Tag: Estates & Trusts

Be Organized Now, Save Your Family Time and Money Later

Recently posted in the National Law Review an article by Jessica M. DesNoyers of Varnum LLP regarding wills and estate planning:

Varnum LLP

I have assisted in the distribution and administration of more than one trust and estate, and I speak from experience – the process is much easier on the family and takes considerably less time if the deceased was organized.

If the decedent died without a valid will or any estate planning, and the decedent owned any assets upon his or her death, the family has to file a claim in Probate Court to transfer the property and hope that they know what all of the decedent’s assets were.  If the decedent died with a valid will, but did not have a trust in place, or did not transfer all of his or her assets into the trust, the family will still have to file a claim in Probate Court.  Finally, even if a solid estate plan is in place, there are a number of tasks to be completed and documents to be filed or mailed before the decedent’s estate can be disbursed or administered.  To make the process easier on family members attempting to comply with your last wishes, here are some easy things you can do now to help your family later:   he distribution and administration of more than one trust and estate, and I speak from experience – the process is much easier on the family and takes considerably less time if the deceased was organized.

  1. Meet with an attorney to ensure your estate plan is up-to-date, and you have all the documents you need.
  2. Keep all of your estate planning documents together and in a safe place, and let your attorney or a trusted family member know where they are.
  3. If you have retirement accounts, money market accounts, or insurance policies where you’ve named beneficiaries, keep all of those document together with your estate planning documents.  Confirm that your documents name the beneficiaries you want named.  Keep company contact information with the documents so that your family knows who to contact at the company to make a death claim and receive benefits.
  4. Keep all title documents together with your estate planning documents, or if kept in a safe deposit box or safe, make a note with your estate planning documents altering family of where it is how to access it.  This would include title to cars and real estate.
  5. If you have specific personal items you want to give to certain individuals, make that clear.  You can create what is called a “holographic will” for personal items by handwriting (not typed) what items you want to give to which people or entities, write the date on the document and sign it at the end of the document.  This does not take the place of an estate plan, but can be used to distribute items such as family heirlooms.
  6. Finally, keep a list of all the assets you have that will need to be transferred.  No, you do not need to list every plate in your cupboard.  You should, for example, list which banks you have accounts with and what types of accounts, where you own real property, life insurance policies, and vehicles or “toys” (i.e. boats, ATVs, etc.) you own.

Being organized is relatively easy, and the benefits of the time you take today will be a gift to your family after you are gone.  Call an estate planning attorney today to assist you in the process.

© 2011 Varnum LLP

The Illinois Civil Union Law and Its Impact on Estate Planning

Recently posted in the National Law Review an article by Gregg M. Simon of Much Shelist Denenberg Ament & Rubenstein P.C. on Civil Unions and Estate Planning:

On June 1, 2011, the Illinois Religious Freedom Protection and Civil Union Act went into effect. The new law provides a legal procedure for the certification and recognition of civil unions between same-sex and opposite-sex individuals. This new Illinois law has numerous real and potential effects on many areas of the law, including estate planning—effects that may not be limited to the parties in a civil union. Much Shelist spoke to Gregg M. Simon, Chair of the firm’s Wealth Transfer & Succession Planning practice, about some of the estate planning issues being raised by the new law.

Much Shelist: Can you give us a brief overview of the Illinois civil union law?

Gregg Simon: For a number of years, advocates of the legal recognition of same-sex couples in Illinois had been working with the state legislature to pass some form of civil union or marriage law. On the other side, certain religious and other groups had expressed concerns about the scope of such legislation and how it might be applied or enforced. Eventually, compromise language was worked out that, while not fully addressing all concerns of all parties, contained provisions that enabled passage of the legislation in the Illinois House and Senate on December 1, 2010. In February 2011, Governor Pat Quinn signed the law, which went into effect on June 1, 2011.

As written, the law is fairly short and direct. It provides procedures for the certification, registration and dissolution of a civil union and entitles parties entering into a civil union the same legal obligations, responsibilities, protections and benefits that are afforded to married spouses. In essence, where “spouse” appears in existing and future Illinois statutes, administrative rules, common law, or other sources of civil or criminal law, the word now also refers to a party in a civil union. These “default” rights and obligations can include the right to make health care decisions (unless, as with married couples, a guardian for the disabled partner has been appointed or an agent under a health care power of attorney has been named), the right to dispose of the remains of a deceased partner, various inheritance and property rights, creditor protections, and so on.

