For auto dealers who've struggled with the impending impact of estate taxes, President Bush's signing of the Economic Growth and Tax Relief Reconciliation Act of 2001 bill will be seen as a cause for celebration. Without question it is a significant improvement over current law. It will likely result in some tax savings.

The issue is whether you're going to take advantage of the opportunities created by this law or trust Washington and risk your business and family's future?

Here are some areas of opportunities and concerns:

How will the new law affect my planning?

Bottomline, how much do you trust politicians? The fact is, this law does not repeal the estate tax for nine more years. In fact, Congress is required to vote to keep repeal after 2010 or the estate taxes revert to the law in effect in 2001.

Therefore you must decide if you will continue to actively plan for your family's and business' future or risk the future on Washington's promises and hope that the estate tax problem will never impact you.

Opportunity - don't miss out

The fact is that the scheduled increase in the lifetime gift exemption allows a dealer to transfer significant assets via proven planning techniques such as Limited Liability Companies, Family Limited Partnerships and Grantor Retained Annuity Trusts.

If utilized properly, a dealer can retain control of assets and eliminate estate taxes, regardless of what Congress does in the future. This should have a major impact on the continued success of your dealership as well as family fairness issues regarding those children not involved in the dealership.

Regardless of whether you want to believe that the estate taxes will be repealed, the need to continue estate and dealership succession planning is of utmost importance. The following is a brief list of the major reasons to continue planning, even if the estate taxes are repealed in full in 2010 and thereafter.

Fact: Significant estate taxes continue to be imposed over the next nine years.

For this reason alone, no knee jerk reactions should be made to your existing estate plan. The table on the next page illustrates the exemption equivalent amounts and highest marginal estate tax rates during the phase out period. Even in 2009, the year before full repeal takes place, an individual dying with an estate of $14,000,000 will owe over $4,500,000 in estate taxes!

Reasons for concern

There are two presidential elections and five congressional elections between now and 2011. This should be the most disconcerting issue of all. If history is any indication of future behavior, there is a good chance that the estate tax repeal will either be stretched out further, frozen at some level or retroactively increased to where it was before. The last major estate tax change was in 1981 with President Reagan's Economic Recovery Tax Act.

That act was supposed to decrease the marginal estate tax rate to 50% and increase the lifetime exemption from $42,000 to $600,000 over time. Congress later voted to delay the exemption phase-in for a few more years and froze the highest marginal rate at 55% with an additional surtax of 5% on estates in excess of $10,000,000.

Do you trust Washington completely, a little or not at all?

There is no guarantee the repeal will actually happen which is perhaps the most important reason to continue your planning. You need to ask yourself a question and give an honest answer.

Do you really believe the estate tax will be repealed in full in 2011? If you honestly and truly believe to your core that the answer is yes, you may very well decide not to have a contingency plan.

However, if you do not trust the tax will be fully repealed or you are hoping that Congress and the future presidential administrations will stick to their word, then you will need to continue to plan. At the very least, you should plan carefully for liquidity needs, gifting strategies to minimize your estate, as well as dealership succession planning assuming estate taxes were not changed. That way you will be prepared if estate taxes are reinstated or frozen.

The act “sunsets” in 10 years

An arcane rule requires Congress to have to vote once again in the future to keep estate taxes repealed. If Congress does not vote to do so, or simply fails to vote on the matter, the estate taxes will effectively be repealed for only one year.

Death during 2010 would result in no taxes but death in any year after 2010 would incur estate taxes at 2001 rates (55%)! The fact that this act will sunset leaves a lot of uncertainty with respect to actual repeal.

Repeal of the step-up in basis

Along with repeal of the estate tax in 2010 comes the repeal of the step-up in basis. It will be replaced with a modified carryover basis instead. This means that only $1,300,000 of assets in the estate will be allowed to step-up the cost basis to FMV as of date of death (an additional $3,000,000 of assets will be allowed a step-up for a surviving spouse). The lack of a full step-up in basis means that heirs selling assets will have to recognize capital gain income, taking the deceased's tax basis into account. This new carryover basis becomes a very significant problem.

