transfer taxes in transition: year end pitfalls and opportunities

Transfer Taxes in Transition: Year End Pitfalls and Opportunities

Co-Presenters:

Thomas E. Peckham, Esquire Partner, Bingham McCutchen LLP (Boston)

George L. Cushing, Esquire Partner, K&L Gates (Boston)

Moderator: Michael L. Brown, J.D., CPA President, Boston Financial Management

Transfer Taxes in Transition

What is Going On with the Federal Estate Tax Gift Tax Generation-Skipping Transfer Tax Income Tax

What Planning Opportunities should we consider? Taking advantage of expiring provisions in the

law – repeal of estate tax, GST Possible changes in the law Low interest rates High dividend yields

Estate Tax – the estate tax was allowed to expire for decedents dying in 2010

Unless Congress acts, the estate tax will be reinstated for decedents dying in 2011 or later.

The “exemption” will be $1,000,000; the top rate will be 55%.

Gift Tax -- The gift tax remains in effect for 2010.

The top gift tax rate is 35%. The “exemption” is $1,000,000.

Interlude: Why is “exemption” in quotation marks? What we have is a credit equal to the amount

of the “tentative tax” that would result from a gift of $1,000,000 under the current gift tax rates, REDUCED BY

The sum of the amounts allowed as credits against the gift tax previously. (See Sections 2505(a)(1) and (2).)

What difference does it make? Suppose client made a taxable gift of

$900,000 in 2009. Gift tax would have been $306,800 and would have been completely offset by credit.

Suppose client makes an additional taxable gift of $100,000 in 2010. At a 35% top tax rate, tax would be $35,000. What credit is available?

Under 2010 rates, tax on gifts of $1,000,000 would be $330,800.

This credit amount must be reduced by credit previously used, $306,800, leaving an available credit of $23,200.

$35,000 is greater than the $23,200 credit; an out of pocket gift tax payment would result!

TRAP FOR THE UNWARY!

GRATs – Short and Long-Term In April 2009 the Administration proposed a

minimum term of 10 years The remainder could not have a zero value Annuity payments could not be front-end

loaded; they could not decrease

Short-term GRATs Rumors that these changes would be included

in tax legislation enacted over the summer of 2010 proved to be false

The ten year minimum term was dropped from the Senate Bill and no vote on the revised Bill was ever taken

Point: Consider Funding Short-Term GRATs in 2010 to beat possible repeal Short-term GRATS are an ideal way to take

advantage of low 7520 rates -- only 1.8% in December.

Advantages of short-term over long-term GRATs

Reduced Mortality Risk Enhanced Volatility

Counterpoint! Long-term GRATs aren’t always a bad thing –

especially when planning with discountable interests in “pass-through” entities with good cash flow!

Consider using insurance to hedge against mortality risk.

Consider using other techniques to take advantage of low AFRs Short-term AFR (3 years or less) .32% Mid-term AFR (3 years - 9 years) 1.53% Long-term AFR (over 9 years) 3.53%

Techniques that take advantage of low interest rates: Intra-family loans Installment sales Refinancing existing installment obligations Note that low interest rates are bad for QPRTs

in general, but enhance value of reversionary interest -- especially important with older clients

Techniques that take advantage of low interest rates: Consider installment sale of preferred LLC

interest Yields on preferred stock are currently high Interest rates are very low Great arbitrage potential!

Generation-Skipping Transfer Tax – The GST has also been repealed for generation-skipping transfers in 2010.

Unless Congress acts, the GST will be reinstated for generation-skipping transfers in 2011 and later years.

The top tax rate will be 55%; the exemption will be $1,000,000, indexed for inflation – this is expected to be $1,360,000 for 2011.

How are transfer taxes likely to change? Who knows? “Bush tax cuts” could be allowed to expire 2009 transfer tax laws could apply temporarily

starting in 2011 2009 transfer tax laws could apply

retroactively to 2010 as well as to later years

The estate tax could be repealed -- temporarily or permanently

Income Taxes in Transition

Modified Carryover Basis Beneficiaries inherit assets at the decedent’s

cost basis; Executor may allocate up to $1,300,000 of

“Basis Increase” to decedent’s assets, up to FMV of each at date of death.

