Business New Haven 05/02/2005
Can't Take It with You As the largest wealth transfer in history looms, federal and state inheritance laws struggle to adapt
Melissa Nicefaro
America is on the cusp of the largest transfer of wealth in history.
Over the next decade, baby-boomers will inherit somewhere around $10 trillion. The exact amount is unknown, but unquestionably vast. In the early 1990s Cornell University economists reported that baby-boomers' parents would pass along more than $10 trillion to their heirs. By the late 1990s Boston College professors had calculated that the sum was actually closer to $100 trillion.
Eric Tashlein, managing member and principal of Connecticut Capital Management Group in Milford and president of the Financial Planning Association of New Haven, is already beginning to see signs of the great passage.
"There is $10 trillion that, in the next years, is expected to be inherited by the baby-boomers," says Tashlein. "We're starting to see that now. Some of that translates into new cars and other folks see themselves as stewards for the money and don't go out and spend it all.
"I see a combination of both, but I'm seeing a lot of inheritance," he adds. "Baby-boomers love to spend money, so it'll be interesting to see what happens when it comes over."
The sudden appearance of large sums of money, very much like hitting the lottery, can pose a challenge for the person on the receiving end. If the estate's value exceeds $1.5 million, there is a federal inheritance tax and a small tax to the state of Connecticut.
"The challenge all depends on if their parents did proper planning," Tashlein says. "Hopefully the family communicates. It's always a great idea to have a family meeting with advisors there with the parents and children. The parents' hopeful expectations for how the money should be used will be spelled out. In the real world, this doesn't always happen."
It may not be an easy conversation to have with your parents or your children, but wills cover only part of leaving an inheritance. Though wills clearly say who is to be bequeathed what, the will doesn't always convey the wishes of the giver regarding what is to be done with the money or other parts of the estate once it's been transferred.
"We like our clients to have family meetings," says Tashlein. "We've seen many inheritances handled well and others have been squandered. There are psychological issues with sudden money, and I would suggest to everyone have goals for the money - spend some and save some."
Tashlein says that inheritance money is most frequently spent on cars, homes, vacations and investments.
It is important to many older parents to know that their estate, no matter how large or small, is going to be wisely spent and will see their children living in comfort into their older years.
Edward Renn, a principal with the New Haven tax law firm Withers Bergman, handles the planning that results in the wealth transfer. Often Renn goes on to represent the recipients of inheritance, the younger generation, as they take over the family business and inherit the structure of their parents' or grandparents' estate.
"Most of my clients who are inheriting money from their parents or grandparents are inheriting in a trust and there's not that much going outright to children," Renn explains. "The trust provides creditor protection if the children get divorced, are sued for malpractice or go bankrupt. The money Mom or Dad left in the trust is protected and serves as a vehicle that, with proper planning, if the children don't use it up, they'll be able to pass it to their children without paying estate tax."
Still, there are not many loopholes to avoid taxation, especially when the estate's value exceeds $1.5 million.
"The system is designed so that one way or another, they [the state and federal governments] get their bite," Renn says. "That's why it's a unified system with gifts and estate. If you could just gift it away and avoid the estate tax, everybody would be gifting it away. If you died suddenly, you wouldn't have the opportunity to do it, but otherwise, people would be in the hospital, signing documents and making gifts."
As a general rule, good estate planning is about transferring assets earlier rather than later so that all the appreciation belongs to the children's rather than the parent's generation. As Renn says, "The things we like to see passed to kids are the growth assets, the aggressive stock portfolio, the family business that is growing rapidly, the real estate that's likely to be the next office park. That's better than the two-family rental house or the bond portfolio or the CD. Those are just going to throw back the six or seven percent and that's that."
The vast majority of estates go to surviving spouses, children and grandchildren. Some clients do have charitable intent, Renn says, but few leave their entire estates to charities. In most cases, they'll leave some percentage or fixed dollar amount.
Those with smaller (less than $1.5 million) estates face no federal tax, state estate tax or succession tax unless it's from complete strangers (see accompanying article). The only costs involved here are probate charges. Somebody who passes an estate with a modest house and a small portfolio totaling $500,000, will face a nominal fee - around $1,000.
