Highlights:

  • Estate planning is a critical component of sound wealth management.
  • Tax law changes could result in smaller estates having to pay estate taxes.
  • Careful planning today can help safeguard your assets from taxes tomorrow.

“Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible.  Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions.  To demand more in the name of morals is mere cant.”

– Justice Learned Hand, senior judge of the United States Court of Appeals for the Second Circuit

In the latter part of the 19th century, Cuba, Puerto Rico, and the Philippines were struggling for independence against Spanish rule.  The U.S. was their ally in those efforts.  In the midst of these tensions, the United States battleship Maine was apparently struck by a Spanish mine on February 15, 1898 while at anchor in Havana Harbor.  (Questions still remain as to the actual cause of the explosion.)  The warship sunk, killing 260 American sailors.  Shortly thereafter, the United States declared war against Spain.  The War Revenue Act of 1898, which was signed into law on June 13, 1898, imposed a wide range of new taxes to raise revenue to finance the U.S. involvement in the Spanish–American War.  One levy was the predecessor to the current federal estate tax.

In last week’s blog post I offered suggestions on how to handle a large financial windfall.  One of my recommendations was to have a solid estate plan in place.  Strategic thinking on this front benefits the newly wealthy, and just about everyone else for a simple reason: a well-crafted estate plan is a critical component of prudent financial planning generally.

An estate plan is needed to (i) direct how assets are distributed after death; (ii) designate who oversees the distribution of assets at death; (iii) safeguard inherited assets from lawsuits, bankruptcy, divorce and other types of creditor claims; and (iv) name the person(s) who will act as the guardian(s) of minor children or incapacitated adults.

In the past, avoiding unnecessary death taxes was a major motivation for having an estate plan.  However, estate taxes have been less of a concern of late because of changes to state and federal death tax laws.  Currently, just 12 states impose a tax at death, and the federal government does not collect a federal estate tax on estates valued at less than $11.6 million (indexed for inflation) — double that amount in the case of married couples.

Death taxes could be making a dramatic recovery in the not-too-distant future.  Several members of Congress have proposed imposing death taxes on much smaller estates.  For example, Senator Bernie Sanders is sponsoring legislation entitled “For the 99.8% Tax Act” that would reduce the current federal estate tax exemption from the current $11.4 million per person to $3.5 million.  Mr. Sanders has also proposed raising the federal estate tax rate to a maximum of 77%, up from the current rate of 40%. 

Senator Sanders is not alone in looking at revising the federal estate tax in an effort to redistribute wealth and raise tax revenues.  President Obama consistently proposed reducing the federal estate tax exemption to $3.5 million during his presidency.  Senator Elizabeth Warren’s “American Housing and Economic Mobility Act” would return the death tax rate to 2009 levels and impose a maximum tax rate of 45% on estates as small as $3.9 million.

Another tax provision that has been under frequent attack is the basis adjustment that currently occurs when the owner of stocks, bonds, real estate and other capital assets dies.  This tax rule provides that the tax basis of appreciated capital assets to be increased (or decreased) to fair market basis at death.  This can be a major tax saver in the case of appreciated securities, as the following example illustrates.

In 1980 Willy Wonka buys 1,000 shares of Chocolate Factory Inc. stock at $5.00 a share, for a total investment of $5,000.  Willy holds onto the shares until his death.  When Willy died in 2018, those same shares traded at $500 a share, for an aggregate value of $5,000,000.  Willy’s estate plan leaves the shares to his son, Wally.  Wally promptly sells the stock to pay for a new yacht.  Under current tax, Wally would not pay taxes on any of the gain realized on the sale.  By comparison, some tax proposals would subject the entire $5,000,000 of sale proceeds to income taxes.  Moreover, some are proposing those taxes be imposed at ordinary income tax rates.

While the future of tax law is never certain, the risk of a significant increase in taxes at death appears elevated.  The good news: There is no shortage of legitimate ways to lock in the tax benefits currently found in the tax code.

For many investors, the time to act is now.  Just as hedging when economic or market risk is elevated can provide valuable protection against a subsequent bear market, estate planning can protect your assets from tax law changes.

“For Whom the Bell Tolls” is the Pulitzer prize nominated novel by Nobel Prize winning author Ernest Hemingway.  The movie adaptation starred Gary Cooper and Ingrid Bergman and was nominated for nine Academy Awards, including Best Picture.  The novel tells the story of Robert Jordan, a young American who volunteers to join the International Brigades, a guerrilla unit fighting in the Spanish Civil War, and is loosely based on Mr. Hemingway’s own experiences during the war.  Jordan (played by Cooper) is given the dangerous task of blowing up a bridge that lies behind enemy lines.  Things get complicated when Jordan falls for María (Bergman), a partisan supporter of Spanish dictator Francisco Franco.  You can see the official trailer for the movie HERE.  (As always, ignore any pop ups that might appear during the video.)

Thank you for reading,

Mr. Market Commentator

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