Civil unions in Illinois are not just for same-sex couples. Opposite-sex couples can also enter into a civil union, although they should carefully weigh the known and potential advantages and disadvantages of a civil union versus marriage. Likewise, the rules prohibiting certain civil unions are generally similar to those that prohibit marriage between specific individuals. For example, an individual is not allowed to enter into a civil union if he or she is in an existing civil union or marriage, and closely related individuals cannot enter into a civil union.

MS: From an estate planning perspective, what should couples be aware of?

GS: With respect to the Illinois civil union law, there are three broad concepts relating to estate planning that people should keep in mind. First, it should be understood that the law could affect almost anyone, not just the parties in a civil union. For example, let’s assume that a parent has drawn up a will prior to the effective date of the Illinois civil union law that designates his or her child and that child’s “spouse” as beneficiaries. Now let’s imagine that at some point in time the child enters into a civil union with his or her same-sex partner. Under a strict reading of the law, that same-sex partner would be treated as a spouse and would therefore qualify for the beneficial interest designated in the will. That might be the intent of the parent whose assets are to be distributed—or it might not.

Second, the civil union law raises almost as many issues as it resolves, many of which will be the subject of legal disputes until a clear body of case law and precedent has been established. Using the same example, let’s imagine that the parent was perfectly happy with his or her child’s same-sex partner receiving a beneficial interest, but failed to clarify in the will that its terms applied equally to a spouse and a party to a civil union (particularly if the parent died before the civil union legislation was enacted). Let’s now imagine that the child’s siblings do not want the same-sex partner to receive a portion of the assets. Since the will only used the word “spouse,” the siblings could take legal action to try to deny the same-sex partner his or her portion of the beneficial interest, claiming that the use of the word “spouse” (and failure to change the language of the will after June 1, 2011) meant that the parent intended only for an opposite-sex, married partner of the child to be eligible to receive any assets.

These examples are not so farfetched. After Illinois law was changed in the early 20th century so that adopted children were treated the same as natural-born children, almost 100 years of related litigation ensued. These cases focused on whether an adopted child was included when a testator used the terms “children” or “issue,” particularly when the document was executed before the law was changed (i.e., at a time when an adopted child would not have been included within those terms).

The takeaway is that clarity is paramount when it comes to estate planning. In order to ensure that your wishes are carried out as you intend, you should review all applicable documents with experienced legal counsel and ensure that any potentially ambiguous language or terms are clarified and reflect current legal realities.

A third important concept is that the federal Defense of Marriage Act (DOMA) and federal tax laws do not recognize same-sex civil unions or marriages, even those that are recognized by the various states. This raises a whole host of issues regarding estate and gift taxation, Social Security benefits and other federal-level treatment of individuals in civil unions. Many of these issues are being litigated right now.

MS: What are some of the key conflicts between state and federal marriage and tax laws?

GS: DOMA defines “marriage” as a legal union between one man and one woman, and defines “spouse” as a person of the opposite sex who is a husband or wife in a marriage. DOMA further says that no state can be required to honor the law of another state regarding legal relationships that are treated as a marriage between persons of the same sex. In essence, DOMA denies same-sex couples all of the federal benefits of marriage, even if the couple was married or entered into a civil union in a state that recognizes such relationships.

From the perspective of estate and tax planning, this means that same-sex couples are denied the following, among other benefits: the estate tax marital deduction for assets passing outright to a spouse, or to certain qualifying marital deduction trusts and qualified domestic trusts; portability of exemption amounts; the gift tax marital deduction; gift splitting, or the right to treat gifts made by either spouse as made equally by both spouses; and, for the generation-skipping transfer tax, treatment of the same-sex parties as being in the same generation. Opposite-sex couples in a civil union may also face some, if not all, of these issues, particularly in states that do not recognize common-law marriage.

On the other hand, there are some transfer rules that apply to married, opposite-sex couples that, by not applying to same-sex couples, might produce favorable results. These include (1) the option of setting up a grantor retained income trust, which typically does not work for married couples, and (2) adding certain provisions to a qualified personal residence trust that are not permissible for married same-sex couples. Sales of remainder interests can similarly work for domestic partners.

