Estate Taxes and Cash Flow

A small number of high net worth people have procrastinated in their estate planning, waiting for Congress to make up its mind on what kind of estate tax system we will have in the future.

As it stands now, the estate tax exemption is currently $2 million and scheduled to increase to $3.5 million in 2009. The estate tax is repealed for one year only, for those souls fortunate enough to die in 2010. Then, in 2011 and forward, the estate tax exemption returns to just $1 million.

Estate taxes must be paid within 9 months of death, and this can present a real challenge to estates that consist primarily of closely held businesses and real estate. Life insurance is the typical way most people fund a future estate tax liability. If the life insurance is inadequate, an estate is typically forced to do a “fire sale” of assets or to go into debt with banks in order to pay the IRS.

Nonetheless, some high net worth people have postponed buying adequate life insurance, again hoping Congress may resolve the estate tax situation. This is a dangerous risk to take because if something happens to you before Congress makes up its mind, the IRS will not be patient and will start registering liens against or even seizing assets to get the estate taxes paid. Also, what if you get a medical condition a few years from now that either renders you uninsurable or insurable only at a very high rated premium?

Some individuals will get a life insurance policy but it will turn out that it is the wrong policy for their needs, too expensive to maintain, or perhaps it is issued by an unstable insurance company. Some insureds get term insurance when they need permanent, variable when they need universal, and so forth. Some under-insure; others over-insure. Often, a second-to-die policy is a good way for a married couple to hold insurance that will be used to pay estate taxes.

Of course, it is also important to make sure that the life insurance is not subjected to estate taxes. Although insurance is typically exempt from income tax, it is included in the taxable estate of those who hold “incidents of ownership” such as the right to change beneficiaries or borrow against the policy. That can be solved through the set-up of an appropriate irrevocable life insurance trust (ILIT).

We at Large & Gilbert, P.C. can help you choose a suitable policy that will take care of your needs. We can help you decide upon the appropriate level of life insurance and how it should be structured. We can help ensure that there will be no fire sales of your assets if you were to depart this world.

Let us know if you would like us to take a look at your life insurance needs in light of estate taxes, and we will be there for you!