President Obama's proposed budget for 2013 adds further urgency to high-net-worth individuals to make gifts in 2012 before the exemption decreases.
Exemption and rates
President Obama's proposed budget for 2013 (issued on Feb. 13, 2012) would permanently restore the estate tax rates that were in effect in 2009 – a $3.5 million exemption with a top tax rate of 45 percent.
Perhaps more importantly, the gift tax exemption would be reduced to $1 million, bringing an end to the unification of the gift and estate tax exemptions. These proposed changes add further urgency to high-net-worth individuals to make gifts in 2012 before the exemption decreases.
Under the Tax Relief Act of 2010, a deceased spouse's unused estate tax exemption can be transferred to the surviving spouse. This is commonly referred to as portability. The provision allowing portability is in effect through 2012. The president proposes to make portability permanent.
In a major rewrite of the estate tax provisions, any individual who is taxed as the owner of a trust (for income tax purposes) will have to include the trust assets in his/her gross estate for federal estate tax purposes. And, distributions from such grantor trusts to beneficiaries during the grantor's lifetime would be subject to gift tax.
These rules would apply to trusts created on or after the enactment date and with regard to any contributions made after the enactment date to grandfathered trusts.
Although the proposal appears to be targeting installment sales to intentionally-defective grantor trusts, the implications are far greater. For example, most irrevocable life insurance trusts are grantor trusts under IRC Section 677(a)(3) (because trust income can be used to pay premiums on a policy insuring the life of the grantor or the grantor's spouse); or under IRC Section 677(a)(1) and (2) (because trust income may be distributed to the grantor's spouse without the consent of an adverse party). Thus, if enacted, the proposal could result in the proceeds in an ILIT being subject to estate taxes.
Dynasty trusts are also under attack. Under the president's proposal, the generation-skipping tax exemption would be limited to 90 years. Thus, distributions from trusts established in states that allow trusts to continue in perpetuity (like Michigan) or for a very long time (like Florida) would be subject to generation-skipping taxes after 90 years. Trusts created before the enactment date of this proposal would be grandfathered.
Two-year, zeroed-out grantor retained annuity trusts have become one of the most popular wealth transfer planning techniques in recent years due to the low Section 7520 hurdle rate (1.08 percent for March 2012). The president's proposal would do away with zeroed-out GRATs by requiring a GRAT to have a minimum term of 10 years. This change would greatly accentuate the mortality risk of using a GRAT.
Valuation discounts obtained through the use of family limited partnerships and family limited liability companies allow donors to leverage their $13,000 annual gift tax exclusion and $5.12 million gift tax exemption. Although lacking in details, the president's proposal would scale back the use of such discounts retroactively to Oct. 8, 1990 (the effective date of IRC Section 2704).
THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.