Additional issues arise when a same-sex couple moves to another state. How will that jurisdiction interpret the civil union law of Illinois, particularly in those states with laws that specifically recognize legal relationships only between one man and one woman?

MS: Will legal challenges to DOMA and other laws help clarify this picture?

GS: In the long run, the answer is yes. There are a number of court cases, perhaps the best known of which is Edith Schlain Windsor v. United States, that are challenging the legality of DOMA and its application on a variety of issues. The Obama administration and the Office of the U.S. Attorney General, which are charged with enforcing the law, have stated that they do not believe DOMA is constitutional as applied to the cases that have challenged its constitutionality and have declined to defend it in these cases. Whether or not DOMA or any of its component parts are upheld as constitutional, the decisions in these cases are bound to add clarity to the situation.

However, “clear” does not always mean less complex. Whether or not DOMA is overturned, the decisions made by the courts will add new twists in the area of estate planning. For example, an older, opposite-sex couple in Illinois may choose to enter into a civil union rather than a marriage, in order to continue receiving Social Security benefits that derive from prior marriages. If DOMA falls, and their civil union is then treated as a federally recognized marriage, they could stand to lose a significant portion of their Social Security benefits.

Given all of the uncertainties, individuals who are considering a civil union should work closely with their attorneys to review their current estate planning documentation. Ambiguous language should be revised and clarified, and new or different tools (trusts, etc.) may be advisable in light of the new legal and tax landscape. Estate plans are “living” things, if you will; as the environment changes, they should be reviewed regularly and adjusted accordingly.

© 2011 Much Shelist Denenberg Ament & Rubenstein, P.C.

Congress Finally Resolves Estate Tax Uncertainty: But Only for Two Years!

Very Comprehensively written article by Michael D. Whitty and Igor Potym of Vedder Price P.C. – so much good Year End Tax Information we thought we’d include it here too:  

As part of a compromise to extend the income tax rates in effect from 2003 to 2010 (sometimes described as the “Bush tax cuts”) and unemployment benefits, Congress has finally resolved uncertainties in the estate, gift, and generation-skipping transfer (“GST”) taxes.  The new law makes the most significant changes to these taxes since 2001, including a generous increase in exemptions and a significant reduction in tax rates for 2011–2012.  In order to take advantage of some one-time wealth transfer opportunities, action is required before the end of 2010. For nearly all high-net-worth persons, the next two years will bring extraordinary estate planning opportunities.  Unfortunately, and contrary to many media claims, 2011 and 2012 will also bring added complexity and uncertainty.  Surprisingly, estate planning for married persons with estates of less than $10,000,000 may actually be more complicated than planning for married persons with larger estates.  Accordingly, all estate plans should be reviewed early in 2011 to determine whether the plan will work as intended under the new tax laws.  Persons who would like to discuss how the new estate, gift, and GST tax laws affect their specific situations and existing estate plans should call a member of the Estate Planning Group of Vedder Price P.C.

Executive Summary

The following is an executive summary of the most notable effects of the new law; a more detailed discussion of each can be found inside this Bulletin:

  • Income Tax Rates Continued for 2011–2012. The 2010 income tax rates are continued for two more years, including the preferential 15% tax rate for long-term capital gains and qualified dividends.
  • Estate Tax Made Optional for 2010.  The estate tax, which had been repealed for 2010, was reinstated effective January 1, 2010, but the executor for a person dying in 2010 may elect to opt out of the estate tax and apply carryover basis instead.
  • Transfer Tax Exemptions Increased, Tax Rate Reduced.  The lifetime exemption amount for transfer taxes—the estate tax, gift tax, and GST tax—is set at $5,000,000.  These increases are effective in 2010 except for the gift tax exemption, which remains $1,000,000 until 2011.  The tax rate on estates, gifts, and generation-skipping transfers above these amounts is 35%.
  • Generation-Skipping Transfer Tax Rate Is Zero for 2010. For all of 2010 (including the balance of the year), the GST tax rate is zero.
  • Unused Estate Tax Exemption Transferable to Surviving Spouse.  Beginning in 2011, the unused estate and gift tax exemptions of the first spouse to die may be transferred to the surviving spouse for both gift and estate tax purposes.
  • Bullets Dodged. The new legislation did not include recent proposals to reduce or eliminate the effectiveness of several of the most advantageous estate planning techniques.
  • Direct Gifts from IRAs to Charities Reinstated for 2010–2011. In 2008–2009, IRA owners over age 70½ could make direct distributions from their IRAs to charities and exclude the amount from income while treating it as part of their required minimum distribution.  The new law extends that option through 2011.  Because so little time remains in 2010, a special rule permits taxpayers to make such a transfer in January 2011 and treat it as if it had been made on December 31, 2010.

