Uncertainty in estate tax future warrants planning
Tim graduated from Purdue Calumet with a Business degree in 1976. The U.S. economy was recovering from recession at the time, but there still wasn't a ton of jobs in Northwest Indiana. He found a job selling fabricated steel products to customers in the agriculture machine industry. He didn't make a lot of money, but he worked hard forming relationships and building a customer base.
Unfortunately, the early 80's took a turn for the worse, the economy slipped back into a deep recession which hit the Region hard. His employer closed the shop and Tim found himself unemployed with a new wife and baby at home. The early 80's were a time of darkness and deep stress for the young family.
Luckily, with a wide network of customers, when the economy recovered Tim was able to find new suppliers for the steel products he had been selling in his previous job and he began acting as a broker. During this time the strong relationships and solid service he provided paid off, and his customer base began to look to him for more solutions. In the late 80's Tim opened his own small fab shop and began supplying customers directly. He took a second mortgage on the family home to open the business, and while times were less dark, the stress never abated.
In order to take care of his employees, prepare for his own future and save taxes, Tim established a company retirement plan for his small group of employees in the early 90s. He always put as much as he could into the plan. The small shop grew, Tim was able to pay off the second mortgage on the house and eventually had enough business history to borrow money from the bank for a more advanced fab shop and equipment. This expansion enabled the company to serve different industries with increasingly sophisticated products. Tim was always a good steward of company assets and managed his finances closely. He spent non-work time serving on various charitable boards and volunteering in his town. The company became larger and more profitable, creating good jobs for nearly 100 people within two decades.
When Tim was 62, he was approached by a larger competitor proposing an acquisition. The deal would enable his company to live on beyond him, preserving jobs and taking care of customers. Between the fab shop building and the business model itself, Tim accepted a $10 million buyout offer.
Going into retirement, after taxes were paid on the business sale, Tim owned his home, now worth $800,000, had $3,000,000 in his retirement plan and $9,000,000 in business sales proceeds and savings. He and his wife would enjoy a great retirement surrounded by their grandchildren at their lovely lake cottage up north purchased with some of their savings. By any measure Tim was wealthy, and he had earned every cent through hard work, taking calculated risks and making good decisions. He had achieved the American dream, and helped the families of his employees find financial security along the way.
Here's the rub. If Tim were to pass away suddenly in 2025, he would pass his wealth down to his wife, adult children and grandchildren, as well as be able to support some local organizations he felt strongly about. With the exception of income taxes due on his retirement plan, his estate would pass unencumbered by taxes to the people and causes Tim worked so hard to support for many years. Tim's wealth would stay in the Region, where it was created, strengthening our community through consumption, charity and investment. Tim's legacy, built in the Region would remain in the Region.
If, however, Tim was to pass away in 2026 an entirely different scenario presents itself. This is because in 2026, the Federal estate tax exemption will revert back to the rule structure prior to 2017 and expose a large portion of Tim's estate to Federal Estate Taxes. While the estate tax calculations are complicated, a reasonable estimate of the tax due on Tim's estate, both estate and income tax, is roughly $3.5 million. $3.5 million that won't benefit his family, $3.5 million that won't benefit local causes, $3.5 million that will be sucked into the Federal morass plagued by deficits and out of control spending.
Can this nightmare scenario be avoided? Perhaps. Congress could act quickly after the next election to establish new estate tax rules. There's a possibility the rules would be better, there's also a possibility they could be worse. With the current state of two-party political dysfunction in Washington, I'm not holding my breath either way.
This potential scenario, however, can also be addressed through good planning. By being proactive, families like Tim's can use existing rules to reposition assets and financial accounts to maximize savings and keep their wealth in the communities where it was created. We may find, that after the rules change might be too late for some of this planning, and 2026 is right around the corner.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