Adjustment to be made by Executor on Form 8939. Form not yet been released. Form theoretically due with decedent’s final

income tax return (i.e., April 15, 2011 unless extended).

Amount may be increased by decedent’s unrealized losses and loss carryovers.

Additional adjustment permitted for assets passing to a surviving spouse of up to $3,000,000 in “Qualified Spousal Property.” Qualified Spousal Property is either property

transferred to spouse outright or QTIP-able property.

“Basis increase” for NRAs limited to $60,000.

Property Eligible for Basis Increase In order to be eligible for “Basis Increase,”

property must be: Owned outright by decedent (solely, jointly or as

community property); or Owned through a revocable trust that would

qualify for an IRC § 645 election Not eligible for basis increase:

Property held in a QTIP Trust for decedent Property over which decedent holds power of

appointment

MA basis issues: No “step-up” under current law in spite of

estate tax on decedent’s assets. Unclear whether MA will respect federal basis

of assets to which “Basis Increase” has been allocated.

MA legislative proposal pending.

Planning Opportunities – Make taxable gifts in 2010 35% gift tax rate is likely to be less than future

gift tax and estate tax rates. Massachusetts does not impose a gift tax;

Massachusetts taxable estate would be reduced by amount of gift.

If donor lives 3 years after the gift, any money used to pay gift tax will escape estate tax.

Risk of Donor’s Death in 2010 after Making Taxable Gifts Gift tax would have been needlessly incurred. This risk can be lessened by making transfer to

a revocable trust which, by its terms, becomes irrevocable on the first to occur of the donor’s death or 11:59 p.m. on December 31, 2010.

No section 2035 issue if power to revoke trust terminates by its terms. Do not release power!

Other things that could go wrong: Estate tax could be repealed Estate tax rate could be reduced to less than

35% Exemption could be increased so much that

decedent’s assets would not have been taxable

Assets given away could decrease in value

Possible Pitfall: MA Estate Tax Where decedent has made taxable gifts prior to death

that have consumed entire unified credit, no longer have a $1M MA estate tax “exemption”

$1M is amount of state death tax eliminated by federal unified credit on first $1M of estate assets, based on 2000 estate tax law

If unified credit has been consumed, actual exemption available is only $60,000

If you have estate involving decedent who has made large taxable gifts (perhaps in order to reduce taxable estate below $1M), be aware that estate may nevertheless be taxable - particularly if you intend to seek an extension of time to file (must pay 80% of tax due or extension will be “void”)

Planning Opportunities – GST Outright direct skip gift in 2010 -- Again, must

deal with risk of death before end of year. Make outright distributions to skip persons

from non-exempt generation-skipping trusts before end of year.

Planning Opportunities – GST – How to deal with risk of retroactive legislation? Disclaimer planning.

Problem with “sunset legislation” -- several helpful EGTRRA provisions, such as qualified severances and certain GST exemption allocations will not apply in 2011 or later unless Congress acts.

If a decedent dies in 2010, when there is no estate tax, and leaves assets to what would otherwise be a generation-skipping trust, would the GST apply to distributions to skip-persons in later years?

For a great discussion of the application of the sunset provisions to the Generation Skipping Transfer Tax, see McCaffrey and Schneider, “Time Traveling and Generation-Skipping in 2010 and Beyond,” appearing in the July 26, 1010 issue of Tax Notes.

Planning Issues – GST – Irrevocable Life Insurance Trusts How to deal with Premium Payments?

Late allocation of GST exemption? Risks Timing

Planning Issues – GST – Irrevocable Life Insurance Trusts How to deal with Premium Payments?

Loan amount required for premium to the trust?

Inter Vivos QTIP Trusts Ideal vehicle to keep all options open Trust is QTIP-able and thus could qualify for

gift tax marital deduction if gift tax retroactively raised from 35% to 45%.