The “Tax Relief, Etc.” Act of 2010

The bill passed by Congress and signed by President Obama on December 17, 2010, H.R. 4853, was titled the “Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010” in its final form.  (It had previously carried other names, including the “Middle Class Tax Relief Act of 2010.”)  For simplification, this Bulletin will refer to it as the “2010 Tax Act” or “the Act.”

The bill went through many changes in the last month prior to enactment, and includes some unexpected provisions while excluding other provisions that had been expected.  As a result, some of our recommendations from prior bulletins have changed.  Please contact a member of our Estate Planning Group for confirmation before acting on our prior recommendations.

The benefits of the Act may be temporary, however.  All of the tax changes included in the Act will expire on or before January 1, 2013. Without further action by Congress, the estate, gift, and GST tax rates and exemptions applicable on January 1, 2001 will return on January 1, 2013.  Additional legislation in late 2012 or early 2013 seems likely, but it is impossible to predict the details of that legislation.

Income Tax Rates Continued for 2011–2012

The Act continues the 2009 income tax rates through 2012, including the preferential 15% tax rate for long-term capital gains and qualified dividends.  Apart from other changes discussed later in this Bulletin, these changes include:

  • Withholding of Social Security tax from wages and self-employment income for 2011 decreased by two percentage points (with the gap made up from general federal revenues)
  • AMT “relief” for most taxpayers through 2011
  • Ability to deduct state sales tax as an itemized deduction through 2011
  • Enhanced business capital investment deductions and research and development credits

Summary of Changes to Transfer Tax Rates and Exemptions

2009 2010 2011–2012 2013 (if no action)
Tax: Exemption Rate Exemption Rate Exemption Rate Exemption Top Rate
Gift $1,000,000 45% $1,000,000 35% $5,000,000 35% $1,000,000 55%
Estate $3,500,000 45% $5,000,000 [1] 35% $5,000,000 35% $1,000,000 55%
GST $3,500,000 45% $5,000,000 0% $5,000,000 35% $1,400,000 [2] 55%
Notes: [1] Executors for decedents dying in 2010 may opt out of estate tax, into carryover basis.
[2] The GST exemption shown for 2013 is a projection, as it would be $1,000,000 indexed for inflation.

Estate Tax Made Optional for 2010

Under the 2001 tax act, the estate tax had been gradually eased, and was then repealed for one year only, 2010.  The new Act reinstates the estate tax and stepped-up basis (used for measuring capital gains) effective January 1, 2010.  This default rule benefits most estates that are too small for estate taxes but benefit from having stepped-up basis automatically apply to all assets.  However, the executor of a 2010 estate may elect to opt out of the estate tax and instead apply carryover basis (where the heirs take the decedent’s basis).  (See the item below regarding due dates.)

Transfer Tax Exemptions Increased, Tax Rates Reduced

The Act resets the estate tax exemption to $5,000,000 per decedent, effective January 1, 2010 (up from $3,500,000 in 2009).  The exemption for the GST tax is also $5,000,000 effective January 1, 2010.  The Act also increases the gift tax exemption to $5,000,000 to re-unify it with the estate tax exemption, but that change is delayed until 2011.  These exemption amounts are also adjusted for inflation, beginning in 2012.  However, all of these exemptions will revert to $1,000,000 in 2013 unless Congress takes additional action.  The Act sets a 35% tax rate on estates, gifts, and generation-skipping transfers above the exemption amounts.  This compares favorably with the 45% top rate that applied in 2009, and the 55% rate that would have applied in 2011 if Congress had not acted (and will apply in 2013 if Congress fails to take additional action).

The Act also changes how prior taxable gifts are taken into account in gift and estate tax calculations, by applying the tax rates for the year in question rather than the year of the prior gifts.  In our October 2010 Bulletin, we described how the transition in the gift tax rates and exemption from 2010 to 2011 would allow some donors who had already used all of their gift tax exemption to make a modest additional tax-free gift of $36,585 in 2011.  The Act’s changes in the gift tax rate, exemptions, and calculations of taxes on prior taxable gifts will eliminate that effect for 2011, but will allow much more extensive tax-free gifts.

