Estates

Estate planning with trusts: Availability limited?

With the looming expiration of the $5 million estate and gift tax exemptions and the current favorable top tax rate of 35 percent, estate tax planning has become a significant area of focus among many tax advisers.

Possible expiration of these provisions has fueled the emphasis on the importance of addressing the impact on individuals and on the transfer of assets to future generations.

Many advisers have focused on employing grantor trusts to help meet clients’ objectives. Grantor trusts have been the target of legislators over the years, and current proposals would eliminate many of the benefits of using these trusts in estate planning.

Most commentators agree that it is highly unlikely that current proposals will be adopted. However, their approval would close the window on these estate tax planning opportunities, making it crucial to act now if you could benefit from these techniques.

To create a grantor trust, a donor transfers property to a trust but retains powers that cause the grantor to be treated as the trust owner under the grantor trust rules. The trust is disregarded as an entity under federal income tax law, and the grantor must account for all items of income and deduction attributable to the trust property.

Because the grantor is required to pay this tax, it is not treated as a gift to the trust, and the grantor effectively transfers additional wealth to trust beneficiaries without affecting the exemption amount or incurring additional gift tax.

In addition, due to differences in the grantor trust and the estate and gift tax rules, as long as the transfer is properly structured as a completed gift, the property will be excluded from the grantor’s estate for estate tax purposes.

When the trust document is drafted as a trust that purposely invokes the grantor trust rules, it is commonly referred to as an intentionally defective grantor irrevocable trust. Although this can be achieved in a number of ways, one of the more aggressive and complicated planning strategies involves structuring an installment sale to a grantor trust.

Using this strategy, the donor sets up a trust in which he retains the power to replace trust assets with assets of equal value. The transaction is structured as a combination gift and sale.

The grantor first makes a gift to the trust, usually cash, and then sells an appreciating asset to the trust in exchange for cash and a promissory note providing for installment payments over time. The interest is based upon the required minimum IRS interest rate.

Because the grantor is treated as the owner of the trust, no gain or loss is recognized on the sale of the asset to the trust or on the note’s interest.

A grantor retained annuity trust (GRAT) is another type of grantor trust. It can provide a unique estate planning opportunity because of the manner in which the remainder interest is valued for gift tax purposes.

To establish a GRAT, the grantor transfers appropriate property to an irrevocable trust. The grantor retains the right to receive an annual payment of a fixed amount for a specified term of years. Then the property passes to the remainder beneficiaries.

The creation of the GRAT is treated as a taxable gift to the extent of the present value of the remainder interest, which can often have de minimis, or minor, value. The trust property is assumed to appreciate at the federally established rate, while the property in the trust is expected to appreciate at a higher rate.

Proper planning should result in the value of the property received by the trust beneficiary substantially exceeding the value on which the donor was required to pay gift tax.

Although these trusts can be an effective planning tool for some taxpayers, they are not appropriate for everyone. If your estate is less than $10 million joint ($5 million single), you can likely accomplish your planning goals through lifetime gifts and less complicated trusts.

With the help of your CPA, you should assess your long-term objectives, personal and financial situation, and the assets that will be held by the trust to determine the most suitable approach. After this assessment, if you believe that a GRAT or grantor trust may be appropriate, you should consider the advantages and disadvantages of each.

Don’t miss estate planning opportunities in 2012

This year may be the last year to take advantage of some unique estate and gift tax planning opportunities.

The current estate and gift tax law is set to expire Dec. 31, 2012, just like the Bush-era income tax cuts you hear so much about.

Absent congressional action, the $5.12 million estate tax exemption and current top tax rate of 35 percent, in place for 2012, will revert to a $1 million exemption with a top tax rate of 55 percent beginning Jan. 1, 2013. The estate tax exemption will no longer be portable between spouses, meaning that any remainder of the exemption after the first spouse’s death may not be added to the surviving spouse’s exemption.

For most of the past decade, the amount a person could transfer tax-free during that individual’s lifetime was less than the amount of the estate tax exemption applicable to transfers at death. From 2002 through 2010, lifetime gifts in excess of the annual exemption were limited to a total of $1 million before the gift tax took effect.

With the lifetime gift exemption also at $5.12 million for the rest of 2012, there exists what could be a once-in-a-lifetime opportunity to transfer significant assets to the younger generation without incurring any wealth transfer taxes. On Jan. 1, 2013, the lifetime gift tax exemption is scheduled to revert to $1 million.

Those contemplating substantial gifts during 2012 should consider the cash flow needs of the grantor well into the future. Transfers of appreciating assets outright to the next generation or through such techniques as grantor retained annuity trusts (GRATs) or sales to defective trusts can result in the transfer of significant wealth, with little or no tax cost.

A well-planned gift in 2012 could transfer significant wealth from the donor�s estate, considering what the gifted property may be worth years from now, when an estate tax may be imposed if the grantor holds onto the property until death.

Along with the high gift tax exemption, the generation-skipping transfer (GST) tax exemption is also $5.12 million during 2012. So the door is open to bypass children and defer the impact of estate taxes for many years into the future.

Legislation has been proposed in Congress limiting valuation discounts attributable to minority interests or lack of marketability. However, such rules have not yet been enacted.

Those contemplating transfers of interests in family businesses or family limited partnerships should monitor the progress of these proposals. Supported by a qualified appraisal, a gift effected before any change to existing law could result in more substantial tax savings than would be available after the enactment of such changes.

