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Many important aspects of estate planning won’t change: choosing executors, passing on a business, planning the timing and manner of inheritance. The tax code, however, changes nearly every year, if not more often. Important changes affecting 2010 year-end tax planning include provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), set to expire in 2011.
What is likely to change in 2011? How can you adapt? Here’s a look at changes to estate, gift and generation-skipping transfer taxes, and how low interest rates affect such planning.
If tax rates rise as expected, it may be better to delay charitable gifts until next year. Higher-income taxpayers will likely see an increase in ordinary income tax rates to 39.6% from 35%, and long-term capital gains rates rise from 15% to 20%. For a
A further complication is that in 2011, donors with adjusted gross income (AGI) over
Charitable remainder trusts (CRTs) are somewhat downtrodden this year due to historically low tax and interest rates. Expect increased use of CRTs in coming years, as capital gains tax and interest rates rise.
Charitable lead trusts (CLTs), the lesser-known cousin of the CRT, are more advantageous than ever because their benefit rises as interest rates decrease. September 2010’s Section 7520 rate is only 2.4%. That compares with a low of 5.4% in the 1990s. Gifts to CLTs make annual payments to charities, and family members (or trusts) receive any funds left over at the end of the trust term. Like the better-known grantor-retained annuity trust (GRAT), these perform well if the investment returns exceed the Section 7520 rate. CLTs fit clients with taxable estates who make substantial charitable gifts every year anyway.
This year there are several strategies that can help reduce the amount of tax to be paid on non-charitable gifts.
Gift-tax rates are due to increase from 35% in 2010 to a top rate of 55% next year. This gives wealthy families a unique opportunity to pass wealth at much lower rates in 2010. It’s important to realize that gift-tax rates, even when ostensibly the same as estate-tax rates, are actually much lower due to the difference in how they are calculated.
For instance, if you decide you can part with
However, one would be foolish to pay gift taxes this year without hedging against the possibility of dying before year-end. Imagine the family learning that you advised making a taxable gift and incurring a
There are several solutions to this dilemma. One could simply transfer the stocks, bonds or other assets to a revocable trust that becomes irrevocable if the donor is still living on
This may be combined with a net gift agreement to achieve even greater tax savings. Basically, a net gift is an agreement between a donor and recipient that the recipient, not the donor, will pay the gift tax. To use the numbers in the example above, the donor would gift
A simple and overlooked transfer technique is an intrafamily loan. Loans should bear an interest rate of at least the applicable federal rates, now at all-time lows. Rates for
A GRAT exploits low interest rates (although it must use 120% of the mid-term rate, called a Section 7520 rate). Like the sale and loan to a defective grantor trust technique, it adds greater leverage and control over the assets than a simple loan. The value lies in achieving asset returns greater than this “hurdle.” Unlike the sale to grantor trust technique, it has specific statutory guidance and certainty, and does not require any seed gift money. Thus it’s ideal for those who have used up their
Taxpayers shouldn’t wait to set these up-the Obama administration has proposed amending GRAT safe harbors to require at least a 10% gift and a 10-year term, which would decrease their attractiveness. If GRATs are now “heads I win, tails I don’t lose,” then the new congressional proposals seek to control how often you can flip the coin and ensure that the house gets a take on each flip.
Alternatively, gifting limited liability company (LLC) or limited partnership (LP) interests are still viable ways to control gifts and achieve better leverage through discounts. However, two issues warrant some additional caution this year.
Recent court cases (Hackl, Price, Fisher) have denied the annual exclusion (now
Another potential problem that is rarely discussed is the potential for later application of generation-skipping transfer tax (GST) to gifts of LLC/LP interests to skip persons. GST regulations encompass transfers to any arrangement that has substantially the same effect as a trust. With the
However, most annual exclusion gifts are made in cash, not with LLC/LP interests. The
And don’t forget that the
Outside of gifting, while the increasing use of Roth conversions in 2010 is mostly an income tax play, it has estate planning implications. The beneficiary designation should be reviewed and many trusts named as beneficiary may be ill-suited for the change in IRA assets payable to them. Roth conversions make the asset protection and “stretch” planning for beneficiaries all the more important. In light of recent asset protection cases, a trust or trusteed IRA is recommended to protect larger IRAs for beneficiaries.
Once we emerge from the wonderland of no estate/GST tax in 2010, what are some immediate concerns?
Protection for spouses. If the estate-tax exclusion truly reverts to
Apportionment and liquidity. Planning for the second death and/or for single taxpayers will require more careful consideration of tax apportionment in 2011. Liquidity analysis becomes more important too-who will pay the tax and where will the cash come from that is needed to pay it? Insurance may be part of this solution.
Business planning. For business succession and buy-sell agreements, is the planned-for liquidity based on a
GST allocations. EGTRRA established some default GST allocation rules for gifts to irrevocable trusts which offered some protection for taxpayers failing to file a Form 709 Gift Tax Return and allocate GST. Because these deemed allocation rules expire next year, and late allocations may also be in order for 2010 gifts, advisors should make sure their client’s tax preparer is on top of this important issue.
For the wealthy, exploiting 2010’s lower gift-tax rate, zeroed-out GRATs and low interest rates may be a very short-term window of opportunity. For the middle class, annual exclusion gifting and basic trust planning is still too-often overlooked.
Now more than ever, collaborative planning between financial advisors, and legal and tax counsel, is crucial to effective planning. Clients have been reticent to pay attorneys for needed amendments to planning due to frustration with nonsensical congressional policies and inaction. Meanwhile new accounts, financial products, beneficiary designations and other circumstances have changed.
For more information on taxes, visit bankinvestmentconsultant.com