application of capital gains treatment of inherited assets via carryover of the deceased owner’s cost basis.
Counter intuitive? Maybe. You can read the report here.
Rather than argue politics, let’s think this through a bit. If we go ahead and play along with the Republicans, what would the impact be on our clients and our businesses? If we look at the issue from the client’s perspective, there are some downsides. All clients’ beneficiaries would now face a tax on inherited assets to the extent there was gain. How do we establish gain? It all starts with establishing basis, and that requires documentation. The burden of proof is on the client. No proof? No basis. No basis? It’s all taxable. “Tough luck, Beneficiary! Mom and Dad should have kept better records.”
Even if the tax is deferred until the asset is actually sold, the end result is the intent of the decedent has been ripped to shreds, and the assets they wanted to go to their loved ones now sit in the government coffers. Sounds like “Estate Planning: 101” to me; create liquidity when it is needed most using leveraged dollars. Frankly, the pool of potential estate planning clients who could really stand to own a bit more life insurance grows dramatically in this scenario. If you manage client assets in any way, you already know how difficult it can be to find the records necessary to establish cost basis.
What if we go up market to the high net worth space? Again, they are all going to need to deal with a tax. The magnitude of the tax in real dollars may be less for some of the very wealthy if they can provide the basis documentation. The pool of potential estate planning clients continues to grow in this segment as well for all the reasons outlined above. We may have to see more clients and motivate them to take action on an insurance purchase to generate the same revenue. That, of course, is where the problem lies, and we need look no further than late in the last decade to see it plain as day.
What did all of our clients hear about 2010? No estate taxes! What was the reality? There was still a transfer tax in the form of capital gains, and it had all the problems (and then some) outlined above. The step up in basis at death of these assets under the “normal” estate tax regime was essentially a “Get Out of Jail Free” card. If you had an asset with a low basis and high market value you simply had to hang on to it until death and then the tax issue was solved. Try convincing a client that there is still a tax when all they hear on the news is that it has been repealed? Tough sell, to say the least.
So what is the answer?
I’m not sure we need one, as the estate tax issue is far from settled. Rather, I think we stick to the basics, knowing that there are very, very few beneficiaries who complain about having too much life insurance when their loved ones pass away. The truth is that there is going to be a transfer tax. It is simply a matter of when and how it is paid.”