Authored by: Neeli Shah, Esq.
In light of Congress’s recent quest to find new sources of revenue and the looming changes to the estate and gift tax regimes, the time to focus on estate planning to make optimum use of current planning opportunities is now.
On August 2, 2011, the Budget Control Act of 2011 created the Super Committee, whose sole mission was to find new sources of revenue in their quest to reduce the U.S. deficit. The estate and gift tax regimes were expected to be its prime target. In early November, there was significant speculation (in the estate planning community) that the Super Committee would propose legislation to reduce the current $5 million federal estate and gift tax exemption amount to the 2009 levels to $3.5 million or even as low as the pre-2001 levels to $1 million. However, late last year, after months of negotiations, the Super Committee threw in the towel and issued the following statement:
“After months of hard work and intense deliberations, we have come to the conclusion today that it will not be possible to make any bipartisan agreement available to the public before the committee’s deadline.”
Under the current law the $5 million exemption at the top rate of 35 percent is currently set to expire on December 31, 2012, when the exemption amount will be lowered to $1 million at the top rate of 55 percent. Nevertheless, the recent speculation due to the establishment of the Super Committee and the uncertain economic and political environment has focused our attention on the possibility that the window of opportunity for our clients to transfer up to $10 million of capital (per couple) free of all transfer taxes may not be available through the end of 2012.
Sensible Estate Tax Act of 2011
In fact, on November 17, 2011, even before the Super Committee released its statement, Jim McDermott, a senior member of the House Ways and Means Committee, introduced HR 3467, the Sensible Estate Tax Act of 2011 (the “Bill”). Congressman McDermott stated that the Bill will “fix” the estate tax by providing “the kind of certainty that practitioners and taxpayers have been calling for since the Bush tax cuts took effect.”
The Bill proposes to reduce the estate tax exemption amount to $1 million for decedents dying after Dec 31, 2011 at a top estate tax rate of 55 percent. The Bill includes provisions designed to co-ordinate with the gift tax to reflect the decrease in the applicable credit amount, allows portability of estate and gift tax exemptions between spouses, calls for consistent basis reporting, and restores the state death tax credit. The legislation also includes a number of critical provisions designed to close estate and gift tax “loopholes” as follows:
- Valuation and Minority Discounts – The Bill eliminates (i) valuation discounts with respect to certain assets which are not used in the active conduct of one or more trade or business, and (ii) lack of control discounts if the transferee and the transferee’s family members have control of the entity.
- Minimum 10-year Term for GRATs – The Bill requires that a Grantor Retained Annuity Trust (“GRAT”) have a minimum 10 year term. The Bill also prohibits annuity payments to be reduced from one year to the next for the first 10 years. Finally, the Bill requires the remainder interest to have a value greater than zero at the time of transfer.
- GST Tax Exemption – The Bill also limits the use of GST tax exemption past 90 years. Thus, the Bill would limit the duration of any dynasty trust to 90 years despite the respective state law rules, which typically determine the duration of a trust.
While it is unlikely that the Bill will pass, it is the first attack in what may become a combative political battle over the next year. Some of the Bill’s provisions have been on Congress’s radar for quite some time now, and if enacted, would eliminate several major tax and estate planning opportunities. These political and tax issues will not fade so quickly from the public mind as there is noticeable anger from many citizens over the tax benefits received from a relatively small population of affluent taxpayers and disparities in income levels all of which have been partly to blame for fueling protests across the U.S. But how Congress chooses to find budget cuts, and where the lines will be drawn, is beyond prediction. Thus, it is important for clients looking to make large transfers to future generations, free of gift, estate and GST taxes, to consider doing so now.
2012: Practical Planning Tips for Clients
For clients who wish to make gifts, but still want to retain some control of the assets, a popular way of using the $5 million gift tax exemption is for one spouse to make a gift to an “inter-vivos credit shelter trust” (also commonly known as a “By-Pass” trust) for the lifetime benefit of the Grantor’s spouse and descendants. An inter-vivos credit shelter trust is typically structured as an irrevocable trust and is very similar in terms to a standard credit shelter trust created under a one’s Last Will and Testament or Revocable Living Trust. As such, the donor’s spouse and children can be permissible beneficiaries and get the income (& discretionary distributions of principal) from the trust during the spouse’s lifetime and at the spouse’s death, the trust property will pass to the trust beneficiaries (typically donor’s children) free of estate taxes. With this approach, the income from the trust can still be used for the ‘marital unit’ if the client is concerned that large gifts may unduly impoverish the donor and his or her spouse. However, the donor gets the tax benefit of having the assets being excluded from the donor’s and his or her spouse’s gross taxable estate. An inter-vivos credit shelter trust is also ideal for the spouse because the spouse can be the trustee, have a limited power of appointment (exercisable at death of in life), and the trust is protected against claims of both the donor’s and spouse’s creditors. Careful planning is required if both spouses want to attempt to use their federal gift exemptions within this planning strategy.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.