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Estate Planning

The Unsettled State of Estate Planning in 2012

By Donald R. Tescher

The Tax Follies continue in Washington. You may recall that it took Congress 11-1/2 months into 2010 to pass tax legislation regarding gift and estate taxation after the estate tax had expired on December 31, 2009. As a result, the carryover basis regime with no estate tax was visited upon those unfortunate individuals who were fortunate to have died between January 1 and December 16, 2010.

On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Tax Relief Act”). The 2010 Tax Relief Act extended the Bush era tax cuts that were set to expire on December 31, 2010, through December 31, 2012. In addition, the 2010 Tax Relief Act capped the federal gift, estate and generation-skipping transfer (“GST”) tax rates at 35 percent and gave taxpayers a $5,120,000 federal estate, gift and GST tax exemption for 2012 (reduced by any prior taxable gifts). Given the uncertainty in today’s political arena, we do not know what the future holds for estate and gift tax laws for 2013 and beyond. If Congress does not address these tax laws in the near future, on January 1, 2013 the federal estate, gift and GST tax exemption will return to $1 million (GST will be indexed for inflation) with a top marginal estate, gift and GST tax rate of 55 percent. In addition, there is proposed legislation that would eliminate existing tax savings techniques such as short-term Grantor Retained Annuity Trusts, valuation discounts for closely held family entities, and favorable tax treatment for intentionally defective grantor trusts.

Coupled with the expiring income tax rate structure, including the favorable treatment of qualified dividends and capital gains, and the additional taxes imposed next year under the Affordable Care Act, taxpayers are facing continued tax uncertainty in what remains a politically charged environment.

Gifts to Heirs in Trust. The easiest planning for those persons who can afford to part with assets and their income is to make taxable gifts to utilize their unused gift tax exemptions. The prevailing view is that the $5,120,000 gift tax exemption will not survive past 2012. A couple who have not used any of their gift tax exemptions can make taxable gifts of up to $10,240,000 to their heirs. If these gifts are made to multi-generational (“dynasty”) trusts and GST exemptions are allocated to the gifts, the assets in these trusts, for as long as they remain in the trusts, will avoid estate and GST taxes in future generations.

Non-Reciprocal Spousal Trusts. In those situations where a married couple is unwilling or unable to part with the access to the income or the assets, each can create irrevocable trusts for the benefit of the spouse (and may also include their descendants as discretionary beneficiaries). Under this arrangement, the income and principal of the trusts remains available to the family. There is potential tax risk in this planning technique based upon a concept referred to as the reciprocal trust doctrine that would negate the planning if successfully asserted by the IRS. In order to avoid its application, the trust terms must be sufficiently different so as to be non-reciprocal and it is recommended that they not be created simultaneously. On the theory that a half of a loaf is better than no loaf, in many circumstances it may be better to have only one spouse create an irrevocable spousal trust and only utilize half of the couple’s available exemption.

Marital Gift Trust. Those couples who do not feel comfortable parting with their wealth and need the continued income from the assets could forgo utilizing their gift tax exemptions and instead create marital trusts for each other. The assets of their trusts remain includible in their federal gross estates, but they can have total control over the income and principal of their trust. While this will not result in an estate tax savings in their estates, by making the trusts dynasty trusts and allocating their GST exemptions to these trusts, it will shelter the assets for as long as they remain in trust from estate and GST taxes in future generations.

Grantor Retained Annuity Trusts (“GRAT”) and Valuation Discounts. The GRAT involves an irrevocable gift transfer in trust with the donor retaining an annual annuity for a term of years. The annuity is typically structured to nearly equal the current fair market value of the transferred property, thereby virtually eliminating a taxable gift. To the extent that the transferred assets outperform the IRS hurdle rate (currently at its lowest ever), any growth in excess of the initial fair market value plus the IRS 7520 rate will pass free of transfer taxes to the remainder beneficiaries of the GRAT. If the legislative proposals effecting GRATs were enacted, which would require a minimum term of 10 years, a maximum term equal to the donor’s life expectancy, and requiring that at inception the remainder interest subject to gift tax be some minimum percentage of the initial value, the future viability of GRATs as an effective planning vehicle would be curtailed significantly.

Frequently, the GRAT technique (as well as other estate planning techniques) is coupled with the use of entities such as limited partnerships and limited liability companies and gift transfers of fractional interests in the entities. These interests are highly susceptible to the application of valuation discounts in arriving at the fair market value of the gifted interest. By minimizing the value of the gift, the donor is able to obtain greater leverage in the use of his or her gift tax exemption or maximize the amount ultimately passing tax free at the end of a GRAT term. If the proposed legislation, which would eliminate the application of certain restrictions in determining the fair market value of certain closely held family entities, were to be enacted, those planning techniques that utilize the transfer of assets subject to valuation discounts will be adversely effected.

What to do. If you have not yet reviewed your estate plan in light of the current uncertainties in the tax system, you need to do so as soon as possible as the window of opportunity to take advantage of planning techniques that could result in very significant tax savings for your family is rapidly closing.

Donald R. Tescher is a shareholder in Tescher & Spallina, P.A., with offices in Boca Raton. He is a graduate of the University of Florida School of Business with a degree in accounting. He is also a graduate of the University of Florida College of Law and holds an LL.M. degree in taxation from New York University. He is a past chairman of the Tax Section of The Florida Bar and recipient of the Gerald T. Hart Outstanding Florida Tax Lawyer Award. He is a fellow of the American College of Tax Counsel and a member of the Business Planning, Asset Protection Planning and Estate and Gift Tax committees of the American College of Trust and Estate Counsel. He has served as adjunct professor at the University of Miami School of Law Graduate Tax Program. He is a member of the Directors’ Committee of The Florida Bar Tax Section, the Executive Council and Trust Law Committee of The Florida Bar Real Property, Probate and Trust Law Section, and member of various committees of the Tax and Real Property Sections of the American Bar Association. His practice is limited to representation of high net worth individuals and families in connection with their business, tax, estate planning, post-mortem planning and trust administration, charitable planning and expert witness and mediator.

South Florida Legal Guide 2012 Financial Edition

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