The
2013 Budget Proposal recently submitted by the Obama Administration would return
federal estate, generation skipping (GST), and gift taxes to 2009 levels. The
top tax rate would be 45 percent and the exclusion amount would be $3.5 million
for estate and GST taxes, and only $1 million for gift taxes. In addition, the
portability of unused estate and gift tax exclusion between spouses would be
made permanent.
If adopted by Congress, the Obama proposals would be
effective for the estates of decedents dying, and for transfers made, after December
31, 2012.
Currently, the estate, GST and gift tax rate is only 35
percent, and each individual has a lifetime exclusion for all three types of
taxes of $5 million (indexed for inflation). However, unless Congress and the
President can agree, in 2013 the tax rate and tax brackets, the amount of the
exclusions and the law governing these three types of taxes will revert to the
law that was in effect in 2001 prior to the enactment of the Bush tax cuts of
that year.
There will be tremendous pressure on lawmakers to prevent
the default reversion of tax rates to 2001 levels. No action by Congress will
mean a maximum tax rate next year of 55 percent, plus a 5-percent surcharge on
the amount of the taxable estate between approximately $10 million and $17.2
million (designed to recapture the benefit of the lower rate brackets). The
exclusion for estate and gift tax purposes would be reduced to $1 million, an
80% reduction from the current level. And there would be no portability of
unused exclusions to a surviving spouse.
While most of the public attention will likely be focused on
the tax threshold issue ($5 million vs. $3.5 million vs. $1 million), the Obama
Administration’s budget proposes a number
of “loophole” closing measures that may be of even greater potential significance
to the wealthy. In addition to the decrease from current exclusion thresholds
and increase in tax rates, the Obama Administration proposes to put new limits
on a number of estate tax reduction devices that are currently in wide use. The proposals include:
Valuation
Discounts. Estate
planners are able to utilize a number of techniques designed to reduce the
value of the transferor’s taxable estate and discount the value of the taxable
transfer to the beneficiaries of the transferor without reducing the economic
benefit to the beneficiaries.
The Administration’s proposal would limit the availability
of such valuation discounts by creating an additional category of restrictions
(“disregarded restrictions”) that would be ignored in valuing an interest in a
family-controlled entity transferred to a member of the family if, after the
transfer, the restriction will lapse or may be removed by the transferor and/or
the transferor’s family.
Require a Minimum
Term of Ten Years for Grantor Retained Annuity Trusts (GRATS). GRATs are
a popular technique for transferring wealth while minimizing the gift tax cost
of transfers. A GRAT is an irrevocable
trust funded with assets expected to appreciate in value, in which the grantor
retains an annuity interest for a term of years. At the end of that term, provided
that the grantor has survived, the assets then remaining in the trust are
transferred to (or held in further trust for) the beneficiaries. The greater
the appreciation in the value of the assets held by the trust, the greater the
transfer tax benefit achieved.
Taxpayers have become adept at maximizing the benefit of
this technique, often by minimizing the term of the GRAT (thus reducing the
risk of the grantor’s death during the term), in many cases to two years, and
by retaining annuity interests significant enough to reduce the gift tax value
of the remainder interest to zero or to a number small enough to generate only
a minimal gift tax liability.
This Administration’s proposal would require, in effect,
some downside risk in the use of this technique by imposing the requirement
that a GRAT have a minimum term of ten years and a maximum term of the life expectancy
of the annuitant plus ten years. The proposal also would include a requirement
that the remainder interest have a value greater than zero at the time the
interest is created and would prohibit any decrease in the annuity during the
GRAT term. This proposal would apply to trusts created after the date of
enactment.
Limit the Duration
of the Generation-Skipping Transfer Tax Exemption. A generation-skipping
transfer (GST) tax is imposed on gifts and bequests to transferees who are two
or more generations younger than the transferor. The GST tax was enacted to
prevent the avoidance of estate and gift taxes through the use of a trust that
gives successive life interests to multiple generations of beneficiaries.
The GST tax is a flat tax on the value of the transfer at
the highest estate tax bracket applicable in that year. Each person has a
lifetime GST tax exemption ($5,120,000 in 2012) that can be allocated to
transfers made, whether directly or in trust, by that person to a grandchild or
other “skip person.”
The allocation of GST exemption to a transfer or to a trust
excludes from the GST tax not only the amount of the transfer or trust assets
equal to the amount of GST exemption allocated, but also all appreciation and
income on that amount during the existence of the trust. Because many states,
like Pennsylvania, have done away with any limits on the tenure of trusts, GST
trusts can now continue, and avoid estate, gift and GST taxation, in
perpetuity.
The Administration’s proposal would provide that, on the
90th anniversary of the creation of a trust, the GST exclusion allocated to the
trust would terminate.
Place new limits
on the use of Grantor Trusts. A grantor trust is a trust of which an individual is treated
as the owner for income tax purposes. For income tax purposes, a grantor
trust is taxed as if the grantor or another person owns the trust assets
directly, and the deemed owner and the trust are treated as the same person.
Thus, transactions between the trust and the deemed owner are ignored. For transfer
(estate and GST and gift) tax purposes, however, the trust and the deemed owner
are separate persons, and under certain circumstances the trust is not included
in the deemed owner’s gross estate for estate tax purposes at the death of the
deemed owner.
Estate planning attorneys exploit the lack of coordination
between the income and transfer tax rules applicable to a grantor trust through
techniques like the “intentionally defective grantor trust” that can transfer
significant wealth to children or others without gift or estate taxation.
To the extent that the income tax rules treat a grantor of a
trust as an owner of the trust, the Administration’s proposal would (1) include
the assets of that trust in the gross estate of that grantor for estate tax
purposes, (2) subject to gift tax any distribution from the trust to one or
more beneficiaries during the grantor’s life, and (3) subject to gift tax the remaining
trust assets at any time during the grantor’s life if the grantor ceases to be
treated as an owner of the trust for income tax purposes.
Basis Consistency
Requirements. This proposal would help ensure that the basis of the
property in the hands of the recipient be no greater than the value of that
property as determined for estate or gift tax purposes (subject to subsequent adjustments).
In order that taxpayers are aware of and use the appropriate
basis, a reporting requirement would be imposed on the executor of the
decedent’s estate and on the donor of a lifetime gift to provide the necessary
valuation and basis information to both the recipient and the Internal Revenue
Service.
Conclusion
Of course, taxes are a contentious issue on Capitol Hill and
it is quite possible that none of the “loophole” reforms proposed by the Obama
Administration will be enacted. However, to the extent that loophole closures
can be viewed as distinct from tax increases, we could well see one or more of
the above provisions become law. Depending
on what happens politically, we could someday look back on 2012 as the last golden
year for wealth transfer opportunities.
Further Reading
Department
of the Treasury, General Explanations of the Administration’s Fiscal Year 2013
Revenue Proposals (February 2012)
Daniel L. Ricks “I Dig It,
But Congress Shouldn’t Let Me: Closing the IDGT Loophole”
