Gift/ Estate Tax Planning After the “2012” Tax Act And Creative GRAT Structures Denver Estate Planning Council March 21, 2013 David A. Handler, Esq. Kirkland & Ellis LLP 300 North LaSalle Chicago, Illinois 60654 312-862-2477 601 Lexington Avenue New York, New York 10022 david.handler@kirkland.com 1
GIFT AND ESTATE TAX PLANNING AFTER THE “2012” TAX ACT A. History of Gift and Estate Tax Rules Until 1998, the gift and estate tax exemption (also known a s the “unified credit”) had been stuck at $600,000. The 1997 Taxpayer Relief Act (the “1997 Act”) scheduled increases to the unified credit, and would gradually raise it to $1,000,000 in 2006. Further, the marginal tax rates applicable to gifts and estates started at 18 percent and went up to 55 percent for aggregate transfers exceeding $3,000,000. When the Economic Growth and Tax Relief Reconciliation Act of 2001 (the “2001 Act”) was enacted, the gift tax exemption was immediately increased to $1,000,000, and the estate and GST tax exemptions were set to gradually increase to $3,500,000 in 2009. At that time, the gift, estate and GST exemptions were no longer unified. The estate and GST exemptions were unified and would increase together, but the gift tax exemption remained fixed at $1,000,000. Thus, one could leave more at death than could be given away free of tax during life. The 2001 Act also reduced the maximum gift/estate/GST tax rate to 50 percent in 2002 and thereafter reduced the rate by an additional 1 percent per year until 2007, at which time the maximum tax rate remained at 45 percent through 2009. In 2010, the estate tax and GST tax (but not the gift tax) no longer applied, except in the case of qualified domestic trusts. A few unfortunate souls (with lucky heirs) paid no estate tax in 2010. However, the 2001 Act was set to expire in full at the end of 2010, reverting back to pre-2001 law. In December 2010, the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Tax Act”) reinstated the estate tax beginning in 2011, but at a 35 percent rate and with a $5,000,000 unified gift, estate and GST tax exemption, indexed for inflation ($5,120,000 in 2012). Thus, the estate tax exemption over time has been: Year Exemption 2002 $1,000,000 2003 $1,000,000 2004 $1,500,000 2005 $1,500,000 2006 $2,000,000 2007 $2,000,000 2008 $2,000,000 2009 $3,500,000 2010 no estate tax 2011 $5,000,000 2012 $5,120,000 However, the 2010 Tax Act was set to expire on January 1, 2013. Absent Congressional action, the estate tax regime existing immediately prior to the enactment of the 2001 Act would be resurrected: $1,000,000 exemptions and a 55% top marginal rate. B. American Taxpayer Relief Act of 2012 2
On January 1, 2013, Congress passed the "American Taxpayer Relief Act of 2012" (the “2012 Act”), just after the nation went over the “fiscal cliff.” The 2012 Act repealed the sunset provisions of the 2001 and 2010 tax acts (repealed the repeal?), making permanent tax laws that have been in effect for the last decade, with some modifications. Importantly, the 2012 Act is “permanent” (as much as any law can be permanent), and is not set to expire in two or ten years. These are laws with which we can plan. The 2012 Act does the following: 1. Exemptions Unified: The 2012 Act keeps the gift, estate and generation-skipping transfer (GST) exemptions unified at $5,000,000, indexed for inflation from 2011. The inflation adjustment is results in a unified exemption of $5,250,000 for 2013, up from $5,120,000 in 2012. 2. Tax Rates: The 2012 Act permanently increased the top gift and estate tax rates from 35% to 40% (which is a net decrease compared to 2009’s 45% rate). Since the GST tax rate is the highest marginal estate tax rate, the GST tax rate also increased to 40%. 3. Portability : The 2012 Act makes “portability” permanent. This was created as part of the 2010 Act, and allows the estate of the first spouse to die to transfer his or her unused estate tax exemption to his or her surviving spouse. This is useful if (a) the deceased spouse did not have enough assets to use up his/her exemption or (b) the deceased spouse left his/her estate directly to the surviving spouse rather than a bypass trust to utilize the estate tax exemption. The portability provision applies beginning in 2011, and the other provisions apply to estates of decedents dying, generation-skipping transfers, and gifts made after December 31, 2012. The 2001 Act made several other important changes, which were set to expire on December 31, 2012, but are now a permanent part of the law: • The limited deduction for a “qualified family owned business” (QFOB), and all its complications, is gone. It was repealed by the 2001 Act, but set to be reinstated in 2013 when the 2010 Tax Act expired. • Qualified severances: These allow a partially GST exempt trust to be split into two trusts, one fully exempt and one non-exempt. • Automatic GST allocation rules and GST trust elections: These rules automatically allocate GST exemption to trusts that are likely to pass multiple generations, and allow elections to automatically allocate (or not allocate) GST exemption to trusts. In many respects, these rules have proved more confusing than helpful, but they are here to stay. • State estate taxes remain a deduction rather than a credit. This means less revenue for the states, more for the U.S. Treasury, and higher overall taxes in states that impose an estate/inheritance tax. • Expansion of conservation easement rules for estate tax deductions: Geographic limitations removed as long as the property is located in the US or a US possession. 3
• Number of allowable shareholders or partners for Section 6166 purposes increased from 15 to 45. In order to be a closely held business for Section 6166 purposes, either 20% of partnership capital or voting stock of a corporation must be included in estate, or the entity must have 45 or fewer partners/shareholders. C. Impact of Tax Act on Estate Planning First, the gift, estate and GST exemptions are now indexed for inflation. In 2013, they are $5,250,000. If inflation is a modest 2%, in 20 years the exemptions will be $7.65 million. At 3% inflation they will be $9.2 million, at 4% inflation they will be $11.06 million, and at 5% they will be $13.26 million. Of course, these amounts are double for married couple. In other words, 20 years from now the combined exemptions for a married couple will be $15 million- $26 million! Additional gifts can be made every year . Not only will we remind our clients to make their annual exclusion gifts (which have increased to $14,000 per donee this year), but also their increased gift exemptions. If inflation is just 2% this year, the combined gift exemptions of a married couple will increase by over $200,000 next year! A married couple with 3 children and 7 grandchildren could make $280,000 of annual exclusion gifts, and another $200,000-$400,000 per year of gifts using their increased gift exemptions, depending on the inflation rate. O ther transactions (such as sales for notes) can be done on a larger scale. The “10 to 1” rule of thumb for sales to grantor trusts will be a non-issue for most clients. Despite the “portability” rules, we will still recommend our clients use credit shelter trusts as part of their estate plan. This is because: (1) unused GST exemption is not portable; (2) the trust provides protection against creditors; and (3) the income and appreciation of the trust assets escapes estate tax. The 2012 Act did not address other items that have been on the current and prior administrations’ radars, such as: The duration of GRATs: 10 year minimum? Required minimum gift? The duration of GST exempt dynasty trusts: Adding a limit for estate/GST tax purposes? Valuation discounts applicable to gifts of interests in family limited partnerships or other entities: Eliminating or limiting discounts? Changing the rules surrounding grantor trusts. D. Conclusions With high (and increasing) gift tax exemptions, low interest rates, and the continued ability to use grantor trusts, GRATs, and discounted FLPs, the opportunity and ability to transfer wealth has never been greater. Any of these doors can be closed by new legislation at any time. It is our job to advise clients to take advantage of these opportunities. 4
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