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Estate planning has always been challenging, combining the need for technical expertise, an understanding of family dynamics and the ability to deal with clients at difficult periods in their lives. Recent changes to state and federal transfer taxes (estate, gift and generation-skipping transfer taxes), the law governing valuation discounts, state law of trust administration and Internal Revenue Service (IRS) requirements governing client communications have made matters worse. As a result, many lawyers wonder whether estate planning is still the right field for them. However, while these changes make life more difficult for estate planners, they also provide the chance to redefine the nature of the job itself. When estate-planning lawyers put the client’s core values ahead of the tax planning, these new changes become much less important. Further, by worrying first about the client’s vision for family wealth, the estate planner actually makes the tax planning easier and more effective. In other words, the manner in which estate planning lawyers deal with these changes can improve the way they handle all aspects of their job. The structure of the federal estate, gift and generation-skipping transfer (GST) taxes drastically changed in 2001 with the passage of the 2001 tax cuts. As a result of these cuts, the exemptions from estate and GST tax increase in 2006 and again in 2009, and both taxes are completely repealed in 2010. However, in 2011 they reappear at their pre-2001 levels. The gift tax, the exemption for which is fixed at $1 million, is not affected by these changes. The goal of these temporary changes was to move toward complete repeal of the federal estate tax when the Senate had sufficient votes to do so. However, in light of budget deficits and the costs of the Iraq war and the hurricane expenditures, the cost of complete repeal seems too high. Senator Jon Kyl, R.-Ariz., formerly a leading proponent of repeal, has proposed a reform, under which the estate, gift and GST taxes each have a $3.5 million exemption and the tax rates on estates in excess of that amount are reduced to the level of capital gains (approximately 15%). See, e.g., Edmund L. Andrews, “Death Tax? Double Tax? For Most, It’s No Tax,” N.Y. Times, Aug. 14, 2005, � 3, at 4; Jeffrey H. Birnbaum and Jonathan Weisman, “The 1% Split Over Estate Taxes/The Few at the Top of the Heap Disagree on How to Keep the Most,” Wash. Post, Aug. 12, 2005, at D1. It now seems that a majority in the Senate favors some kind of reform rather than repeal. Estate planners are left wondering which, if any, of their clients will be subject to estate taxes and to what extent tax planning will be appropriate for them. For example, traditional estate tax planning for a wealthy married couple involves the creation of a “shelter trust” at the first spouse’s death for the benefit of the surviving spouse. This irrevocable trust holds the amount that can pass free of estate taxes in the deceased spouse’s estate and “shelters” it from the estate tax in the surviving spouse’s estate. In past years, this was basic estate planning for couples with a combined wealth of more than $1 million; now, it is less clear the level of wealth at which even such basic estate tax planning should be used. Further, the amount of more complex planning that a client should consider is hard to determine because clients who in past years had enough wealth to justify the use of life insurance trusts, annual gifts and valuation discount techniques may be adequately covered in their future estate planning by the use of simple shelter trust techniques. A variety of approaches As a result, some estate planning lawyers are now drafting flexible plans that allow for post-mortem tax decisions, such as whether to fund a shelter trust or not, while others are using “disclaimer” trusts, under which all property is given from one spouse outright to the other, with no shelter trust involved, unless the surviving spouse “disclaims” some or all of the deceased spouse’s assets. See, e.g., Christopher P. Cline, “Some Post-Mortem Planning Ideas after EGTRRA,” 43 Tax Mgmt. Memorandum 163 (May 6, 2002). Still others are using elaborate trust agreements that spell out different results, depending upon the level of the client’s wealth and the state of the tax structure at the date of death. All of these approaches are difficult to explain to clients, and make estate-planning documents harder to read. The uneven imposition of state inheritance taxes makes matters even worse. For instance, Oregon imposes an inheritance tax beginning at $1 million, with the result that some decedents’ estates must file an Oregon inheritance tax return but need not file a federal estate tax return. On the other hand, states like California have no state inheritance tax at all. Such uneven application of inheritance taxes has some lawyers advising clients to move to a nontax jurisdiction, particularly if they already have real property in that jurisdiction, and creating tax planning that contemplates the deferral or avoidance of state inheritance, rather than federal estate, taxes. These changes only present difficulties, however, if the estate planner defines his or her primary job as the reduction of transfer taxes. If the planner instead focuses