Dedon on Estate Planning

An Estate Planning Present from Congress

When the President signed into law a two year extension of the Bush Tax cuts, most Americans were focused on the income tax ramifications. However, the gift and estate tax changes are a huge departure from what the estate planning community expected. The options were believed to be a 45 percent or 55 percent estate tax rate, applying to assets exceeding $3.5 million or $1 million. But the law applicable for the next two years is vastly different from those expectations. Among the highlights are the following:

-- For 2011 and 2012, a $5 million exemption amount, meaning a single person can pass $5 million upon death without any federal estate tax. A married couple with proper planning can protect $10 million.

-- Just as significant, the amount a person can gift during lifetime is $5 million. This is a radical departure from the current $1 million gift amount. The significance is that 2011 is a year when substantial wealth can be transferred without incurring any gift tax. For the very wealthy, assets in excess of $5 million can be transferred with only a 35% gift tax. Also, with a $5 million gift exemption amount ($10 million for a married couple), advanced gifting techniques, such as transfers involving a gift and sale of assets to intentionally defective trusts, are even more useful.

-- The Generation Skipping Tax Exemption is also $5 million. Again, using advanced planning tools, there is an opportunity to provide significant estate tax savings for future generations.

-- The law also addressed the uncertainty pertaining to taxpayers who die in 2010. The decedent's estate may elect the $5 million exemption amount, or benefit from no estate tax but also no step-up in basis for assets exceeding $1.3 million (and an additional $3 million increase in basis to property that goes to the decedent's spouse). Generally, estates under $5 million will benefit from the $5 million exemption amount, and estates such as George Steinbrenner's will benefit from no estate tax.

Some planning decisions are immediately obvious and others will emerge as the new law is studied. Despite the abundance of good news, there is remaining uncertainty: the law only applies for two years. But two years provides ample time to take advantage of the planning opportunities.

Santa - I mean the President and Congress - was very generous this Holiday Season.

 

Estate Tax Legislation – A Temporary Fix?

Finally, this past week there is some movement on the estate tax front. On December 6^th, President Obama and Republicans tentatively agreed to extend the Bush tax cuts for two years. Included in the compromise was an estate tax exemption amount of $5 million per person and a 35% tax rate. Most experts had expected that, if a compromise was reached, it would be at a $3.5 million per person exemption amount and a 45% tax rate. The Obama compromise fully adopted the Republican position proposed by Senators Kyl and Lincoln for the last couple of years.

Many Democrats are livid with the compromise, particularly the estate tax provision. Even moderate Democrats, such as Congressman Earl Pomeroy, stated they will not support any legislation with a $5 million exemption amount. As Congress begins to consider the compromise this week, expect the Democrats to seek a cut back to $3.5 million. However, the momentum favors passage of the Obama compromise, even with the $5 million exemption amount.

Regardless of the final provisions, assuming there is a Bill signed into law this year, it will cover only 2011 and 2012. Taxpayers will continue to have uncertainty in their estate planning.

Wealth Transfer Opportunities

As Congress wrestles with expiring income tax cuts and the return of the estate tax, significant wealth transfer options remain for taxpayers with taxable estates. These techniques are designed to transfer assets to children at reduced or no gift and estate tax.

What is a taxable estate in 2011? Absent Congressional action, for a married couple it will be estates with values exceeding $2 million. For a single taxpayer, a taxable estate is an estate exceeding $1 million. If you add the equity in your real estate, retirement plans, other liquid assets and the death benefit of your life insurance, and you exceed these amounts, you have a taxable estate. For those with closely held businesses, there are greater estate values to consider.

So if you are worried about the return of the 55% estate tax, what are the wealth transfer options alluded to above? Well, there are several, but two of them are GRATS and Gift and Sale transfers to Intentionally Defective Trusts. I have written in the past on both techniques, so I won't explain again. See the Posts on December 15, 2008, April 13, 2009, May 18, 2009, February 22, 2010, May 3, 2010 and August 2, 2010 regarding GRATS, and see the attached article published in Virginia Business Magazine, regarding Gifts and Sales to Intentionally Defective Trusts.

Download Va bus art - gift_sale IDGT 6-30-09

The reasons why it is worth mentioning these techniques again are the same reasons that have made them appealing over the last few years. First, values are down, making it a good time to transfer assets before the economy improves or there is a sale event at a higher value. Second, assets can be transferred at even lower values because of market and minority discounts. Third, the IRS interest rates - the rate that determines the investment return taxpayers must receive in exchange for removing assets from their estates - are at historically low values. For a GRAT, the December interest rate is a meager 1.8%, and for the note payments on a sale to an Intentionally Defective Trust, the December interest rate on a nine year note is only 1.53%; on a three year note the rate is .32%.

These factors make it appealing to act now and before Congress and the Obama Administration outlaw these transfer techniques. Both techniques are in Congress' crosshairs. There was a legislative proposal in 2009 that would have eliminated market and minority discounts. The elimination of these discounts would have affected both GRATS and Gift/Sales to Intentionally Defective Trusts.

Regarding GRATS alone, within the last two years, there have been a couple of Congressional Bills that would have eliminated in large part the benefits of a GRAT. One Bill passed the House before it died in the Senate. The common themes to these Bills were to require a 10-year minimum term for GRATS and a minimum taxable gift. Now, GRATS can be designed for as little as two years (thereby allowing the appreciation to be transferred sooner) and without a gift consequence. Many expect two year GRATS to be eliminated by Congress in 2011.

By acting before the enactment of any legislation, you can still take advantage of short-term and zeroed-out GRATS and transfers of assets at discounted values to Intentionally Defective Trusts.