Obama Budget Endangers Some Estate Planning Techniques

Loophole closure would severely reduce wealth planners’ arsenal

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The American Taxpayer Relief Act of 2012 left wealth planners’ estate planning tool chest largely intact, but the White House budget for 2013 and comments by congressional leaders strongly suggest their permanence is anything but assured.

In the aftermath of the Jan. 1 passage of ATRA, both Senate and House leaders said that the act was only a first step in righting the country’s fiscal house, intimating that rules made permanent by the act may indeed be temporary.

Meanwhile, President Barack Obama’s 2013 budget proposal would restrict certain estate planning techniques as a way to close “tax loopholes”; some of these proposals were under discussion long before enactment of ATRA.

ATRA left untouched grantor retained annuity trusts, which allow for the transfer of wealth while minimizing the gift tax cost of transfer. The administration’s proposal would impose severe restrictions.

In setting up a GRAT, a grantor funds an irrevocable trust with assets likely to appreciate in value, and retains an annuity interest for a number of years—sometimes as few as two years.

After that, if the grantor is still alive, the assets left in the trust are transferred to beneficiaries. The more the value of the assets held by the trust appreciates, the greater the transfer tax benefit the estate can claim.

The White House proposal would impose the requirement that a GRAT have a 10-year minimum term and a maximum term of life expectancy of the annuitant plus 10 years. “The administration’s proposal would require, in effect, some downside risk in the use of this technique,” said Jeff Marshall, a Pennsylvania tax lawyer.

In other words, the likelihood that the grantor could die during the term of the GRAT would increase, thereby undermining the estate and gift tax savings she sought.

AdvisorOne Special Report: 20 Days of Tax Planning Advice for 2013The proposal would also eliminate zeroed-out GRATs. Instead, the grantor would have to make a taxable gift when setting up the instrument.

ATRA made no changes in the step-up basis on inherited property. The recipient’s tax basis for inherited property is its fair market value at the date of the decedent’s death rather than the latter’s cost basis.

Under the president’s proposal, the value for estate and income tax purposes would have to be consistent. The property’s basis in the hands of the recipient would be no greater than its value as determined for estate or gift tax purposes.

The proposal would impose a reporting requirement on the estate’s executor and the lifetime gift’s donor to provide both the IRS and the recipient necessary valuation and basis information.

Grantor trusts allow grantors to make gifts to beneficiaries free of gift tax by paying the trust’s income tax liability. Assets placed in the trust are removed from the grantor’s estate. Future appreciation of the assets is not subject to estate or gift tax.

Under the president’s proposal, the benefit of the up-front income tax payment would be eliminated.

Dynasty trusts could also be reined in by the president’s proposal. Some states allow wealth to be transferred through multiple generations for many years or in perpetuity, with no estate, gift or generation-skipping transfer tax effects. These trusts can continue in perpetuity is a small handful of states, making them attractive venues for residents of other states to locate a multigenerational trust.

The president has proposed that the generation-skipping transfer tax exemption terminate at 90 years.

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