Important Regulatory/Legislative Updates

As part of our ongoing planning work for clients, we are keeping an eye on relevant changes in the planning environment. Here are a few current developments.

Section 529 Plans: A move to stop the sunset!

“The College 529 InvEST Act of 2005” (Investment in Education Savings for Tomorrow) consists of two bills circulating in the Senate and House of Representatives that make permanent the provisions for tax-free growth and spending for qualified higher education expenses. Current law calls for a sunset of favorable tax treatment in 2011.

Kochis Fitz has championed tax-free §529 plans for education funding since legislation passed in 2001 and have predicted that the tax advantages would be made permanent. These plans are very broadly recognized as one of the best investment opportunities for post secondary education. At the end of the first quarter, assets in excess of $55 billion had been invested in § 529 plans, and this number is expected to climb to $200 billion by 2008. Given the popularity of this savings tool, we believe that members of Congress will find it difficult, if not impossible, to vote against repealing the sunset. So, not only are existing §529 plans safe, but the path seems about to be clear for much more of this opportunity.

Estate Tax. Reform or Repeal?

Again in April 2005, the House voted to permanently repeal the estate tax in 2010; the decision-making process has now moved to the Senate. Supporters of a permanent repeal, including President Bush, denounce the estate tax as an unfair punishment of the wealthy and a double taxation of life-time earnings. Opponents to the bill consider it an unfair break for the wealthy at a time when federal deficits have soared. A compromise would likely involve some trade off of rates and/or exemption relief in exchange for retaining some version of the tax. For example, Senator Jon Kyl (R) suggests a $10 million per person exemption and a 15% estate tax rate (equal to the current federal capital gains rate). Senator Max Baucus (D) wants a higher rate, but with a personal exemption between $3-5 million instead of the current $1.5 million.

How many individuals could this impact? In 2003, 20,600 estate tax returns were filed with the IRS for estates worth more than $1 million. Of those, just 3,486 were estates worth $5 million or more. In 2004, it’s estimated that 19,000 estates owed estate tax with an average tax bill of $935,000, or a total of $17.6 billion. Over the next twenty years, it’s estimated that a repeal could reduce federal revenue by $1 trillion! Lawmakers who favor a compromise claim that a total repeal would be too costly to the Treasury at a time of concern about the federal budget.

Arguments against a permanent and total repeal have also been voiced by charitable organizations. Without an estate tax, they claim, there is less incentive for the wealthiest Americans to make charitable bequests through their estate. A repeal could result in as much as a $10 billion loss in annual charitable giving. Responsible Wealth, a coalition of business leaders with a membership among the nation’s wealthiest five percent that includes Bill Gates, Sr. and Warren Buffet, claim the estate tax is our most progressive tax and an important source of revenue. And importantly, it serves as an “incentive to recycle wealth through the nonprofit sector.” Still, these commentators seem to miss the point that both charities and donors can often do better through gifts made during the donors’ lifetime. Such gifts also, of course, reduce the estate size and produce current income tax savings that can be more valuable than eventual estate tax savings; and the benefits to charity come sooner rather than later.

Basis Step-up

There is also a less publicized potential repeal of the step-up in basis rules. Currently, an heir’s tax basis is either the more favorable of the fair market value of the assets on the date of death, or the fair market value six months after the date of death. This long-standing arrangement for step-up in basis continues through 2009, undergoes major changes in 2010, and comes back in 2011. In 2010, not all appreciated assets in the estate will receive a basis step-up. Those not adjusted would be subject, at sale, to capital gains taxes for any appreciation from the decedent’s original cost. Some proposals would make that arrangement apply to all assets. Kochis Fitz believes that it’s unlikely that this provision will survive as it would create an accounting nightmare. It was tried once before, in 1976, and was almost immediately repealed.

There will undoubtedly be more arguments from both sides of the aisle before a compromise on estate tax reform or repeal is reached in the Senate. There is, however, large bipartisan support to establish some permanent change to our existing estate tax legislation and the consensus is that changes will be made in 2005. For good or ill, we think full repeal is very unlikely, but some form of reform will likely benefit our clients. For now, we are recommending that clients not make major, non-dispositive revisions to estate plan documents until the outcome of pending legislation is more certain.

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