on the client’s core values, these changes become of only secondary importance. For example, if the amount of transfer taxes imposed at a person’s death decreases, then the amount that can pass to his or her beneficiaries necessarily increases, so lawyer and client must now spend more time focusing on more basic and important questions. First, does the client really want to leave everything to the children? More clients are asking themselves this question, and the lawyer who ignores it does the client a disservice. Instead, perhaps some of the client’s net worth should pass to charity. If so, what does the gift to the children look like? If stated as a dollar amount, the real value of the gift will decrease over time due to inflation. Alternatively, the client can give an inflation-adjusted dollar amount. Another alternative is to give a percentage of the wealth to the children and the balance to charity. This approach allows the children to share in the future growth of the couple’s wealth after the estate planning documents are executed, but also could reduce the children’s gift below an appropriate level if the client’s wealth drops in value. There are no right answers to these questions; the lawyer simply must make sure they get asked. Second, if the client is leaving property to beneficiaries in trust, then what should those trusts look like? Clients lately are concerned that wealth will drain the beneficiaries’ initiative. The lawyer should ask the client enough questions to help the client define the goals for the trust. Some clients may want the trust to support the beneficiary while a minor, but after he or she reaches age 18, distributions for support might stop unless the beneficiary is enrolled in school for some minimum amount of time (perhaps half-time or three quarter’s time) and working toward graduation. This is the “go to school or get a job” model. Other clients may want the trust assets to be available for very restricted purposes only (health care, emergencies, down payments on a house and so forth) until the beneficiary reaches retirement age, at which point the trustee can make distributions for support. This is the “retirement plan” model, which might be attractive to a client who wants the beneficiary to have to work for a living, but wants the beneficiary to have the option of working at a low-paying but rewarding job without having to worry about saving for the future. A third option is simply to grant complete discretion to the trustee, together with a statement of intent by the client about the general goals of the trust. By putting the “real world” questions first, the lawyer has accomplished two things: First, she has demonstrated a concern for the client’s personal goals (which, regardless of what the client says, are almost always of greater concern to her than tax planning); and second, the lawyer has created a framework around which the thornier tax-planning questions can be addressed. Valuation discounts Federal transfer taxes are calculated based on the value of the property transferred, so if the value of that property is reduced, so is the tax. In the early 1990s, estate planners started using family limited partnerships and limited liability companies (LLCs) to cause such a reduction. The theory behind this technique is simple: If a person owns a partnership or LLC interest over which that person has no management control, then the value of his or her interest is worth less than a pro rata share of the entity’s assets because the owner of such an interest cannot find a ready buyer for it. The IRS, of course, views such planning as attempts to artificially lower asset values and improperly avoid taxes. Older decisions tended to favor the taxpayers. See, e.g., Christopher P. Cline, “The Facts Speak for Themselves: Recent Cases on Valuation Discounts for Family-Owned Entities,” 25 Tax Mgmt. Est., Gifts and Trusts J. 247 (September-October 2000). More recently, however, courts have tended to favor the IRS. See, e.g., John W. Porter, “FLP Wars Update,” Trusts & Estates 49 (July 2005); J. Joseph Korpics, “How Estate Planners can Use Bongard to Their Advantage,” 32 Est. Plan. 32 (July 2005). These IRS victories have estate-planning lawyers wondering whether such planning remains viable. Two fairly recent decisions show how it might be. In the first, Stone v. Comm’r, T.C. Memo 2003-309, five family entities were created to avoid litigation among siblings. In the second, Schutt v. Comm’r, T.C. Memo 2005-126, the family entities were designed to ensure that the family’s significant holdings in two corporations were maintained. In each case, because the court found a “real world” purpose for the family entities, the discounts were upheld. Obviously, any device created solely for the purpose of avoiding taxation will face heightened IRS scrutiny. On the other hand, if the lawyer and client treat the family limited partnership or LLC as a tool to teach children and grandchildren how to manage money, actually give them control over management and investment decisions and respect the entity’s form, then the client will have accomplished several goals. First, and most importantly, the client will have helped to develop in his or her beneficiaries a sense of responsibility about money management, rather than avoid the topic. This achievement is far more