FOLLOW-UP TO 2012 GIFTING
Because of the uncertainty over the future of the federal estate, gift and generation-skipping transfer (GST) tax exemptions through the end of last year, many individuals made significant taxable gifts to trusts for their families in an attempt to capture the then current $5,120,000 federal exemption amounts before a possible decrease. As it turned out, those higher exemptions were in fact made permanent by the American Taxpayer Relief Act of 2012, signed into law on January 2, 2013. Now that the dust has settled on these gifts, it is appropriate to review a few planning notes.
- Trust Assets. Some of the trusts
established at the end of last year were funded with cash, which
made the initial transfer simpler and ensured the transfers would
be completed before year end. In those cases, this is an
appropriate time to review the trust's investments. In many
cases, it may be advantageous to "pool" the trust's
investment assets with similar investments of other family members,
using a limited partnership or limited liability company (LLC)
structure. In addition, if the trust is a "grantor" type
trust, transactions between the trust and the settlor (the person
who set it up) are disregarded for income tax purposes, and assets
the settlor owns can be swapped for assets of equivalent value in
the trust without recognizing capital gain for any unrealized
appreciation.
- Trust Administration. It is important
for your tax preparer to be aware of the trust, to ensure the
trust's income is properly reported. Many of these trusts were
established as grantor trusts using the settlor's Social
Security number as its taxpayer identification number, meaning a
separate trust return is not required but the income must still be
reflected on the settlor's individual income tax return. Gift
tax returns on extension until October 15, 2013, must be carefully
prepared to reflect these gifts, including consideration of the
advisability of electing "gift-splitting" between spouses
and treatment of generation-skipping transfer tax exemption.
In addition, if the trust included provisions qualifying gifts to the trust for the annual exclusion, it is important to confirm any required notices are sent to the trust beneficiaries whenever a gift is made to the trust.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. - Additional Gifting. The now-permanent federal transfer tax laws provide for an annual inflation adjustment for the estate, gift and GST tax exemptions. Thus, even those who made maximum exemption gifts of $5,120,000 in 2012 have an additional $130,000 of exemption available for use in 2013. (Connecticut residents should consider the effect of Connecticut's $2,000,000 exemption on any additional gifting.)
YEAR-END PLANNING
It is never too early to think about year-end planning strategies, including the following items.
- Annual Exclusion Gifts. Annual
exclusion gifts, either outright or to appropriate trusts, remain
one of the simplest and most effective ways of transferring wealth
to your family without transfer taxes. The annual exclusion amount
for 2013 has increased to $14,000 per individual. A married person
can transfer $28,000 per individual if the gift is reported on a
gift tax return that reflects the spouse's consent to
gift-splitting.
- Additional Exemption Available. The
federal estate, gift and GST tax exemption amounts have increased
to $5,250,000 for 2013. As noted above, even those who made
significant gifts in 2012 to capture their then-available exemption
amounts have an additional $130,000 (or $260,000 for a married
couple) available for 2013 gifts.
- IRA Rollover. The IRA charitable rollover remains in effect for 2013 (but is not presently scheduled to be extended in the future). This provision permits direct distributions from an IRA to be excluded from income and to count as part of the required minimum distribution for individuals over age 70.
LEGISLATIVE DEVELOPMENTS
President Obama's budget plan for fiscal year 2014, released
in April of this year, includes a number of proposed changes to the
estate, gift and generation-skipping transfer tax laws.
Many of these changes have been proposed in the past
without being enacted, and therefore we share these proposals more
as a matter of interest than as a warning of likely
legislation. However, because they are part of the
president's budget plan, you should be aware of them.
- Return to 2009 Transfer Tax Levels. The
federal estate and generation-skipping transfer tax (GST)
exemptions would be lowered to $3,500,000, and the gift tax
exemption would be lowered to $1,000,000. (All three exemptions are
$5,250,000 for 2013 and indexed for inflation in future years.) In
addition, the tax rate would be increased to 45 percent from the
current 40 percent. Although this proposal has appeared before, it
is striking for two reasons: (1) The tax law passed in 2012 made
current rates permanent, and many assumed there would be no further
legislative activity in this area; and (2) the changes would not go
into effect until January 1, 2018.
