As we enter the final quarter of 2010, Congress still has failed to pass any changes to the estate, gift and generation skipping transfer tax laws. Congress has presented more than two dozen proposed changes to these laws, but none have gained sufficient support. During this unrest, it has become more apparent that Congress may not have time or be able to make changes on a retroactive basis. This may provide us with beneficial planning opportunities for a limited time.
As a reminder, the following is a summary of the laws currently in effect for this year and next year.
Estate Tax – There currently is no estate tax. Absent further action, the estate tax will return in 2011 with rates as high as 55% on estates that exceed $1 million. This will represent an increase over the 45% tax rate on estates that exceeded $3.5 million that had applied in 2009. Absent further action, the prior 5% surtax for estate, gift and generation skipping transfer tax purposes will be assessed on transfers between $10 million and $17.184 million.
Gift Tax – The gift tax currently remains. The gift tax annual exclusion ($13,000) and lifetime exemption ($1 million) amounts have not changed this year. However, lifetime gifts in excess of the lifetime exemption amount are now taxed at a 35% gift tax rate (whereas they had been taxed at a 45% gift tax rate in 2009). Absent further action, the gift tax rate will be as high as 55% on gifts that exceed the $1 million lifetime exemption amount.
Generation Skipping Transfer (“GST”) Tax – There currently is no GST tax. Absent further action, the GST tax will return in 2011 with rates as high as 55% on estates that exceed an inflation adjusted value of $1 million (likely to be $1.35 million). This will represent an increase over the 45% rate on estates that exceeded $3.5 million that had applied in 2009.
Planning Opportunities – Current lower gift tax rates, the lack of the GST tax and the likely return of the estate tax and the GST tax all encourage consideration of the following planning opportunities by year end.
Making Taxable Gifts – As noted above, the current gift tax rate is 35%. If Congress would propose a return to the laws in effect during 2009, the gift tax rate would be 45%. If Congress would not act by 2011, the gift tax rate would be 55%. The historically low gift tax rates this year provide a prime opportunity to consider making taxable gifts and paying any corresponding gift tax at the currently low 35% rate.
Making Taxable Gifts to Grandchildren – When the GST tax law was in effect, it discouraged certain gifts to grandchildren by triggering payment of this additional tax. Since the GST tax is not in effect this year, this may be the perfect time to make gifts to grandchildren and pay only the corresponding gift tax at the currently low 35% rate.
Making Distributions from Certain GST Trusts – Some existing trusts have been funded to maintain a portion that would not be subject to GST tax and another portion that would be subject to GST tax in the future. These latter trusts are typically referred to as “Non-Exempt GST Trusts”. A GST tax would be due at the time when all child beneficiaries have died or when assets would be distributed to any grandchild beneficiary. Since the GST tax is not in effect this year, this may be the perfect time to make distributions from Non-Exempt GST Trusts to grandchildren to minimize the negative effect of the GST tax on Non-Exempt GST Trusts when it returns.
Congress also has introduced legislation to eliminate successful estate planning techniques. Until such legislation passes, we may have a final opportunity to use these beneficial techniques for a limited time.
Family Limited Partnership (“FLP”) – This type of entity enables families to pool assets for investment purposes and to protect family members from a variety of creditors, including potential former spouses in the event of a divorce. Some family members have benefitted from a by-product of this planning by making discounted gifts of FLP interests to other family members. Congress has proposed to eliminate such discounted gifts, and a court case from earlier this year has held that such transfers may not qualify as gifts of a present interest to which the gift tax annual exclusion would apply. Caution therefore must be exercised in connection with this gift planning and we may have a limited window to use FLP planning to promote discounted gifts. Clients with existing FLPs should review their gift plans and current operations in light of this developing law.
Grantor Retained Annuity Trust (“GRAT”) – This type of trust enables a parent to transfer property (preferably highly appreciating assets that generate significant income) to a trust under which the parent retains the right to receive an annuity payment for a term of years based on the value of the contributed asset. If the parent survives the annuity term, the remaining assets will benefit other family members thereafter.
The initial gift when funding a GRAT equals the difference between the fair market value of the assets gifted and the actuarial value of the annuity retained by the parent. Under current law, this gift can be structured to be almost zero. Congress has proposed to eliminate the planning structure which produces such “zeroed-out GRATs”.
For a GRAT to succeed, the parent must survive the GRAT term. Furthermore, GRATs perform best when assets grow and produce income at a higher rate than the required annuity payment. Current low asset values and low interest rates provide the greatest opportunities to clear this hurdle. With Congress poised to eliminate the structuring benefits associated with zeroed-out GRATs, now may be the perfect time to act.
Other Planning Opportunities – Federal interest rates have reached their lowest point since last summer. While interest rates remain low, family members should consider restructuring family loans, creating charitable trusts for the ultimate benefit of other family members and selling appreciating assets to their family or to trusts for their benefit. These other planning opportunities all take advantage of the spread between interest rates relative to asset value and the ability to shift wealth to future generations. Although there currently is no estate tax this year, we expect it to return by next year and continue to encourage such planning by our clients.
Please don’t hesitate to call us to discuss these planning opportunities further.