important to most clients than saving tax dollars. Second, as the cases show, the client will have increased the chances that valuation discounts will withstand IRS scrutiny because the client will have established a purpose for the entity other than simply avoiding taxes. Paradoxically, by ignoring the tax-savings aspect of the entity, the client increases the likelihood that such savings will be available. Trust administration changes Until recently, trust administration (with the exception of the occasional family fight) has been a stodgy business. However, new laws make it more challenging. First, the Uniform Prudent Investor Act requires that trustees invest trust assets for “total return” and according to “modern portfolio theory,” which mandates diversification and assumption of appropriate risk levels for the investments. Second, the Revised Uniform Principal and Income Act allows trustees to adjust their receipts between income and principal in order to make the administration of the trust more equitable, by allowing the trustee to invest for greater overall growth while also ensuring that income beneficiaries are not short-changed. For a more complete discussion of both the Uniform Prudent Investor Act and the Revised Uniform Principal and Income Act, see Christopher P. Cline, “Prudent Investing, Reallocating Income and Total Returns: The Curmudgeon’s View,” 28 Tax Mgmt. Est., Gifts and Trusts J. 62 (January-February 2003). Additionally, the Uniform Trust Code incorporates into state trust law the requirement that certain beneficiaries must receive notice of a trust’s existence and of their right to receive trustee reports. This requirement cannot be overridden by the trust terms. This new requirement may upset many clients because they may have created tax-planning trusts without letting the beneficiaries (often younger children or grandchildren) know that they exist. The Uniform Trust Code now makes clear that such secrecy is out of the question. These uniform acts impose a greater burden on trustees, but again may have a silver lining. First, they make more practical the idea of collaborative decision-making between the trustees and the beneficiaries. Rather than acting imperiously, a trustee now must be more forthcoming with the beneficiaries, disclosing the existence of the trust and the trustee’s investment plan. This, in turn, might lead to greater involvement by the beneficiaries and (in the best case scenario) the opportunity to teach the beneficiaries about managing money. Required disclosures The IRS issued Circular 230, 31 C.F.R. 10 (see T.D. 9165 (12/20/04), as amended by T.D. 9201 (5/18/05)), requiring lawyers to make certain disclosures to clients when rendering tax opinions. A lawyer who does not make these disclosures can be barred from IRS practice. Designed to prevent lawyers and accountants from approving questionable tax schemes, Circular 230 is broad enough to include simple letters from estate planners explaining how the most basic planning techniques, such as shelter trusts, work. See, e.g., Natalie B. Choate, “How I Will Comply with Circular 230,” Trusts & Estates 22 (July 2005); Emanuel J. Kallina II, ” ‘Trust Us’: The IRS’s Inadequate Response to Circular 230 Concerns,” Trusts & Estates 59 (May 2005). Estate-planning lawyers have responded to this mandate by attaching a caveat to virtually all communications, written or electronic, to the effect that the communication cannot be relied upon for purposes of avoiding tax penalties. (This approach has the laughable result that one can’t even schedule lunch via e-mail with one’s estate-planning friends without receiving significant tax disclaimers.) There is little good to say about Circular 230; however, if the lawyer takes the “real world” approach to estate planning described above, the importance of such disclosures is significantly reduced. If a lawyer emphasizes the “family vision” aspects of planning techniques like trusts, partnerships and LLCs, the lawyer’s letters will be more interesting to the clients, bring the lawyer a closer relationship to the client, create greater certainty that the tax planning will succeed and reduce the importance of Circular 230 disclosures because the tax planning, though available, is not emphasized or perhaps even discussed. In sum, the estate-planning lawyer’s life, never easy, seems to have gotten a lot more troublesome lately, leaving him or her with three alternatives: Just deal with it, quit practice or find a new way to go about his or her work. The last course, if taken with the client’s personal, rather than tax-planning, needs as a signpost, has the potential to be the most satisfying. By helping the client with the hard question of how to leave a family or philanthropic legacy, the lawyer will find that the complexities described above, as well as others, become more manageable, because they no longer are the primary focus of the lawyer/client relationship. And, paradoxically, the lawyer may find that the tax planning is more effective, because it is now tied to goals that are important to the client. Christopher P. Cline is a partner in theadministration and advising family businesses. Portland, Ore., office of Holland & Knight, specializing in estate planning and advising family businesses.

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