Mark Evans, founder of Winnipeg-based software company EISI, was sitting at his Canadian lake home in May watching CNN when he heard the news. The U.S. Congress had passed a law repealing the estate tax. Sort of.
"Oh my God," he thought. "There goes my summer."
He and other vendors dealing with financial planning software knew that Congress eventually would pass a law like the Economic Growth and Tax Relief Reconciliation Act of 2001. But he hoped it would be later, perhaps when the leaves started to mellow. Evans' company sells NaviPlan software, an integrated tax and estate planning suite.
Another software developer, Mobius Group, a unit of CheckFree Investment Services, had to temporarily drop development of a Monte Carlo simulator to refocus not only on estate tax changes but also on new IRA-distribution rules. "Ultimately, you've got to be driven by what Washington does," says George Chamberlin, research and product design analyst for Mobius in Research Triangle Park, N.C.
Making planning projections based on the new tax law could be likened to charting a map of a sinking island. The law erases all kinds of certainty about the future and makes estate planning a terrible guessing game. What's more, being a few months behind on updates can give a software company a bad rep. The firms had to scramble over the summer not only to re-code programs, but also to talk with clients and accountants, track down obscure bits of information and try to figure out what it all meant.
"We spent the better part of June trying to discover what the modifications are, using publications from the Big 5 accounting firms," Evans says. "Their target is to inform the public what the changes are, not [to supply] software vendors [with calculations]. ... If there's a missing part of a calculation, we have to dig for it."
What's more of an insult to some is that the trumpeted repeal of the estate tax does not actually take effect until 2010, slowly moving from 55% to zero, only after several years of gradual reductions. For one year only, decedents may pass on their estates tax free (though not gift-tax free). After that, the generous new law vanishes, like Cinderella's coach at midnighton, on Jan. 1, 2011. Planner John Olsen of Olsen Financial Group calls the new law the "Assisted Suicide Act of 2010." "The problem with most estate planning software," he says, "is that it allows a practitioner to do an elegant plan that works just fine, as long as everybody agrees to die on time."
Some say software isn't up to the task at all.
"I don't use prepackaged software," says James Floyd of Floyd & Associates in Menlo Park, Calif. Floyd, who works with the ultrawealthy, has been dissatisfied, even with high-end products. "I didn't like any of them because they did not allow me to illustrate the complex planning that I do. They were fine if I was doing living trusts or single insurance trusts-elementary planning. But I had to create my own tools."
Another monkey wrench: Nobody expects the new law to survive for 10 years. Certain provisions (such as the carryover in basis on assets) have been difficult to implement in the past, usually prompting new legislation.
Software vendors, however, are in the projection business, and they say that they can make lemons into lemonade. As Olsen (beta tester and technology fan) puts it, increased options and flexibility can work to the planner's benefit. How else, he asks, are you going to create models if you don't look at the variety of outcomes that software can provide?
Several companies, including EISI, Mobius Group, WealthTec and IMPACT Technologies, all have created similar approaches to the change in the law using three hypothetical situations:
1. The sunset of the new law and reinstatement of the 2001 tax code. In other words, the estate tax would return to the 2001 rate of 55% for 2011 and continue thereafter. The unified-credit-exemption amount would go back to $1 million (its on-time schedule for 2006).
2. The continuation of the repeal. In this case, lawmakers would decide to keep the new legislation, sunset the sunset and drop the estate tax forever. Almost nobody is putting money on this eventuality. "Most of the practitioners in the industry say that it has a 5% chance of happening," says Scott Schrader of the law firm Miller & Schrader in Little Rock, Ark. He adds that the dilemma has become even less clear-cut in the wake of terrorist attacks in the United States. "The estate tax was historically enacted to help fund wars."
3. The holding of estate tax provisions at 2009 values. Vendors call this the "2009 Freeze." Under this scenario, the estate and generation-skipping transfer taxes remain at 45%, as does the $3.5 million exemption. "Our intention is to give the planner options to show what might happen under these three different routes," Chamberlin says. "It gives you more work to do. You run figures under three different assumptions."
The new law has added further complications, however.
