Estate tax changes Date of death Exemption limit 1997: $600,000 1998: $625,000 1999: $650,000 2000-2001: $675,000 2002-2003: $1 million 2004-2005: $1.5 million 2006-2008: $2 million 2009: $3.5 million 2010: repealed 2011: $1 million Data: Internal Revenue Service

James Waddill IV of Chester would go home and plop down in his favorite chair with a blank stare on his face. He
didn’t know how to explain to his wife that their retirement money was gone, killing their dreams of taking it easy in eight years on the beaches of the Outer Banks. Two years ago, the 47-year-old real estate agent says he invested about $100,000, half of it bought on margin, in a stock play pushed by a broker with Salomon Smith Barney. But the investment, in a high-tech
start-up, proved a massive dud and Waddill lost his money and his dream.

Waddill is yet another Virginian seeing his best-laid plans for retirement go “poof.” Many relied on the seemingly unstoppable stock market to make their Golden Years pleasant. But their 401(k) plans, some pushed on them by employers, have lost big chunks of value. The same goes for IRA and Roths and a variety of other saving instruments.

Still others are dealing with a multitude of fees demanded by investment professionals for managing what today are often big financial losses. Waddill believes that he is the victim of outright fraud and, along with six others, has filed a $22 million lawsuit against Salomon Smith Barney and one of its financial consultants. A spokeswoman for Salomon Smith Barney, the nation’s second-largest investment house, said she wasn’t aware of the suit and offered no comment. “I now feel stupid and look stupid,” laments Waddill over his lost investment.

Today’s bleak mood among investors is generated by the gnawing realization that the 1990s were a dizzy decade during which the economy became a legal casino, where think-tank gurus were prophesying a 36,000-point Dow Jones industrial average. Some economists even claimed the New Economy had negated the basics of economics, right until the dot-com bubble burst. And just when the economy seemed to be recovering, it was kicked back by the worst-ever terrorist attacks on U.S. soil.

The irony is, all this travail has people flocking to financial planners — so the very ones getting a share of the criticism, warranted or not, are getting more work as well. Raymond Moore with Moore Financial Services in Chesterfield County says a big problem a few years ago was that amateur investors believed “all you had to do was throw a dart at The Wall Street Journal and you had a winner.” Now they’re willing to pay for expertise, says James Shepherd with Financial Managers and Consultants in Richmond. The current turmoil is helping consultants “because people know they must follow fundamental principles.”

Another reason investors want advice is the ongoing phase-out of the estate tax. Last year, the law allowed tax-free inheritance of estates valued at $675,000 or lower. That cap has increased to $1 million this year and next year, and will reach $3.5 million in 2009. A total repeal comes in 2010; then the tax is revived in 2011 with a $1 million exemption and a top marginal tax rate of 55 percent.

Timing is a problem for some investors. Not knowing the hour of their death, they can’t know how much estate tax their heirs will face, so it’s hard to know which steps they should take now to avoid taxes. It’s possible a future Congress may loathe restoring the tax, and make the 2010 repeal permanent. That would suit James C. Cherry, CEO of the Mid-Atlantic Bank for Wachovia Bank in Richmond. “I think it’s ludicrous of the government to have an estate tax regime that has such uncertainty and that reverts back to the past,” he says.
Dennis Belcher of McGuire Woods said that after Sept. 11 more investors began leaning toward creating revocable trusts for their children. The thinking is, why lock up money in an irrevocable trust when the estate-tax exemption could someday protect it just as well? Now many aren’t trying any sophisticated tax planning strategies until the estate-tax issue is settled. Richmond tax attorney David Addison with Williams Mullen Clark & Dobbins says some of his clients are making two plans: one in case the estate tax is abolished; another if it isn’t.

Indeed, the tax is viewed as onerous by many — the “death tax,” opponents call it. Historically, the estate tax brought in just a trickle of revenue to the federal government, about 2 percent to 3 percent of gross revenue. But in the next decade or so the trickle could become a flood, says Thomas Millhiser, a tax attorney with Hunton and Williams in Richmond. Those who will be dying in the coming decades could “have a potential net worth of $3 trillion dollars,” he says. Congress might come to view the estate tax as a “federal government profit center” and keep it permanently on the books.

What to do? Belcher says investors have several options: forming limited family partnerships; devising charitable remainder trusts (CRTs) which give money to a charity, but provide for lifetime income and tax relief for those who set them up; or creating a GRAT. A grantor retained annuity trust allows a client to put assets, such as stocks and real estate, into a trust and then retain the right to receive an annuity for a specified period of time. If the grantor survives the duration of the GRAT, then the beneficiary can get the assets in the trust without paying taxes, including any assets that appreciate. Those who choose a GRAT are betting they’ll outlive the terms of the trust, and that the property will appreciate faster than the applicable federal rate, which is set each month by the IRS.

Even if the estate tax is permanently erased, there’s still the capital gains tax to deal with, and it’s changing as well. Under current rules, the presumed cost of inherited assets is raised to the current market value, and that lets the heirs avoid most or all of the capital gains tax. But in 2010 this “step up” to current market value will be limited to $1.3 million, plus another $3 million for assets passed on to a surviving spouse, according to attorney Addison. Plus, some assets such as annuities and IRAs won’t be given this step up. So investors planning to celebrate the demise of the estate tax may find that higher capital gains tax has taken its place.

With tax laws in such flux there is a growing uncertainty in retirement planning. What’s more, the volatile stock market is making it tough for investors to think of retirement — they’ve got today’s money woes to worry about. Waddill certainly knows about that, but still thinks he might return to the market after taking a breather and after corporate America is cleaned up. He thinks he was led astray, but he also believes that someone somewhere will be his new financial “hero.”

Return to Virginia Business - September 2002