The gift tax annual exemption remains at $13,000 per donee for 2012. With gift splitting, spouses can transfer up to $26,000 to each person before the lifetime gift tax exemption comes into play. That means a husband and wife with two married children and four grandchildren can, with proper planning, transfer over $200,000 annually to their family members before they invade their $5.12 million lifetime exemption.

On Feb. 13, 2012, the Obama administration presented its revenue proposals for fiscal year 2013. Among these proposals are several significant changes to transfer tax provisions. Except as noted, the effective date of these proposals will be the date enacted, rather than Jan. 1, 2013.

If these proposals are enacted into law:

The maximum estate, gift and GST tax rate will be 45 percent. The estate tax and GST exemptions will each be $3.5 million, and the gift tax exemption will be $1 million. The portability of unused estate and gift tax exemptions between spouses will continue. This provision will be effective Jan. 1, 2013.

  • An executor will be required to report the basis of property transferred at death, and a donor will be required to report the basis of property transferred by gift. Recipients will be required to use that basis when they sell the property.
  • A category of “disregarded restrictions” will be defined that will be ignored for purposes of valuing an interest in a family-controlled entity, limiting the use of valuation discounts.
  • A grantor retained annuity trust (GRAT) will be required to have a minimum term of 10 years and a maximum term of the life expectancy of the beneficiary of the annuity plus 10 years.
  • On the 90th anniversary of the creation of a trust, the GST exemption allocated to the trust will terminate. So, distributions from the trust after that date to skip generations will incur GST tax.
  • The estate tax and gift tax treatment of grantor trusts will change:
    • The assets of a grantor trust will be subject to estate tax at the grantor’s death;
    • Any distribution from a grantor trust to a beneficiary during the grantor’s lifetime will be subject to gift tax; and
    • The assets of a grantor trust will be subject to gift tax if the trust ceases to be a grantor trust during the grantor’s lifetime.
  • In the case of an election to defer estate tax on an interest in a closely held business, the term of the estate tax lien (10 years) will be extended for the full estate tax deferral period (15 years).

Estate planning with trusts: Availability limited?

 With the looming expiration of the $5 million estate and gift tax exemptions and the current favorable top tax rate of 35 percent, estate tax planning has become a significant area of focus among many tax advisers.

Possible expiration of these provisions has fueled the emphasis on the importance of addressing the impact on individuals and on the transfer of assets to future generations.

Many advisers have focused on employing grantor trusts to help meet clients’ objectives. Grantor trusts have been the target of legislators over the years, and current proposals would eliminate many of the benefits of using these trusts in estate planning.

Most commentators agree that it is highly unlikely that current proposals will be adopted. However, their approval would close the window on these estate tax planning opportunities, making it crucial to act now if you could benefit from these techniques.

To create a grantor trust, a donor transfers property to a trust but retains powers that cause the grantor to be treated as the trust owner under the grantor trust rules. The trust is disregarded as an entity under federal income tax law, and the grantor must account for all items of income and deduction attributable to the trust property.

Because the grantor is required to pay this tax, it is not treated as a gift to the trust, and the grantor effectively transfers additional wealth to trust beneficiaries without affecting the exemption amount or incurring additional gift tax.

In addition, due to differences in the grantor trust and the estate and gift tax rules, as long as the transfer is properly structured as a completed gift, the property will be excluded from the grantor’s estate for estate tax purposes.

When the trust document is drafted as a trust that purposely invokes the grantor trust rules, it is commonly referred to as an intentionally defective grantor irrevocable trust. Although this can be achieved in a number of ways, one of the more aggressive and complicated planning strategies involves structuring an installment sale to a grantor trust.

Using this strategy, the donor sets up a trust in which he retains the power to replace trust assets with assets of equal value. The transaction is structured as a combination gift and sale.

The grantor first makes a gift to the trust, usually cash, and then sells an appreciating asset to the trust in exchange for cash and a promissory note providing for installment payments over time. The interest is based upon the required minimum IRS interest rate.

Because the grantor is treated as the owner of the trust, no gain or loss is recognized on the sale of the asset to the trust or on the note’s interest.

A grantor retained annuity trust (GRAT) is another type of grantor trust. It can provide a unique estate planning opportunity because of the manner in which the remainder interest is valued for gift tax purposes.

To establish a GRAT, the grantor transfers appropriate property to an irrevocable trust. The grantor retains the right to receive an annual payment of a fixed amount for a specified term of years. Then the property passes to the remainder beneficiaries.

The creation of the GRAT is treated as a taxable gift to the extent of the present value of the remainder interest, which can often have de minimis, or minor, value. The trust property is assumed to appreciate at the federally established rate, while the property in the trust is expected to appreciate at a higher rate.

Proper planning should result in the value of the property received by the trust beneficiary substantially exceeding the value on which the donor was required to pay gift tax.

Although these trusts can be an effective planning tool for some taxpayers, they are not appropriate for everyone. If your estate is less than $10 million joint ($5 million single), you can likely accomplish your planning goals through lifetime gifts and less complicated trusts.

With the help of your CPA, you should assess your long-term objectives, personal and financial situation, and the assets that will be held by the trust to determine the most suitable approach. After this assessment, if you believe that a GRAT or grantor trust may be appropriate, you should consider the advantages and disadvantages of each.