Step-Up In Basis Disappears
The new law eventually ends the step-up in basis provisions of the old law, which allowed beneficiaries to keep the same basis for fair market value of assets at the time of a decedent's death. In 2010, the new law instead will retain a carryover of basis. That means if the decedent's original purchase price of a $1 million holding was $250,000, the beneficiary could pay tax on a capital gain of $750,000 if he or she sells immediately at that time. Carryover requires beneficiaries to determine the original value of assets when purchased by the decedent-an extremely thorny (and some say impossible) job.
Under the 2010 provision, however, the executor of the estate still may boost the basis of certain assets within a limit of $1.3 million for beneficiaries and $3 million for spouses (raising the level of assets that can be transferred tax free). That means a $4.3 million step-up total could be applied to non-IRD properties (those that aren't IRAs, qualified pensions, nonqualified stock options, etc.) The problem is then deciding which beneficiary gets the money and how to spread it across assets. At this point, sisters and brothers and spouses could begin fighting over goodies.
NaviPlan allows a hypothetical situation in which users assign the $1.3 million in basis increase either to all assets pro rata or to specific assets. The software also allows the planner to consider whether the husband or wife dies first.
IMPACT tracks basis in its estate program but does not illustrate an assumed capital gains tax by the beneficiaries past 2010, says Andy Brincefield, president of IMPACT's Advanced Impact division. The consensus from clients was that showing a need based on the assumption that all inherited property would be immediately sold was inappropriate, he says. "Past 2010," he says, "if there is a repeal and the sunset provision gets cut, how would you do a basis calculation? You have to assume two things: When the beneficiary sells the asset and how much it is worth at that point in time. ... I don't know how you do that in software."
Evans disagrees. "The law is there," he says. "You can address the step-up in basis. The issue is how you present it to the client. ... You don't have to guess variables. You can say that it is for this snapshot point in time. For example, you're passing $1 million [to an heir], but you're also passing on a $250,000 basis. So the beneficiary knows at that point, if he tries to redeem it today, he will have a $750,000 capital gain. If in 20 years from now, I want to sell it, maybe at $25 million, if I haven't done any reinvestment on basis, it's still got $250,000 in basis."
Another program, WealthMaster, created by WealthTec in Silver Spring, Md., also takes into account carryover in basis, though the firm's president, Howard Eisenberg, understands others' reticence. "Let's face it," he says. "On a lot of these issues, whether we're in the planning profession or creating software, we're guessing about a lot of things."
State Death Taxes
With the death of the death tax, the individual states, which have depended on a chunk of the federal government's take, will now be empty-handed. Chamberlin says that many states will likely come up with their own death taxes, yet another variable.
NaviPlan has added a mechanism that allows advisors to add a state death tax based on the percentage the states would lose after federal money falls away. Planners can do a manual override, as it were, and edit this percentage directly in the software.
"Nobody knows what will happen," Evans says. "We want to provide in the software a mechanism on a state-by-state basis."
IMPACT's software, on the other hand, calculates updated state inheritance taxes for all 50 states, plus U.S. territories, Brincefield says. "We keep those up to date," he says. "If you pick a state like Pennsylvania in July 2001, we already know their laws might change. When the system clicks 2001, or death occurs in 2001, we'll apply that taxation."
Making It Clear
In the end, the most important aspect of the software, however, is presentation, say vendors. Evans says that NaviPlan's original beta test was great for calculating assumptions, but tedious in its display, so the company created summary reports based on different assumptions.
Presentation is "of utmost importance," Brincefield agrees. "You could preach about annual exclusions and rates and basis," he says, but the presentation has to explain to clients what the estate tax and sunset means over time and different scenarios.
"If you called our [planning] clients, they would say presenting these to clients is the most important thing."
IMPACT recently released its new Wealth Strategies software, which came out of beta testing in August. Olsen calls this an ambitious program that allows more uncertainty about the future into the equations, something that's good for advisors because it will keep clients focused on their plan, not for one month or two, but for the long haul.
The program is different from the firm's well-known Estate Tax Analysis software in that it runs Monte Carlo simulations on the data. The program runs a number of trials (hundreds or thousands, depending on what the end user wants) to meet several goals, including living expenses, net worth and net-to-heirs, coming up with a probability of success for each goal, adding in low expected and high expected values.
"If you built a scenario in which Harry dies in 2010 and his wife survives until five years later, that will produce a certain net-worth-value to heirs," Olsen says. "But if they die in different orders and at different times, the results can be hugely different. ... The only software out there to my knowledge that allows us to model what happens if people die at various times is IMPACT Technologies."