Heirs could be inadvertently left out of an inheritance if the nuances of estate taxes are not taken into consideration by financial advisors, says Michael Delgass, CEO of Sontag Advisory, a wealth management firm in New York City.
2016 marks the 100th anniversary of the federal estate tax, and its implications for advisors and their clients are immense, Delgass says.
On the surface, the estate tax would seem to be a simple tax, but, as with most things, it is much more complicated than it seems, especially when combined with state-level estate, inheritance and gift taxes.
Delgass has had clients who ended up spending their entire inheritance on taxes because of the way clauses in wills were written, he says. “There are some financial advisors who may think of themselves as strictly investment advisors who may not think of the estate tax implications until it is too late,” he says.
For instance, a wealthy couple in New York may want to give the Connecticut summer home to the children before they die to reduce their estate taxes, but Connecticut is the only state with a gift tax. That has to be taken into consideration before employing that strategy to reduce the federal estate tax, Delgass says.
“Each state has its own complicated tax system, and advisors need to look forward to determine what strategies can be used to try to lower the estate tax,” he says.
One hundred years ago, the estate tax kicked in starting with estates over $50,000 and was less than 1 percent. Now it is applied to estates over $5.45 million and the rate is 40 percent. Those levels are always subject to change. On top of that, one-quarter of states impose their own estate or inheritance taxes with many different variations.
“If an advisor is really doing holistic planning, he or she has to look forward in order to employ the most tax-efficient strategies,” he warns.
Clients can use the federal gift tax to reduce the size of the estate by giving up to $14,000 to as many people as they want each year. “But the advisor has to consider, can the client afford this? What are the other implications?” he asks. “Such things as paying for a grandchild’s medical school education also are exempt from the federal gift tax, so advisors have to understand all the exemptions.
“The will of the estate owner usually has a clause to say who pays the taxes that are due, but you can get to the point where you need calculus to determine each person’s share. And if you give one heir an IRA, there is no tax, so does the estate tax burden fall on the one who gets the cash?”