In the ever changing world of estate tax and estate planning, here are three proposed changes that could significantly affect your estate plan: (1) the determination of tax basis; (2) valuation discounts; and (3) grantor retained annuity trusts (GRATs). And even though these are merely proposed changes, they are a signal to all individuals that many of the “once-in-a-generation chances to save money” could be coming to an end. All of these changes are part of the Obama administration’s proposed budget that was recently released (see Yahoo Finance Article).
Determination of Tax Basis
Under current law, a recipient of a gift also receives the giver’s basis in the property (i.e., “carryover basis”). The recipient of property through a will or intestacy, on the other hand, gets a step-up in basis (not in 2010; see my early post on the subject) to the value as of the decedent’s date of death. Basis is used to determine the amount of gain or loss an individual recognizes, and is taxed on, when the property is sold. For instance, if your rich grandma gives you property during her life that is worth $12,000 but she paid $1,000 and you sell it, you would have a $11,000 taxable gain. If, on the other hand, you received the property upon grandma’s passing and you sold it, you would have no gain ($12,000 FMV – $12,000 Basis = 0 gain) (Absent legislative change, this is not the case in 2010).
A gift of property valued at less than $13,000 is not taxable and no filing is required. Similarly, when there was a federal estate tax, no estate tax filing is required unless certain exemption amounts are exceed and in 2010, no filing is required as a matter of law regardless of the estate’s size. In these scenarios, how is the IRS to know your actual basis in the property? It cannot. And this fact has led many individuals to abuse the system. Individuals were selling property and claiming a higher basis than they were entitled to. Obama’s budget proposal would require that the basis of the property be reported any time property passes as a gift or pursuant to a death.
Planning for these new reporting requirements, puts an increased emphasis on managing the distribution of property during your life and at death. An experienced Kansas or Missouri estate planning attorney can help you achieve not only the best tax result but also the best result for your family.
Valuation Discounts
Estate planning attorneys have utilized valuation discounts in order to reduce the tax burden on the recipients of gifts and inheritance. These discounts have been most prevalent in family controlled entities, in particular interests in family limited partnerships. These discounts include minority discounts and marketability discounts. Minority discounts are given to recognize the fact that the person does not have the authority to control the entity’s decisions. Marketability discounts recognize the fact that the interests might be hard to sell later.
Taxes due is a function of the property values and marginal tax rates. Reducing the value of the property reduces taxes due by decreasing the property value and, in some cases, reducing the marginal tax rate. The Obama budget proposal would allow the IRS to ignore these discounts in valuing family-controlled entities if the ownership interests involved are transferred by bequest or gift to family.
Grantor Retained Annuity Trusts (GRATs)
GRATs generally take the following structure. An individual (the grantor) gives assets to a trust for a very short period of time. In return, the grantor receives a very high annuity payment. The trust names who ever the grantor wants to receive the property at the end of the annuity period (the remainder beneficiaries). Because the annuity payments are so high, the value of the gift to the remainder beneficiaries is effectively zero. If the trust out performs a specific market interest rate, at the end of the annuity period, the remainder beneficiaries receive a windfall. If the trust does not, the property is returned to the grantor in the form of the annuity payments. Thus, it is a win-win, no gift tax and no risk of losing the property.
The Obama administration seeks to establish a minimum trust period of 10 years. Thus, there is a risk that the individual will die before the property is returned in the form of annuity payments making the gift tax value something greater than zero. An experienced estate planning attorney can help you analysis the mortality tables to determine if a GRAT is the right planning tool for your estate plan.
As the laws and regulations relating to estate planning continue to change, it becomes more and more important to consult with an experienced Kansas or Missouri estate planning attorney not only to set up your estate plan, will, and trust but also to update your documents accordingly. Your relationship with your estate planning attorney should not end once the documents are signed. This relationship is ongoing and should be consistently monitored.
– The State Line Lawyer
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