"Unless they have a very complicated pattern," Renn says, "it doesn't cost a whole lot to move that asset."
Probate in Connecticut is not a very expensive procedure compared to some of Western states where it's calculated as a percentage of the estate. It depends on the type of property and the relationship of the person inheriting to the person doing the giving.
Compared to other states, Connecticut is not a particularly bad state, but it's not a tax haven either, according to Renn.
"In Florida, there's a constitutional provision that prohibits addition of a new tax without amending the [state] constitution. They're stuck with an estate tax that doesn't do what it used to do and they have no income tax. Very often people will have vacation homes in other states like Florida, and if they don't plan properly, they have to go through the probate procedure in two different states. If they go ahead and move that property in the ancillary jurisdiction into a trust, they can avoid probate."
The cost of the trust is often much less than the cost and hassle of probating in another state.
Says Renn: "It's not the cost to the probate courts. It's the filings, the tax returns, being under three different state tax systems. It's not pretty."
Inheritance Laws
They say two things are certain: death and taxes. If so, nothing could be worse than facing those two certainties at once.
The good news is that if you inherit less than $1.5 million, you pay no estate taxes in Connecticut.
In fact, a married couple, as long as both are U.S. citizens, can pass any amount of money to each other without paying estate tax.
"That's called the unlimited marital deduction," explains Edward Renn, a tax attorney with Withers Bergman. "A husband and wife can pass a billion dollars and no taxes will be due. Once you get beyond that, this year it's to $1.5 million, in total to any number of beneficiaries without being hit with federal taxes."
The cap is frequently changing as a plan to eliminate the estate tax exemption works its way toward 2010. For 2004 and 2005 the cap was $1.5 million. In 2006, the exemption ceiling goes up to $2 million. In 2009, any estate under $3.5 million is exempt and by 2010, there will be no more estate tax, unless Congress votes to renew it. When Congress passed the legislation in 2001, estate tax was assessed on any taxable estate of more than $675,000.
"That's called the applicable exclusion amount, or the unified credit," Renn explains. "The taxing system on the federal side is a unified system in that they pay attention to your gifts as well as your inheritance. Of the $1.5 million tax exemption you have from the feds, you can use only $1 million for lifetime gifts. There is an annual exclusion of $11,000 per year which will probably go to $12,000 next year, depending on what inflation does. I suspect it will make it next year."
Connecticut has two "inheritance" taxes: the estate tax and the succession tax. The succession tax affects only people leaving assets to distant relations or unrelated individuals. A longtime couple who is not married, same-sex couples, or an uncle who has no family and leaves money to nieces and nephews will face succession tax.
Charitable Giving
While many (though not all) sons and daughters stand to inherit countless riches in years to come as their wealthy baby-boomer parents begin to pass from the scene, they will be paying less in estate taxes. Though a full repeal of the federal estate tax planned for 2010 is good news to most, one group stands to suffer: charities.
In July 2004, the Congressional Budget Office (CBO), at the request of the Senate Finance Committee, examined the effect that changing the estate tax would have on donations to charity. Because charitable bequests lower the taxable amount of estates, the tax gives people an incentive to contribute to charity at death rather than leave assets to heirs. The estate tax is thus an incentive to make charitable contributions during life.
The paper calculated that increasing the amount exempted from the estate tax from $675,000 to either $2 million or $3.5 million would reduce charitable giving by less than three percent. Repealing the tax would have a larger impact, decreasing donations to charity by anywhere from six to 12 percent based on 2000 contribution figures. Adjusting the figure to forecasted 2010 contributions would put the loss closer to 22 percent.
This has Nancy Roberts, president of the Connecticut Council for Philanthropy, understandably concerned.
"The Congressional Budget Office did this study in 2004 to look at what would happen to giving to non-profits without the estate tax and they found that there would be a 22-percent hit to the non-profit sector," Roberts says. "If the estate tax is eliminated, that's 22 percent now going to non-profits that will not be going to them."
In 2002, 2,124 Connecticut residents left their entire estates - totaling nearly $4.6 billion - to charity. Connecticut residents also made 410 charitable bequests totaling more than $383 million in 2002. Connecticut's totals grow about two percent each year, according to Roberts.