Due Dates for 2010 Returns, Disclaimers

To prevent unfairness, the Act extends the due date for all estate and GST tax returns affected by the Act until September 17, 2011, nine months after the date of enactment (as that date falls on a Saturday, the effective date will be September 19, 2011).  The due date for related tax payments is also extended to the same date.  The deadline for qualified disclaimers (an affirmative election to decline a gift or bequest, treated under federal law as if the disclaimant had predeceased the transfer) is also extended to September 17, 2011.  However, the due date for 2010 gift tax returns was not extended.

Generation-Skipping Transfer Tax Rate Fixed at Zero for 2010

The Act sets the GST tax rate at zero for all of 2010 (including the balance of the year after enactment).  This means that gifts, bequests, trust terminations, and trust distributions to grandchildren made this year will face no GST tax.  If the transfer was made to a trust for a grandchild, the GST tax consequences are more tricky.  Neither the transfer to the trust nor a future distribution to the grandchild will be subject to GST tax. However, future distributions from the trust to great-grandchildren or younger descendants will be subject to GST tax unless the trust is made exempt by allocation of the transferor’s GST exemption.  In addition, a transfer in 2010 to a typical generation-skipping trust that benefits children, grandchildren, and younger descendants will not be exempt from GST tax in the future unless the trust is made exempt by allocation of the transferor’s GST exemption.  If you have already made or plan to make gifts to grandchildren in 2010, contact a member of our Estate Planning Group to discuss the effects of the new Act, including reporting requirements and tax elections.

Unused Estate Tax Exemption Transferable to Surviving Spouse

Beginning in 2011, the unused estate tax exemption of the first spouse to die may be transferred to the surviving spouse by an election filed with the first spouse’s estate tax return.  This may require the filing of an estate tax return in cases where a return would not otherwise be required.  The surviving spouse may use this transferred exemption for lifetime gifts as well as for bequests at death.  Only the unused exemption from the last deceased spouse will apply, and the death of a subsequent spouse will reset the identity of the last deceased spouse.  However, lifetime gifts could use a predeceased spouse’s exemption before the death of a subsequent spouse changes the amount of exemption available.

For planning purposes, transferability of the unused estate tax exemption of the first spouse does not eliminate the value of so-called credit shelter trusts and QTIP trusts as part of the estate plan.  As one example, the new law does not allow the unused GST tax exemption of the first spouse to be transferred to the surviving spouse.  The credit shelter trust and QTIP trust are two tools to avoid wasting the first spouse’s GST tax exemption.

Bullets Dodged

The Tax Reform Act of 2010, in its final form, did not include recent legislative proposals (some of which had already passed in the House or Senate, but not both) to reduce or eliminate the effectiveness of several of the most attractive estate planning techniques.  The final legislation did not include recent proposed legislation to reduce or eliminate valuation discounts on intra-family transfers of non-operating partnerships and LLCs, to impose a 10-year minimum term on grantor retained annuity trusts (commonly known as GRATs), or to require taxpayers to use a consistent basis for estate and income tax purposes.

Direct Gifts from IRAs to Charities Reinstated for 2010–2011

In 2008–2009, IRA owners over age 70½ could make direct distributions from their IRAs to charities of up to $100,000 per year and exclude the amount from income, while treating it as part of their required minimum distribution.  The new law extends that option through 2011.  Because so little time remains in 2010, a special rule permits taxpayers to make such a transfer in January 2011 and treat it as if it had been made on December 31, 2010.

Roth Conversions

The new Act did not change the rules regarding Roth IRA conversions, discussed in prior Bulletins.  The only thing that expired in 2010 was the election to report the tax over the following two taxable years (2011 and 2012).  Conversions in 2011 will still work as in 2010, except that the taxable income has to be recognized entirely in 2011.

The New Law’s Effect on Estate Planning

The fundamental principles and priorities of estate planning will remain the same.  However, the effect and relative value of certain specific techniques have changed.  Some opportunities have been improved, others have disappeared, and still others remain but have decreased in relative importance.

As noted at the opening of this Bulletin, the new tax laws create extraordinary estate planning opportunities for high-net-worth individuals.  Additionally, the new tax laws will impact the basic estate plan of nearly all persons with significant assets.  Estate planning for married persons with combined estates of less than $10,000,000 will be particularly complex, given the possibility that the estate, gift, and GST tax exemptions will revert to only $1,000,000 per person in 2013.

