“Status Of Transfer Taxes” by Thomas D. Peebles, Jr.

For the first time in nearly 12 years, we have a transfer tax system (estate, gift and generation skipping taxes) which is “permanent.” Since 2001, estate planners and their clients have endured temporary tax provisions with scheduled expiration dates. The American Taxpayer Relief Act of 2012, effective January 1, 2013, restored a sense of stability by enacting a permanent set of transfer tax rules to guide us in wealth transfer planning.
The law now provides for a permanent, indexed, exemption for estate, gift and GST taxes. The indexed exemption for 2013 is $5.25 million. A maximum tax of 40% is now imposed on transfers in excess of the indexed exemptions.The “portability” of exemptions between spouses is now a permanent feature of the estate and gift tax (but not GST tax) law.The permanence of these transfer tax provisions is welcome news for clients (and their advisors) and gives us the ability to make longer term wealth transfer decisions.
Although the “big picture” issues of exemptions, tax rates and portability appear to be settled for the time being, there are other transfer tax issues that have been proposed by the Administration and/or considered by Congress which may be included in future legislation. If enhanced tax revenues are to be considered in the ongoing attempt to reduce budget deficits, transfer taxes would seem to be an attractive target since the tax only impacts the top one-half of one percent of taxpayers. A review of two wealth transfer techniques currently utilized which may become targets for future legislation is instructive.
On April 10, 2013, the Obama Administration released its federal budget proposals for fiscal year 2014, which include recommended changes to the transfer tax system. Two of the key proposals, and their impact on current planning techniques are summarized as follows:
1. Require a Minimum Term of 10 years for GRATs
The use of short-term zeroed-out GRATs has been an extremely effective wealth transfer strategy, particularly in the last 5 years. A GRAT (Grantor Retained Annuity Trust) is an irrevocable trust funded with assets expected to grow in value, in which the Grantor retains an annuity interest for a term of years that the Grantor expects to survive. GRATs can currently be structured so that the Grantor’s annuity interest is essentially equal to the value of the assets transferred to the trust, so that no gift tax is imposed upon creation and funding of the trust (gift tax is “zeroed out”). At the end of the annuity term, the assets remaining in the trust after payment of the annuity to the Grantor are transferred to (or held in further trust for) the remainder beneficiaries, generally the children/grandchildren of the Grantor. If the trust assets appreciate in value during the GRAT term in excess of the amount required for the annuity payments, then the appreciated value is transferred to children/grandchildren transfer tax free. Particularly in these times of low interest rates, GRATs have proven to be an efficient technique for transferring wealth while minimizing (or avoiding) the gift tax cost of transfers, provided that the Grantor survives the GRAT term.
The Administration continues to propose that a GRAT have a minimum term of 10 years. This would prohibit the use of short-term GRATs (2 to 3 years) that have been widely used over the last several years and would increase the risk that the Grant or might die during the GRAT term and lose the anticipated transfer tax benefits. The Administration’s proposal would also require the remainder interest to have a value greater than zero at the time the interest is created, which would eliminate a true “zeroed out” GRAT for gift tax purposes.
Clearly, short-termzeroed-outGRATs are on the Administration’s target list. The good news is that these proposed new rules would apply to transfers to GRATs on or after the enactment date, so existing GRATs and GRATs created and funded before enactment would be unaffected.
2.Limit GST Exemption to 90 Years
The GST tax is imposed on gifts and bequests made to individuals who are two or more generations younger than the person making the transfer (“skip persons”). However, each person has a GST exemption which can be allocated to transfers made to skip persons or to trusts for skip persons (“GST Trusts”). Accordingly, it is possible to “skip” transfer taxes on amounts equal to the GST exemption (currently $5,250,000), plus all appreciation and income on that amount during the existence of a GST Trust.
At the time the GST provisions were first enacted, the law of most states included a common law Rule Against Perpetuities (RAP), or some statutory version of it, which prohibited trusts from continuing in perpetuity. The RAP limited, then, the amount of time thatGSTTrusts could exist and take advantage of the GST exemption. In recent years, many states (including Missouri) have repealed the RAP or lengthened the amount of time that assets can remain in trust. As a result, it is currently possible to create “Dynasty Trusts” which last in perpetuity and take advantage of the GST exemption forever.
The Administration’s proposal would severely restrict the use of “DynastyTrusts” by directing that a GST Trust would no longer be exempted from the GST tax after it has been in existence for 90 years. Again, the good news is that the proposal would apply to GSTTrusts created after enactment and to the portion of an existing trust attributable to an addition made after the date of enactment.
Planning Point: Clients considering the use of short-term zeroed-out GRATs and/or Dynasty Trusts are well advised to consider moving forward now with that planning so as to take advantage of current law and not be restricted if these Administration proposals are, in fact, enacted. If you have questions or wish to discuss those planning opportunities in more detail, please contact any member of the Estate Planning Practice Group.