We haven’t seen the end of estate tax reform.
That’s the consensus of lawyers meeting in Orlando this week at the Heckerling Institute on Estate Planning, the annual Super Bowlon the subject sponsored by University of Miami School of Law.
The good news is that the New Year’s day passage of the American Taxpayer Relief Tax Act Of 2012 or ATRA ended 12 years of uncertainty about how much could pass tax free; what the tax will be on transfers above that amount; and even whether there would be an estate tax at all. Going forward, it’s possible to transfer $5 million during life or at death, and this amount is adjusted for inflation — in 2013 it’s $5.25 million per person ($10.5 million for married couples). For a summary of the changes, see my post “After The Fiscal Cliff Deal: Estate And Gift Tax Explained.”
What’s still in play are the cute tax tricks that some of the best minds in the field have devised to leverage or pack more into the tax-free amount. The Obama administration took aim at a bunch of old standbys and some new targets in its 2013 budget issued last February. Nothing became of it in the New Year’s day tax package–much to the relief of rich folks and their financial advisors. But we can expect renewed interest as the legislators tackle part two of the fiscal cliff crisis: cutting spending and raising revenue.
Don’t expect thoughtful estate tax reform — we’re talking congressional horsetrading, perhaps done incrementally.(Heads up: watch those transportation funding bills.) The following estate planning tools were mentioned in the last Obama budget, and might be expected to show up in the next one, which is likely to be issued in March.
Grantor trusts. This is not a single variety of trust, but a set of characteristics that can be incorporated into various types of popular trusts. The term refers to the fact that the person who creates the trust, known as the grantor, retains certain rights or powers. As a result, the trust is not treated as a separate entity for income tax purposes and the grantor, rather than the trust or its beneficiaries, must pay tax on trust earnings.
A 2004 Revenue Ruling made it clear that paying the tax is not considered a gift to the trust beneficiaries. Yet this tax, on income that the grantor probably never receives, shrinks his estate. At the same time, assets can appreciate inside the trust without being depleted by ordinary income taxes or capital gains taxes.
Until now, another attractive feature of these irrevocable trusts is that assets placed in the trust are removed from the senior family member’s estate. From an estate and gift tax perspective, the transfer is treated as a completed gift. The value of the assets is frozen at the time of the transfer, so that future appreciation is not subject to estate or gift tax. These hugely popular trusts have been used for a broad range of people, from young entrepreneurs with mushrooming assets to elderly couples with securities portfolios.
The President’s proposal would eliminate this additional feature of these trusts. This an enormous change that would wreck havoc with an important tax-saving tool. Going forward, Obama would like these trusts to be taxable as part of the grantor’s estate. And distributions from the trust to beneficiaries during the grantor’s life would be subject to gift tax.
Dynasty trusts. Some states allow trusts to continue in perpetuity (or for a very long time) and pass wealth through multiple generations without incurring estate, gift or generation-skipping transfer taxes. These trusts are allowed to continue in perpetuity only in states that have abolished the rule against perpetuities. These include Alaska,Delaware, South Dakota and Wisconsin. Residents of other states can choose one of these states as the situs, or location, of a trust; in most cases, some connection to the state is needed and certain conditions apply.
The president’s proposal would do away with dynasty trusts, limiting the generation-skipping transfer tax exemption to 90 years.
The low-risk grantor retained annuity trust or GRAT. This device allows someone to put assets into an irrevocable trust and retain the right to receive distributions back over the trust term. The annuity is equal to the value of what’s been contributed plus interest at a rate set each month by the Treasury called the Section 7520 rate (named after the section of the Internal Revenue Code that applies).
If the value of the trust assets increases by more than the hurdle rate, the GRAT will be economically successful. In that case, the excess appreciation will go to family members (the remainder beneficiaries) or to trusts for their benefit when the GRAT term ends. If the appreciation never occurs, the trust can satisfy its payout obligations by returning more of the assets to the grantor—the person who created the trust.
For the moment, it is possible to form what’s called a zeroed-out GRAT, in which the remainder is theoretically worth nothing so that there is no taxable gift. The President’s proposal would do away with zeroed-out GRATs. It would also require that a GRAT have a minimum term of 10 years, compared with the current two-year minimum.
This greatly accentuates what is called the “mortality risk” of a GRAT: If the grantor dies during the trust term, all or part of the trust assets will be included in her estate for estate tax purposes. Rich folks would no longer be able to use short-term GRATs to minimize that risk.
Using family entities to achieve discounts. Some people use closely held enterprises, such as family limited partnerships, or FLPs, and limited liability companies, or LLCs, to discount assets before transferring them to family members or trusts for their benefit.
Here is how these family-controlled entities work: A senior family member puts assets, such as marketable securities, real estate or shares of an operating business, into the entity, which is most often an FLP but may be a LLC (some lawyers are more familiar with that structure). Then the individual sells or gives away shares in the entity that holds the assets – not the assets themselves. Since the interests can’t readily be sold outside the family, their value is discounted for both lack of marketability and lack of control (typically a total discount of 20% to 30%).
By reducing the value of partnership units or membership shares for gift tax purposes, discounts enable you to minimize the tax cost of transferring assets.
Valuation discounts have been the subject of multiple and protracted tax court battles, and the outcome of some cases are hard to reconcile. The budget proposal suggests that the Administration wants to scale back on the use of discounts, though the contours are not clearly spelled out. However, it clearly indicates that whatever restrictions emerge would apply retroactively to October 8, 1990 (the effective date of section 2704 of the Tax Code).
Congress May Tighten The Belt On Cute Tax Tricks. 2013, Jan. 16. By Deborah L. Jacobs retrieved from http://www.forbes.com/sites/deborahljacobs/2013/01/16/congress-may-tighten-the-belt-on-cute-tax-tricks/?utm_campaign=forbestwittersf&utm_source=twitter&utm_medium=social .