Time for Action

A few of the opportunities described in this Bulletin have an absolute expiration date:  December 31, 2010. Others may expire as soon as December 31, 2012.

© 2010 Vedder Price P.C.

Other Super Year-end Tax and Estate Planning Articles:

FEDERAL TAX NOTICE:  Treasury Regulations require us to inform you that any federal tax advice contained herein (including in any attachments and enclosures) is not intended or written to be used, and cannot be used by any person or entity, for the purpose of avoiding penalties that may be imposed by the Internal Revenue Service.

Time Is Running Out for One-Time Estate Planning Opportunities: Gift Tax Rates Will Increase in 2011, Bonus Gift Tax Exemption Available for Some Gifts Made in 2010-11 and Opportunity for Gifts or Trust Distributions to Grandchildren

Very comprehensive post recently received at the National Law Review from Michael D. Whitty of Vedder Price P.C. on year end estate and tax planning issues: 

As the end of the year approaches, it appears increasingly unlikely that Congress will pass legislation on gift and estate taxes before 2011.  Many one-time opportunities for gifting and tax planning will expire at the end of 2010.

Executive Summary:

  • Gift Tax Will Increase in 2011. For 2010 only, the tax rate on gifts that exceed the $13,000 gift tax annual exclusion and the $1 million lifetime gift tax exemption is only 35%, compared to a 45% rate in 2009 and rates of up to 55% in 2011 and beyond.  Persons who are otherwise facing substantial estate taxes should consider making gifts this year to take advantage of the 35% rate.
  • Bonus Gift Tax Exemption Available for Some Gifts Made in 2010–2011. Due to quirks in the way the $1 million lifetime gift tax exemption is determined, some donors may not have a full $1 million exemption this year, but if they use the full exemption by the end of 2010, they can obtain a bonus exemption in 2011.
  • Opportunity for Gifts or Trust Distributions to Grandchildren. Some gifts or trust distributions to grandchildren (or similar younger-generation beneficiaries) can be made in 2010 without any generation-skipping transfer tax (GST tax).  Such gifts and distributions must be carefully structured to avoid GST tax in the future, however
  • Low Interest Rates May Not Last Much Longer. Interest rates have remained low this year, but they will eventually increase.  This year could be the best opportunity for the foreseeable future to use a leveraged techniquesuch as a grantor retained annuity trust (GRAT), an installment sale to a grantor trust, an intra-family loan (including refinancing an existing family loan), or a charitable lead annuity trust.
  • Converting to Roth IRA with Charitable Deduction to Offset the Tax. Conversion of a regular IRA to a Roth IRA in 2010 may provide substantial benefits for certain individuals, in particular those with sufficient liquid assets outside of the IRA to pay the tax.  The tax burden can be further reduced, or offset entirely, with substantial charitable gifts made this year.  The temporary sunset (for 2010 only) of the phase-out of itemized deductions (including charitable deductions) for high-income earners will allow those taxpayers to obtain a greater after-tax benefit from their 2010 charitable deductions.

Gift Tax Rates Will Increase in 2011

Due to political considerations, the 2001 estate tax act eliminated the estate tax for only one year—2010.  The gift tax was retained, even for 2010, primarily to avoid the loss of income tax revenue.  For 2010 only, the tax rate on gifts that exceed the $13,000 gift tax annual exclusion and the $1 million lifetime gift tax exemption isonly 35%.  This is a substantial discount from the 45% rate for 2009 and rates of up to 55% that will apply after 2010.

Persons facing substantial estate taxes who can afford to transfer assets and pay gift taxes now should give serious consideration to making gifts this year.  Gifts in 2010 should substantially reduce the total tax cost of transferring wealth to descendants and other beneficiaries as a result of four factors:

  • the lower gift tax rate for 2010;
  • the shift of future income and appreciation out of the taxable estate;
  • the potential for valuation discounts that often apply to gifts but not bequests of the same property; and
  • the potential to reduce the taxable estate by the amount of gift taxes paid if the donor survives the gift by three years.

