How will the approaching expiration of estate and gift tax provisions of the 2010 Tax Relief Act impact your clients? Can one structure an irrevocable life insurance trust as a non-grantor trust? What role can side funds play in fixing life insurance-funded split-dollar or private premium financing arrangements that were established without an exit strategy?
Lawrence Brody, a partner at the St. Louis, Mo.-based law firm Bryan Cave LLP, provided answers to these questions, among many others focused on wealth transfer planning, during the opening generation session, “What’s Hot, What’s Not—2012 Edition,” of LIMRA’s Advanced Sales Forum, held in Chicago August 6-7.
Following the 2010 Law to 2013
Much of the talk by Brody—who co-presented the session with Thomas Commito, a vice president of Sales Concepts at Lincoln Financial Distributors, Radnor, Pa.—dealt with wealth transfer planning considerations in 2012 of the 2010 Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010; and of the Obama’s Administration’s 2013 budget proposal.
A top concern of advisors is the effect of the 2013 proposal on irrevocable life insurance trusts, a standard tool of financial planners for shielding policy proceeds from estate tax and for paying estate taxes assessed on other assets. The budget proposal would, if adopted, change the estate tax treatment of grantor trusts by coordinating income and transfer tax rules applicable to these trusts.
The lack of coordination under the current tax regime, said Brody, lets individuals transfer “significant wealth” without transfer tax consequences.
Brody highlighted tax implications of cases where income tax rules treat a trust creator (“grantor” or “settlor”) as the trust’s owner for income tax purposes. Trust assets would, for example, be includable in the gross estate of the settlor for estate tax purposes. And a gift tax would be imposed on trust distributions to a beneficiary during the settlor’s life. Brody noted that nearly every life insurance trust is a grantor trust under the Internal Revenue Code, which directs ILIT trustees to use the trust’s income to pay premiums.
“If the 2013 proposal were adopted, we’d have to change the way we create irrevocable life insurance trusts, many of which are intentionally created as grantor trusts,” said Brody. “Clients who establish ILITs would have a tough time keeping the trust out of their taxable estate.”
“There’s only way to do it: You have to stipulate that trust income to pay premiums is discretionary—not required,” he added. “And payments could only be done by the trustee with the consent of the beneficiary. That’s the only way I can think of to make an ILIT not a grantor trust.”
One bit of good news, Brody continued, is that the proposal would be prospective, affecting only trusts created after the proposal’s enactment. One exception to the prospective rule: pre-existing trusts that are later integrated with a new ILIT.
Turning to charitable gifting, Brody noted that clients who haven’t used their lifetime gift tax exemptions can make gifts up to $5,120,000 through the end of 2012 without incurring gift tax; the federal estate, gift and generation-skipping transfer (GST) tax exemption thereafter returns to $1 million, as per the pre-2001 tax regime.
Clients who have previously used their full $1 million gift tax exemption, or have exceeded their gift exemption and paid gift tax, can therefore make an addition $4,120,000 gift in 2012. (In 2011, the gift tax exemption was $4 million.)
Next page: Claw-back: Your worst nightmare?
Brody noted, however, that gifts in 2011 and 2012 exceeding the reinstated $1 million exemption could potentially be “clawed back” into a client’s estate in 2013, making the excess gifts subject to estate tax.
But he also pointed out that Congress may not have intended to impose such a claw-back; and that claw-back likely would “sunset” (expire) in 2013. The reason: The 2010 Tax Relief Act providing for the increased gift tax exemption treats the earlier 2001 tax act (EGTRRA), upon expiration, as if it never were enacted.
The sunset provision aside, Brody noted that, with a few exceptions, only the difference between available exemptions would be clawed back. Any appreciation on, and income derived from, a gift would not be subject gift tax. Additionally, claw-back doesn’t apply to a client’s lifetime use of the GST tax exemption—hence the value of allocating the increased gift tax exemption to an inter-generational or dynasty trust.
“I don’t think you can get hurt very badly even if the claw-back stays in force,” said Brody. “In most cases, all that happens is there is a recalculation at death as to how much of your money you gave away.”