- Minimum GRAT Terms. Grantor-retained
annuity trusts (GRATs) funded after the date of enactment would be
required to have a minimum term of 10 years and a remainder value
greater than zero (currently there is no stated minimum value).
This proposal increases the possibility that the person setting up
the GRAT would not survive the GRAT term. Because surviving the
GRAT term is required in order to achieve the tax benefits of a
GRAT, a 10-year minimum term would make "mortality risk"
a significant consideration to weigh in deciding whether to use
GRATs in the future.
- Limit Duration of GST Exemption. For
transfers on or after the date of enactment, the GST-exempt status
of a trust would terminate after 90 years. After that time,
transfers from the trust would again be subject to transfer
taxation. This change would have little effect on trusts
established in jurisdictions that currently have similar
limitations on the duration of trusts, including Connecticut,
Massachusetts and New York. For trusts established in jurisdictions
that have extended or even eliminated the maximum term of a trust,
including New Jersey, Florida and Delaware, the tax planning
benefits of these trusts would be limited to no more than two or
three generations, in most cases.
- Coordinate Income and Transfer Tax Rules Applicable
to Grantor Trusts. Certain trusts are now treated as
being owned by the person setting them up (the grantor) for income
tax purposes but are not included in the grantor's estate at
death. Earlier proposals had effectively called for a broad
elimination of these so-called grantor trusts, which would have
severely limited the effectiveness of many common estate planning
techniques, including insurance trusts. The current proposal is
more narrowly tailored and only affects grantor trusts that engage
in a sale transaction with the grantor. In that case, the portion
of the trust involved with the sale transaction will be included in
the grantor's estate and subject to estate tax. This proposal
would be effective for sales on or after the date of enactment,
presumably including those involving trusts previously established,
although there is regulatory authority to create exceptions.
- Limitation on HEET Trusts. Gifts made by a donor directly to a medical or educational provider for the benefit of a grandchild are excluded from both gift and generation-skipping transfer (GST) taxes. This exclusion currently applies to transfers from a trust. This makes a Health and Education Exclusion Trust (HEET), which permits distributions to medical or educational providers or to charity, an effective vehicle to provide for future generations without using GST tax exemption. The current proposal, introduced for the first time in the 2014 budget plan, would eliminate the GST exclusion for trust distributions for trusts created after the date the bill is introduced and for transfers after that date to existing trusts. Existing HEETs would continue to operate as intended, but care should be taken before making any additions to those trusts. Those individuals interested in establishing a HEET may wish to take steps to complete and fund the trust promptly.
These proposals have not yet been introduced as legislation, so no immediate action is necessary.
However, if you have not updated your documents in the last few years, this may be an appropriate time for a review of your estate plan to ensure it still meets your estate planning needs and objectives in light of the current tax laws and these proposals.
SUPREME COURT DOMA RULING
On June 26, the Supreme Court released its decision in
United States v. Windsor. The Court held that Section 3 of
the Defense of Marriage Act (DOMA), defining "marriage"
as exclusively a union between a man and a woman and
"spouse" as a person who is married to someone of the
opposite sex, is unconstitutional. The Court explained that the
states have the primary role in regulating domestic relations and
that, therefore, the federal government must generally look to
state law in determining a couple's marital status for purposes
of administering federal benefits incident to marriage.
As a result of this decision, legally married same-sex couples
living in one of the 13 states (including Connecticut,
Massachusetts and New York) and the District of Columbia that
recognizes same-sex marriage will now have access to more than
1,000 federal benefits that turn on the definition of
"spouse," including the ability to file joint federal
income tax returns, to claim a marital deduction for gift and
estate tax purposes, to split gifts, to "roll over"
qualified retirement plans into the surviving spouse's own
account, to receive employer-provided medical insurance premiums
gift tax free, and, for a non-U.S. spouse, to be eligible for a
green card. The impact of the decision on other same-sex couples
may vary depending on where the couple married, where they
currently live and how a federal benefit is administered.
Individuals who are affected by this decision should review their
estate plan, the manner in which they hold title to their assets,
and their beneficiary designations for qualified retirement plans
(such as 401(k)s, 403(b)s or IRAs) and insurance policies.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