This is illustrated by the three examples in the table on the following page, each involving a donor who has previously used his or her available gift tax annual exclusions and $1 million lifetime gift tax exemption.  The donor owns $10 million of other assets in addition to a controlling interest in a company, which would be included in the donor’s estate without valuation discounts (Example 1).  Examples 2 and 3 assume a gift of the interest in the company structured in a way that achieves valuation discounts for lack of marketability and lack of control.

It appears increasingly likely that Congress will not act in 2010 to retroactively impose a higher gift tax rate on gifts made previously in 2010.  However, to avoid that risk entirely, a gift could be set up in advance of the year-end and then executed in late December 2010 after the possibility of a retroactive rate increase disappears.  Other, more complicated alternatives can be structured to allow final decisions to be postponed into 2011.

Large gifts require some planning and implementation, especially if special entities are to be created and appraisals obtained to determine valuation discounts.  Consequently, it is important for donors interested in taking advantage of this opportunity to contact their advisors as soon as possible so that there is sufficient time to plan and implement the transfers.  Donors who wait until December may not have enough time to implement full and optimal strategies.

Gift Tax Exemption Available for Some Gifts Made in 2010–2011

The common understanding that there is a $1 million lifetime exemption from gift taxes in 2010 and 2011 is not exactly correct.  There are some modest but real variations in the way the gift tax exemption is determined in those years.  As a result, donors who used $500,000 or more of their exemption before 2010 do not have a full $1 million lifetime gift tax exemption in 2010.  However, those who use their full amount by the end of 2010 can obtain a small amount (up to $36,585) of bonus exemption in 2011.

For example, a donor who has made $1,000,000 of taxable gifts before 2010 will have no additional lifetime gift tax exemption in 2010, but will have another $36,585 of exemption in 2011.  On the other hand, a donor who had made $600,000 of taxable gifts before 2010 will have only an additional $394,386 (not $400,000) of lifetime gift tax exemption remaining in 2010, but if he or she makes a taxable gift of at least $394,286 in 2010, that taxpayer would have an additional $41,742 of exemption available in 2011.  In each case, careful calculations must be made to determine a donor’s remaining gift tax exemption for 2010 and the amount of taxable gifts that should be made in 2010 to obtain the maximum possible additional exemption in 2011.

Table:  Illustration of Benefits of Taxable Gifts in 2010

Description Example 1: Bequest in 2015  

Example 2: Gift in 2011

 

 Example 3: Gift in 2010
Value of property in 2010, before transfer

(transfer = by bequest or gift, as indicated)

 $10,000,000 $10,000,000 $10,000,000
Period of appreciation before transfer 5 years 1 year 0 years
Appreciation before transfer, at 5% per year $2,762,816 $500,000 (None)
Value at time of transfer $12,762,816 $10,500,000 $10,000,000
Valuation discounts (33%*) $0 ($3,465,000) ($3,300,000)
Value subject to transfer $12,762,816 $7,035,000 $6,700,000
Transfer tax type Estate Gift Gift
Marginal transfer tax rate 55% 55% 35%
Transfer taxes (estate or gift; federal and state combined) $7,052,689 $3,699,250 $2,345,000
Value of other estate in 2015** $10,000,000 $6,300,750 $7,655,000
Estate taxes on other estate $5,671,059 $3,682,200 $4,478,000
Net to beneficiaries *** $7,276,251 $8,919,300 $10,832,000
Cost of postponement compared to 2010 gift ($3,555,749) ($1,912,700) (None)
Effective tax rate **** 63.62% 45.28% 38.65%
*  Valuation adjustments for factors such as lack of marketability and minority interest are commonly in this range, but sometimes higher or lower.  A qualified appraisal should be arranged as part of the planning on the transaction.  This table’s Example 1 assumes that the interest is retained until death in a manner that does not qualify for valuation discounts.
**   Value of other estate = $10 million less gift taxes paid (Examples 2 and 3), plus value of other estate in 2015, less estate taxes on other estate
***  Net to beneficiaries = pre-discount 2010 value less transfer (estate or gift) tax, plus value of other estate in 2015, less estate taxes on other estate
**** Effective tax rate = tax ÷ (tax + net to beneficiaries)

