There has been much written recently on Congress’ failure to enact estate tax legislation so that taxpayers would have some certainty as to the current estate tax laws and appropriate planning. Congress allowed the $3.5 million exemption amount existing in 2009 to expire resulting in no estate tax for one year, 2010. Next year, the estate tax exemption amount is only $1 million, meaning a married couple, if they plan properly, can only protect $2 million. Besides this uncertainty, we have the current mess of having to track the basis of assets because upon death, there is no longer a "step up in basis."
Although not discussed as much, there is also uncertainty in other areas because of proposals that may eliminate or curtail current estate tax planning strategies. Two strategies involve Grantor Retained Annuity Trusts and transferring assets among family members at discounted values.
GRATs allow donors to transfer closely held stock, real estate, or marketable securities to a GRAT for a minimum of two years. If the donor receives an annual annuity from the GRAT, the appreciation in the transferred assets will pass to the donor’s family at the end of the GRAT term at a reduced value and is removed from the donor’s estate. The asset value is reduced for gift tax purposes because of the retained annuity. Obviously the greater the annuity and the longer the GRAT term, the greater the reduction in value of the transferred asset for gift tax purposes. In fact, it is possible to "zero out" (meaning eliminate) the gift tax.
One catch: the donor needs to survive the GRAT term. Thus, an 80-year old donor would not choose a 20-year GRAT. In fact, regardless of age, many donors choose two-year GRATs with the same assets (so called "rolling GRATs").
Under one proposal, GRATs less than 10 years in duration would be prohibited, meaning the donor must live 10 years to remove the asset from the donor’s estate. A separate proposal in Congress would not change the length of the GRAT, but would require a minimum gift imposed on the donor, perhaps as much as 10 percent of the transferred asset (thus eliminating zeroed-out GRATs).
Transfers of Assets at Discounts
Taxpayers and the IRS have battled for years over family members transferring their business and investment interests to family members at discounted values. With the appropriate appraisals, the discounts applicable to such transferred interests can range between 20 percent and 50 percent. The planning typically involves forming an LLC, or creating non-voting stock, and transferring non-controlling interests.
The Court cases pertaining to discounting of family assets are split, with victories for both the IRS and taxpayers. The IRS often prevails because of taxpayer greed (if taxpayers seek to discount all their assets); lack of a business purpose (personal assets transferred, such as a residence); procrastination (so-called "death bed" planning – transfers shortly before death); failure to observe formalities (co-mingling assets, not creating proper accounts and record keeping); or the retention of control.
The Obama Administration and Congress may seek to eliminate the discounts for transfers of non-controlling interests among family members. Typically, if new laws are passed, they carry the date of enactment as the effective date but Congress could seek to impose a retroactive date.
Thus, acting before certain planning opportunities are eliminated is important.