Wealth Transfer Tax Update
As we reported in our December 2009 Trusts and Estates Update, for the year 2010 only, the federal estate and generation-skipping transfer (GST) taxes have been repealed, the gift tax rate has dropped from 45% to 35%, and carryover basis rules have replaced basis "step up" rules for inherited assets. That Congress would not act before the end of 2009 to prevent these temporary rules from coming into effect was the first unexpected event. We have now arrived at a second unexpected event (or nonevent): we are more than halfway through the year and Congress does not appear to be any closer to passing legislation to settle the myriad issues that have been created by the temporary 2010 rules than it was at the beginning of the year. Moreover, we are marching closer to the scheduled January 1, 2011 automatic reinstatement of the estate and GST tax with an exemption amount of only $1,000,000 (down from a $3,500,000 exemption in 2009), and a return to a top estate, gift and GST tax rate of 55% (with an additional 5% surtax on certain large estates).
In our December 2009 Update, we mentioned the possibility that Congress might pass legislation reinstating the 2009 estate, gift and GST tax law retroactively to January 1, 2010. Although retroactivity remains a possibility (and some lawmakers have said so), we believe that it is much less likely now that we are so far into the year and becomes even less likely as the year goes on, since such a move would undoubtedly result in litigation which might take years to resolve.
Planning Opportunities in 2010
As a result of the diminishing likelihood of retroactivity, we thought this would be a good time to remind our clients and friends of some of the planning opportunities that may be considered while the law is still in a state of flux.
Gifts Taxed at Lower Rate. Since the gift tax rate is currently 35% (down from 45% in 2009 and scheduled to increase to 55% in 2011 if Congress fails to pass legislation by the end of this year), some clients may want to consider making lifetime taxable gifts and taking advantage of the lower rate. Generally, making lifetime gifts is more efficient from a wealth transfer tax perspective than bequeathing assets at death because the appreciation in the value of the gifted asset from the date of the gift to the date of death escapes gift and estate tax, and the money that is used to pay the gift tax when the gift is made will not itself be subject to gift or estate tax. In contrast, if the assets were held until death, estate tax would be imposed on that appreciation and on the money that is used to pay the estate tax.
The temporary lower gift tax rate that is currently in effect provides even more incentive for clients who are inclined to make a taxable gift to do so before the rate increases. This would include, for example, clients who have used all or nearly all of their $1,000,000 gift tax exemption and were considering making further gifts during their lifetime and clients who have not used their exemption but were considering making a sizeable gift in excess of the $1,000,000 exemption. Again, the possibility of a retroactive increase of the rate still exists, but if a client was inclined to make a taxable gift anyway (even at the higher 45% rate), it would seem there would be nothing to lose. If a client is inclined to make a taxable gift only at the lower 35% rate, then a gift now would be riskier and take more consideration given the possibility of a retroactive increase of the rate. Again, we believe that likelihood diminishes with each passing day.
No Generation-Skipping Transfer Tax on Distributions to Grandchildren and More Remote Descendants. Since the GST tax is repealed for 2010, trusts that would otherwise be subject to GST tax may have a limited opportunity to make distributions to the Grantor's grandchildren and more remote descendants (great-grandchildren, etc.) and thereby avoid the tax (assuming, of course, that such distributions are permitted under the trust agreement and make sense economically given the needs of other beneficiaries). We wanted to remind trustees of non-GST-exempt trusts of this potential planning opportunity, which can have enormous benefit in the right situation. For example, if an existing trust permits discretionary distributions to the grantor's descendants and no GST exemption was allocated to the trust (perhaps because it was originally thought that the trust would be for the primary benefit of the children rather than the grandchildren), but the children are now in a financial position where they do not need the funds (or do not need all of the funds), the trustee may consider making a distribution to grandchildren now, without any imposition of the GST tax. Again, the possibility of retroactivity is the risk - retroactive reinstatement of the GST tax would (subject to potential challenge in court by the trustees) make the distributions taxable.
No News Is Not Necessarily Good News. We were hopeful that Congress would have acted earlier in the year to clarify the laws that apply to 2010 and thereafter. Some lawmakers have recently suggested that they are open to the idea of giving estates of decedents who died in 2010 an option of choosing which law will apply to the estate - either the law as it existed at the time of death or the law that Congress ultimately passes. Not surprisingly, some lawmakers do not support that idea. Since the estate tax is such a controversial issue, it is possible that lawmakers may not want to act until after the November elections. At that late point in the year, it may prove difficult to agree upon and pass legislation by year-end. That would result in yet another unexpected event: an automatic return to a 55% top wealth transfer tax rate (and additional 5% surtax on certain large estates) and a $1,000,000 estate and GST tax exemption. While we do not expect that to happen, the current state of the law was not expected to happen either, so hopefully Congress will act soon. One lawmaker has recently said "We know we have to do something." The only questions that remain (as they did at the start of the year) are what that something will be and when. We will keep you apprised of developments in this area.