Opportunity for Gifts or Trust Distributions to Grandchildren

In years before and after 2010, gifts or trust distributions to grandchildren (or similar younger-generation beneficiaries) were subject to a generation-skipping transfer tax in addition to any gift tax that might be due.  The GST tax is a flat tax at the top estate tax rate, and only applies after a lifetime exemption is fully used.  Because the GST tax is suspended for 2010, gifts or trust distributions this yearcan avoid that additional tax.  Such gifts and distributions must be carefully structured to avoid future GST tax, however.  Transfers to trusts or trust equivalents (including UTMA accounts) for the benefit of a grandchild will still be subject to GST tax when later distributed to the grandchild.  A direct transfer to a grandchild (including, we believe, a guardianship estate for a minor grandchild) will avoid the tax, both now and later.  Persons planning gifts or bequests to grandchildren should consider whether a gift this year might be more advantageous.  Trustees expecting future distributions to grandchildren of the trust’s donor should consider whether accelerating the distribution into 2010 would provide more of a tax advantage.  In both cases, an attorney  can help analyze whether and to what extent taking action this year would help.

Low Interest Rates May Not Last Much Longer

Interest rates remained low this year, but they will eventually increase.  We may never see a better opportunity to use leveraged techniques such as GRATs, installment sales to grantor trusts, intra-family loans (including refinancing existing family loans) and charitable lead annuity trusts.  A weighted average of Treasury rates is used to calculate the rates used in these wealth transfer techniques.  Once those rates increase, techniques that perform best with low interest rates will lose some of their advantage.  This would affect some of the most attractive wealth transfer techniques, all of which are described in prior newsletters:

  • GRAT:  a gift of future appreciation while retaining the present value of the transferred property
  • Charitable lead annuity trust (CLAT):  a gift of future appreciation while transferring the present value of the transferred property to charities of the donor’s choice
  • Installment sale to grantor trust:  a sale of appreciating property without immediate income tax consequences, with low interest rates and principal repayment in the future
  • Intra-family loan (including refinancing of a prior loan):  giving family members the benefit of lower interest rates than those available from commercial lenders

Because these leveraged techniques will be far more powerful while interest rates remain low, now is the time to put these techniques to work for you.

Converting to Roth IRA with Charitable Deduction to Offset the Tax

Starting with 2010, the income ceiling for conversions of regular IRAs to Roth IRAs was eliminated.  Conversion of a regular IRA to a Roth IRA in 2010 or 2011 can provide a substantial benefit for certain individuals, in particular those with sufficient liquid assets outside of the IRA to pay the tax.  Conversions in 2010 are generally more favorable than those postponed to 2011, both for a lower tax rate (under current law) and for the option to spread the additional taxable income over two years (2011 and 2012).

The tax burden of a Roth IRA conversion can be further reduced, or offset entirely, with substantial charitable gifts made this year.  Donors who have substantial charitable plans but do not wish to donate large amounts to independent charities in the current year could make substantial charitable gifts this year to a private foundation or donor-advised fund, from which those funds could be donated in turn to other charities over many years.  Private foundations and, to a lesser extent, donor-advised funds take some time to set up in time for gifts to be completed by year-end.  If this opportunity is of interest, donors should contact their advisors as soon as possible.

From 1990 through 2009, and again after 2010, high-income taxpayers (with $166,800 or more of adjusted gross income in 2009) lost up to the lesser of 3% of their AGI or 80% of their itemized deductions (including charitable deductions).  The temporary sunset (for 2010 only) of this reduction of itemized deductions will allow those high-income taxpayers to obtain a greater after-tax benefit from their 2010 charitable deductions.

To Reduce Tax Uncertainty, Plan Now, Execute in December

Some tax legislation in the 2010 post-election “lame duck” session cannot be ruled out, and the chances for tax legislation in early 2011 are even greater.  Unfortunately, the opportunities described in this Bulletin will generally have to be implemented by the end of 2010 to take full advantage of them.  Fortunately, the types of tax legislation that would most likely be passed in early 2011 will not remove the advantages of transactions completed in 2010.

Time for Action

Many of the opportunities described in this Bulletin have an absolute expiration date:  December 31, 2010.  Others may not be available much longer than that in this volatile economic and legislative environment.  Your advisors to identify the opportunities that are most relevant in your situation and implement them while the opportunities remain available.

FEDERAL TAX NOTICE:  Treasury Regulations require us to inform you that any federal tax advice contained herein (including in any attachments and enclosures) is not intended or written to be used, and cannot be used by any person or entity, for the purpose of avoiding penalties that may be imposed by the Internal Revenue Service.

© 2010 Vedder Price P.C.