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When I read about what sounds like a train wreck of estate tax proposals, I am reminded that people really worried about passing on an estate can always just insure against the tax that might be assessed. For pennies on the dollar, anyone can buy life insurance that, if owned properly, can generate a tax-free windfall large enough to pay all costs at death. Current proposals call for doing away with the estate tax (the "death tax") and replacing it with a capital gains tax. Either way you slice it, heirs will have taxes to pay sooner or later as a result of the death of any substantial family member. Where does the new capital gains tax come from? Well, right now when someone dies, their assets are all revalued based upon today's appraised value. If they are sold later, the taxable gain will be just the increased value from the time of death until the subsequent sale. This new appraised value triggered by a death is referred to as a "stepped-up basis." It is the value on which any future sale's gain is "based." A "family farm" bought during the depression era out of foreclosure for $2,000 might be worth $5,000,000 when the sole matriarch dies. If the heirs sell it a year after death for $5.5 million, they only pay capital gains on $500,000 thanks to the stepped up basis described above. Earlier in the year, they paid estate taxes on the $5 million. The dreaded "death tax" was taken away by a politically popular bill with bipartisan support in both houses of congress. However, in an attempt at revenue neutrality, the tax was effectively replaced by taking away the advantage of the stepped-up basis for calculating capital gains. In the example above, the heirs will avoid the estate tax but they will now pay capital gains taxes on $4,498,000. Calculating this tax exactly, of course, will require that someone has kept track of all the capital improvements made on the farm since 1930 that were paid for with after-tax dollars. All these expenditures will have increased the "basis" from $2,000 up to something higher that will therefore reduce the net gain and therefore the capital gains tax---but probably not by much, and who knows where those records are? Gains on stock portfolios that had dividends reinvested over the years will be even more impossible to calculate. To his credit, President Bush has vetoed everything and put all of this nonsense on hold. Meanwhile, we have people like Warren Buffet and Bill Gates' father weighing in publicly on the fact that the estate tax is "the most intelligent tax ever devised. ?it doesn't tax labor or investment. It encourages each generation to build new wealth. And it accepts the idea that the very wealthy owe something back?" The bottom line is that it costs money to run a government. If we did away entirely with the estate and capital gains taxes, we're kidding ourselves if we think we can reduce government spending by that much. For example, the Clinton administration ended welfare as it had existed for thirty years, and now we are compassionately extending benefits in the face of the economic downturn. If this is what compassionate conservatism is about, I'm all for it. Like they say, "a recession is when our neighbor is out of work; a depression is when WE are out of work." Practically speaking, it doesn't look like the death tax will go away. It will just be replaced by something more difficult to calculate that sounds better from a marketing standpoint. The words "Estate Tax" convey that giant sucking sound that Ross Perot used to talk about. Capital gains tax, on the other hand, is real common and will always be with us. It's like "Bogie" said in the movie Casablanca, "We'll always have Paris." Anyone with some marketing background can see the advantage of this name change. People concerned about the costs of transferring assets from one generation to another, then, need to think about life insurance. There are still great people in the insurance industry who know a lot about estate planning. They can steer you in the right direction to set up trusts and insurance products that will pay these taxes at what amount to huge discounts. Gifting premiums to heirs sets the stage for tax-free insurance windfalls to pay whatever taxes you anticipate. Anyone serious about solving their potential problem would do well to talk with a Chartered Life Underwriter or financial planner about a spectrum of options. Buying life insurance has some other collateral benefits. You learn something about your health and what the actuaries have calculated as your particular life expectancy. In my case, a life insurance physical a few years ago lead to a non-standard rating and prompted me, an intense hypochondriac, to become extremely concerned about my cholesterol problem. Two years of eating nuts, garlic and oatmeal has made me difficult to live with but has solved my problem and generated substantial savings in my brand new policy. It's nice to save money, but it's even nicer to know that I might live longer. By triggering a dialogue and some course correcting, the purchase of life insurance can be constructive for reasons apart from the major problem it solves. Don't hold your breath waiting for Congress and the President to make this problem go away. Jack Nicholson,
in his new movie "About Schmidt," plays the role of an actuary.
Actuarial science is the study of statistics that determine when
people will die. It takes into consideration their age, sex, health
problems, hobbies and many other factors. When two actuaries are
together, it's easy to tell which is the extrovert. He's the one
looking at the OTHER guy's shoes. These quiet, super-smart people
can be helpful, and like Felix Frankfurter, many of us have neglected
to consider the insurance product they help to create. |
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