You will need to keep detailed records of your tax basis, not only from this point forward, but going back to your original purchase of the asset. Sometimes, this means going back 30 years or more.

Year Exemption Highest Estate Tax Rate
2002 $1,000,000 50%
2003 $1,000,000 49%
2004 $1,500,000 48%
2005 $1,500,000 47%
2006 $2,000,000 46%
2007 $2,000,000 45%
2008 $2,000,000 45%
2009 $3,500,000 45%
2010 Estate tax repealed 35%* (Gift tax only)
2011 Estate tax reinstated** 55%**
*The rate will equal the highest marginal federal income tax rate, scheduled to be 35% in 2006 and thereafter. Of course, if this rate changes it will affect the gift tax rate.
**The estate tax would be reinstated to the law that was in effect in 2001 if Congress does not vote to keep repeal in place. See below.

The record-keeping nightmare this produces is exactly the reason Congress repealed the carryover basis when it first flirted with it back in the 1970s. It shouldn't take too long for Congress to realize again what a nightmare they created. The best time to document basis is now, while you are alive. Waiting until the asset is actually sold will leave a big problem for your heirs to prove what the basis really is (and the burden of proof is on the taxpayer).

The gift tax is not being repealed along with the estate tax

This may sound ludicrous, but Congress is afraid if it repeals estate taxes and substitutes the modified carryover basis people will find a way to circumvent the capital gains tax by gifting assets.

Theoretically, if you knew you were going to sell an asset in or after 2010 that had capital gains, you could gift all or a portion of the asset to your children first.

Once the asset was sold, all owners would recognize the capital gains proportionately. If your children were in a low tax bracket, they might be able to take advantage of the 10% capital gains rate rather than the 20% applicable to most owners of capital assets. For this reason, Congress will impose a gift tax equal to the highest marginal income tax rate on amounts over $1,000,000 after 2009 (35%).

The exemption equivalent amounts in the table above apply to death transfers only. Gifts made during lifetime will have an exemption capped at $1 million. Any gifts in excess of that will be subject to gift tax. However, you will continue to be able to make $10,000 annual gifts (indexed for inflation) without eating into the lifetime gift exemption.

Gifting of assets during lifetime will continue to be an important tax strategy. What will have to be weighed is the potential for gift taxes versus the income tax savings. There may be other reasons for gifting as well, such as stock in a dealership where the heir will need a certain amount to qualify as an operator. Obviously, if estate taxes are not fully repealed, having made gifts in the past would be advantageous since it removes appreciation on assets from the estate.

What do I need to do now?

Meet with your advisors to thoroughly review your current planning situation in the light of the new law. Furthermore, consider the consequences to your plan in the event Congress changes the law.

First, determine how much risk you are willing to impose on your estate and dealership succession plan. It would be foolish to count on full estate tax repeal given past history and the open-ended nature of the new law. Contingency plans and ongoing planning transactions need to be continued.

Remember, planning is NOT just about taxes!! Prudent planning involves many non-tax issues, a few of which are:

  • Family issues
  • Concerns about fairness
  • Protecting parents' financial positions while determining when and how your children should receive as sets
  • Should dealership related assets be owned exclusively by children active in the business?
  • What obligations are reasonable to impose on the children running the dealership?

Finally, remember that most dealership succession plans fail due to people issues, not tax issues. The sooner you and your advisors begin to address how to prepare the heirs to take over the dealership and how to facilitate that, the greater the chances of seeing your legacy become a reality.

Are you going to depend on Washington to solve your problems or are you going to step up and take advantage of the opportunities presented? As a dealer you have always depended on yourself for results, certainly not politicians. Now should be no different. Don't put your head in the sand!


Hugh B. Roberts, CFP, is a partner in the deVries-Roberts-Kelley Group in Woodland Hills, CA, a company specializing in succession and estate planning for family owned auto dealerships. He's at 818-702-0889.