Election not due until as late as October 15th, 2011(on Donor’s 2010 gift tax return)

Spouse can also disclaim for up to 9 months and allow property to pass to alternate family beneficiaries or to revert to Donor (desired outcome must be drafted into the trust terms)

Consider gifts of appreciated property to terminally ill spouse Takes advantage of “Basis Increase” available

to such spouse $1,300,000 Basis Increase:

Donee spouse bequeaths donated property to discretionary trust for donor spouse and descendants (eligible for $1,300,000 Basis Increase)

$3,000,000 Basis Increase Unlike Section 1014(e) restriction, property given to

a spouse may be bequeathed back to donor spouse without restriction as to time and $3,000,000 Basis Increase will be fully available.

However, since spouse may not die in 2010 and 1014(e) may be revived with pre-EGTRRA laws, consider having Donee spouse bequeath donated assets to QTIP-able Trust for donor spouse if death occurs within one year

Client Considerations Review existing Marital Deduction and GST

Formula Clauses (especially for clients of advanced age or in poor health)

MA has not enacted a “patch” law that will construe a tax driven formula bequest which relies on federal estate and or GST Tax exemption amounts to determine funding of marital/by-pass/GST Tax exempt trusts based on 2009 tax law.

Client Considerations Possible to seek judicial constructions of will

or trust but concerns about possible need to have Bosch protection of SJC decision.

QDOTs Terminating QDOTs by full distribution – a trap

for the unwary? Suggestion is that in 2010 you “disqualify”

existing Qualified Domestic Trusts (QDOT) for the benefit of non-citizen surviving spouses of decedents who died prior to 2010.

QDOTs Disqualification causes surviving (non-citizen)

spouse to be treated as having died immediately.

Disqualification can be accomplished by having US citizen or domestic corporation trustee resign and appointing n on US trustee.

QDOTs Death of spouse non taxable?

No; estate tax on QDOT is tax computed on earlier decedent’s estate which was deferred due to existence of QDOT.

Disqualification will accelerate (but not avoid) delayed estate tax since tax will be collected based on estate tax rates and exemptions available in the year of the death of the earlier decedent.

CARNAC THE MAGNIFICENT TAX WIZARD

Investment Council

Wealth Management

CARNAC THE MAGNIFICENT

Answer: SIS BOOM BAH!

Investment Council

Wealth Management

Question:

Describe the sound made when a sheep explodes!

Investment Council

Wealth Management

Answer: George Clooney Brad Pitt Jon Hamm George Cushing Tom Peckham

Investment Council

Wealth Management

Question:

Name 5 men who were NOT selected as “Sexiest Man of the Year” by People Magazine!

Investment Council

Wealth Management

Answer: 13%

Investment Council

Wealth Management

Question:

How much will the top tax bracket increase in 2011?

Investment Council

Wealth Management

Answer: 25%

Investment Council

Wealth Management

Question:

How much will the Capital Gains tax increase in 2011?

Investment Council

Wealth Management

Answer: 264%

Investment Council

Wealth Management

Question:

How much will the tax on Dividends increase?

Investment Council

Wealth Management

Answer: Who the hell knows?

Investment Council

Wealth Management

Question:

Will Congress roll back the 2011 tax increases?

Investment Council

Wealth Management

Answer: To Save Taxes…Stupid!

Investment Council

Wealth Management

Question:

Why would someone accelerate gains?

Investment Council

Wealth Management

Answer: With an IRA Rollover Switcheroo!

Investment Council

Wealth Management

Question:

How do you avoid underpayment penalties?

Investment Council

Wealth Management

Answer: George Cushing, Esq. Tom Peckham, Esq.

Investment Council

Wealth Management

Question:

Name two world famous attorneys we want to thank for a great talk this morning!

Investment Council

Wealth Management

Stump the Chumps (Thanks, Car Talk!) Questions? Answers?

transfer taxes in transition: year end pitfalls and opportunities

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