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Budget proposal targets estate planning tools

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Estate planners should take note that the administration’s budget plan is soon expected to take aim at some of their most effective planning tools. Though the American Taxpayer Relief Act (ATRA) provided some certainty in the tax code, much remains in the political battle over government spending and revenue generation. Many of these estate planning tools have survived budget battles in the past, but today’s generous estate tax exemption makes them a much more likely target for 2013. Here is what you need to know to keep your clients’ planning strategies on the right page.

Grantor retained annuity trusts

A grantor retained annuity trust (GRAT) allows a client to transfer assets into a trust from which it retains an income interest that is received as an annuity payment. The trust assets are then distributed to the beneficiaries at the end of the trust term. Typically, a GRAT is set up for a relatively short term — sometimes as little as two or three years — and funded with assets that are likely to appreciate in value more quickly than the IRS-imposed interest rate applicable at the time.

This allows the client to minimize transfer taxes while passing wealth to beneficiaries. Gift tax is determined at the inception of the trust term, and any appreciated value is passed to the beneficiaries without further tax liability if the client is still alive at the end of the trust term.

Now, as in the past, this tax-savings technique has attracted the attention of the government, which is now proposing to require a minimum trust term of 10 years. This increases the possibility that the grantor will die during the trust term, which would require that the trust assets be included in his or her estate for estate tax purposes.

The proposal would also eliminate the possibility that the GRAT could be “zeroed out” — essentially requiring that some gift tax be paid when the trust is created.

Intentionally defective grantor trusts

The intentionally defective grantor trust (IDGT) is a grantor trust that is not treated as a separate entity for income tax purposes, but can serve to exclude the value of its assets from the client’s taxable estate. Because the client continues to pay the income taxes on the appreciated value of the trust assets (rather than the trust itself paying those taxes), more value can be transferred to beneficiaries outside of the client’s estate.

President Obama’s proposal would require that gift tax be paid upon any distribution from the IDGT and that any value remaining in the IDGT at the grantor’s death be included in the estate for estate tax purposes. Since the primary purpose of the IDGT is to maximize the transfer of wealth to a client’s beneficiaries while reducing the taxable estate, these proposals would largely eliminate the purpose of an IDGT strategy.

The GST tax-exempt dynasty trust

The dynasty trust is a type of irrevocable trust that uses the generous $5.25 million exemption from the generation skipping transfer (GST) tax to allow clients to pass wealth to future generations without subjecting the transfer to GST taxation. In some states, the rule against perpetuities serves to limit the duration of these trusts, but in states that have eliminated this rule, a dynasty trust can continue almost indefinitely.

The tax savings can be dramatic. By allocating a client’s lifetime GST tax exemption to trust assets, those assets can appreciate in value within the trust tax-free, passing income to current beneficiaries and allowing for withdrawal of the principal at some point in the future without transfer tax liability.

The administration proposal would limit this strategy by imposing transfer taxes after a dynasty trust has been in existence for 90 years. For some clients, the strategy will remain attractive, but those who had counted on the potentially indefinite duration of a dynasty trust should reexamine their estate plans to identify alternative solutions.


GRATs, IDGTs and dynasty trusts are only some of the tools that could be on the chopping block this spring. While nothing is certain, clients who are betting on these strategies must be kept current on administration proposals that could reduce or eliminate the benefit of their trust plans.

For more on estate planning, see:

10 estate planning tax facts you need to know

Estate planning in a post-fiscal cliff world

Twitter chat recap: Estate planning and the new estate tax law