With a new 35% estate tax, $5 million individual exemption and portability, experts say tax savings will no longer motivate clients to hire estate planners. Advisors and planners alike are going to need to change marketing messages to stay ahead.

In a stunning turn of events, on December 6 President Obama announced that he reached a deal with Republicans on estate tax and to extend the Bush tax cuts.

Under the deal, the 2010 repeal of the estate tax will not be extended, ending the long uncertainty about the future of federal estate taxes that allowed billionaires to die tax-free this year.

If Congress had not reached an agreement, the estate tax was scheduled to come back next year at a top rate of 55% and in some cases 60% with an exemption of only $1 million for individuals.

Under those circumstances, estate planning attorneys and trust firms insisted that their thriving practices would continue to help wealthy Americans avoid estate taxes and plan for generations to come.

However, as a complete surprise to the trust community, the defeat that Obama suffered in the November 5 election forced him to accept a Republican proposal that will give Americans a tax rate of 35% — the lowest rate since the 1920s — with a $5 million exemption for individuals and $10 million for couples.

On the surface, you would think that that would be great news for wealthy Americans. However this week I have spent hours on the phone listening to financial planners crying the blues about what is going to happen to their practice since the main reason people came to them was to avoid paying estate taxes.

Martin Shenkman, author and estate tax attorney, told me, “Estate planners have had the wind knocked out of their sails.” He added, “They are going to need to work harder to offer new products to get the wealthy clients into their office.”

He added, “What’s going to happen in many cases is that clients are not going to appreciate the benefit of what the planners are doing if a tax motive is not there. They are going to be less inclined to spend the money to do it right, and more inclined to do something on the cheap with a general practice attorney — or on their own because they will argue, ‘How can I screw this up if no taxes are involved?’”

“Dead as a doornail”

To make matters worse, Howard Zaritsky, a Virginia-based estate planning expert, told me that if the current bill passes, “estate planning as we know it may be dead as a doornail.”

“Most clients under $10 million will need very little in the way of tax planning,” he added. “That will as a practical matter almost eviscerate the rank-and-file financial planning business, because that’s the bulk of clients.”

Portability of exemptions is the key here. Historically, while married couples were always allowed full estate tax exemptions for both spouses, they often needed good legal advice to get the value of both exemptions.

The Senate bill has a “portable” exemption that makes this planning much easier. After the death of the first spouse, any unused portion of the spouse’s $5 million exemption may go to the surviving spouse’s future estate.

Up until now, a couple would be required to establish a complex QTIP trust that permits the surviving spouse to receive the credit — but under the proposed portability rule, the credit becomes automatic.

Tony Barnard, a trust marketing expert with Financial Marketing Associates, told me, “Estate planners and trust firms are going to now have to rethink their strategies in order to sustain their current practices.”

“Two reasons that a wealthy client will walk into a planner’s office are to maximize profits or to protect assets from litigation or taxes. Now taxes will become more obscure. Planners are going to have to do a better job at profit and asset protection benefits in order to continue to have conversations with clients.”

New products for the new world

Richard Nenno, an estate planning strategist with Wilmington Trust, told me that without an apparent estate tax hurdle, the equation will have to be more along the lines of directed trust and asset protection trust as opposed to dynasty trusts and other vehicles that deliver tax protection from estate taxes.

Darlynn Morgan of the Morgan Law Group said she agrees that the $5 million exemption will likely chill estate planning for a while, but most of her clients do estate planning for other reasons — including incapacity planning, family dynamics or planning for blended or nontraditional families. She sees no shortage of clients coming in the door to have these critical conversations.

Martin Shenkman added that under the current rules, he still sees a market for GRATs (grantor retained annuity trusts) and other vehicles that permit the protection of taxes for the long haul.

Trafficking in portability credits?

Estate planners in the American Bar Association’s email discussion group for probate and trust law (ABA-PTL) are going back and forth with “what if” scenarios over the proposal and alternative planning opportunities that it could spawn.

According to Arlington, Virginia estate planner Douglas Blair, the wave of the future may end up as something like a “Nevada Domestic Portability Partnership” or “Alaska Domestic Portability Partnership,” neither of which exists as yet but could theoretically  be created by filing documents (or perhaps filling out forms online) from anywhere in the country.

“Mail ‘em in or enter your signature keys, pay your filing fee, and poof! You’re Nevada Domestic Portability Partners, entitled to take full advantage of your partner’s unused portable exemption if he should, sadly, predecease you,” he notes. “And who’s to say you could have only one Nevada Domestic Portability Partner at a time, if you have real need for those unused exemptions? Or, a clever programmer could set up a system of cascading Nevada Domestic Portability Partner online applications, so that when one died, the new partner would be ‘online’ with his exemption waiting, milliseconds later, until the full $10 million was filled up.”

Napa Valley estate planner David Diamond — tongue in cheek — wonders if this could spin out into an entire new business for today’s estate planners:

“Maybe I should retire from the practice of law, get ordained so I can perform marriages, and start a match-making service where I pair up and marry destitute seniors in nursing homes to wealthy unmarried individuals. What’s a $5 million exemption worth? At least $1,750,000 in today’s dollars. Even taking life expectancy into account and discounting to present value, a fee of $50,000 to $100,000 doesn’t seem unreasonable for this service. Putting a few marriages together per year would sure beat sweating out 1,500 billable hours.”

Jerry Cooper, senior editor, The Trust Advisor Blog.

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