Estate and Gift Tax Planning Opportunities for 2009

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1 Estate and Gift Tax Planning Opportunities for 2009 Although financial markets are as confused, depressed and frozen as they have been in the lifetimes of most living Americans, clients should not use these circumstances as an excuse to ignore their current estate planning needs. In fact, the current economic environment, as unsettling as it may be, offers some unique opportunities to maximize estate and gift tax savings, and many of those opportunities could disappear soon. This Client Alert will highlight a few recent developments affecting trust and estate planning, will suggest some planning ideas that are particularly timely, and will offer a few other action items that all clients should consider implementing. What happened on January 1, 2009? As we rang in the New Year, we also rang in two changes in the estate and gift tax regime: 1. The estate tax exemption increased to $3.5 million. The value that can be transferred at death with no estate tax increased from $2 million to $3.5 million for decedents who die in As a result, with proper and relatively simple planning, a husband and wife can collectively leave up to $7 million estate tax free. The top estate tax rate is currently 45%. What happens after 2009? Under current law, no estate tax will be imposed on estates of decedents who die in 2010, but there will be a tax on the estates of decedents who die after 2010 with only a $1 million exemption available. However, we expect new legislation will be enacted this year to make the estate tax permanent and to stabilize the exemption. Under the plan suggested by President Obama during the presidential campaign, the estate tax would be locked in permanently at the 2009 rate and exemption levels, i.e., $3.5 million exemption per person ($7 million per couple) and an estate tax rate of 45%. Any existing estate planning documents (primarily trusts and wills) which define the value of any gifts by reference to the amount of the estate tax exemption should be reviewed immediately to make sure they accomplish the desired result and tax efficiency. Married or same-sex couples with smaller estates should reconsider whether establishing and funding a bypass trust when the first spouse or partner dies makes sense after the increase in the estate tax exemption. 2. The annual exclusion gift limit increased to $13,000. The value that any one person can give to any other person in any calendar year without reducing any portion of the donor s gift tax exemption increased to $13,000 (from $12,000) in Of course, the requirements for an annual exclusion gift still apply, such as the requirement that the gift be a present interest. In addition, direct payments of tuition or medical expenses can continue to be made without reducing either the available annual exclusion or the lifetime gift tax exemption. You should consider implementing a regular, recurring program of making annual exclusion gifts to your children and/or other intended beneficiaries. If you already have such a program, make sure you are taking full advantage of it. For example, it is generally better to make the annual exclusion gifts early in Page 1

2 the calendar year so the beneficiary has the opportunity to benefit from appreciation and/or income that may occur during the year. If you intend to gift interests in property that require an appraisal, you can make one gift in December and the following year's gift in January so you only have to obtain and pay for one appraisal. You should consider direct payments of tuition or medical expenses for your beneficiaries. If paid directly to the school or medical service provider (and not to the student or patient), they will not count against the annual exclusion amount. You can contribute up to five years worth of annual exclusion gifts (i.e., up to $65,000) in advance to an education savings plan account for your intended beneficiary this year. This is a particularly attractive planning technique given the depressed investment market. Of course, this uses the annual exclusion amount available for that beneficiary for this year and the next four years. Gifts to a Section 529 plan will accumulate income tax free and distributions used for qualified higher education expenses will not be subject to federal income tax. 3. What didn t happen in 2009? The lifetime gift tax exemption is still $1 million. The cumulative value of lifetime gifts that can be made by any one person without incurring a gift tax liability remains at $1 million. When Congress enacted the laws that automatically increased the estate tax exemption to, eventually, $3.5 million, they decided not to increase the gift tax exemption, thereby preventing taxpayers from giving away more than $1 million tax free during their lifetime when the estate tax exemption might, some day, revert to the old $1 million amount. A lifetime gift that uses any portion of the $1 million gift tax exemption will reduce your estate tax exemption on a dollar for dollar basis as well. The top gift tax rate is also 45%. Take advantage of current low market values to gift up to $1 million in value to your intended beneficiaries. While the estate tax exemption available at death is reduced by the amount of these gifts, appreciation in the assets transferred and all future income there from will pass to the beneficiary estate tax free. And you can improve these advantages by making gifts that can be discounted for gift tax purposes. How can my estate plan benefit from the current low interest rate environment? The minimum interest rates which the IRS imposes on loans between family members and for purposes of valuing the gift component of certain estate planning tools, such as GRATs, are extraordinarily low. While intended to jumpstart the economy, low interest rates can be used to supercharge your estate plan because certain interest rate-dependent estate planning techniques become very favorable - if you act while the rates are low. Here are just a few of the available techniques that can benefit from low interest rates: 1. Loans to children or other family members. The required minimum interest rates for loans to family members are at historic lows. For January 2009, you can loan money to a family member for less than 3 years at a rate of 0.81%, for a term of 3-9 years at just under 2.1%, and for more than 9 years at a rate under 3.6%. However, these rates change monthly and will increase when interest rates rise. Intrafamily loans can benefit family members who would like to purchase a home or start a business. The loan proceeds could, instead, be invested, and if your family member earns a higher annual rate of return than the interest rate, the excess is effectively a tax free gift. If you believe that the stock, real estate or other investment markets are valued so low that they will appreciate dramatically over the next period of time, this is an ideal planning device and relatively simple to execute. However, note that intra-family loans Page 2

3 must be properly documented and should be treated by your family as any other arm s-length loan to be respected as a loan and not a gift for tax purposes. 2. Shift future growth in business or property by selling to family members. By selling business interests (stock, partnership or LLC interests, etc.) to family members in exchange for a promissory note bearing a legal rate of interest, current value and future growth in the business can be transferred to those family members at a very low cost. The cost can be further reduced by selling partial (i.e., minority) interests in the business at a discounted value. And if the sale is made to a defective grantor trust that you create, you can further increase the net annual after tax return on the value of the gift because you, as grantor, will pay the income tax liability due on any income generated by the defective grantor trust (which means that as to the trust beneficiary, there is no tax on the trust s earnings). 3. Grantor retained annuity trusts. You, as grantor, can transfer assets to a grantor retained annuity trust (or GRAT ), reserving the right to receive a fixed payment for a number of years, with the remainder passing to your beneficiary at the expiration of the GRAT. If the GRAT s assets appreciate at a rate that exceeds the amount required to be paid to you (i.e., the retained annuity amount), the excess can be passed to the beneficiary gift and estate tax free. Currently, a very low interest rate is used to value the transfer to the GRAT and the value of the grantor s retained annuity. For January 2009, the rate is just 2.4%. Since the GRAT is a grantor trust for income tax purposes, a further tax-free gift to the beneficiary occurs because you, as the grantor, will pay the GRAT s income tax liability, allowing the GRAT to grow income tax free. 4. Charitable lead trusts. For the charitably inclined, similar results can be achieved by using a charitable lead trust, which is similar to a GRAT except that a charity, and not you, will receive the annuity payments, giving rise to an income tax charitable deduction as well as, potentially, a gift of a remainder interest to your beneficiary that is not subject to transfer taxes. All of the above techniques require careful evaluation, planning and legal documentation. The risks and rewards should be considered. If any of these ideas appeal to you, contact us so we can help you decide whether it makes sense. What other recent developments should I consider when thinking about my personal planning? 1. You may be eligible to make direct gifts to charity from your IRA. In October 2008, Congress renewed, through 2009, the provisions that were in effect for 2006 and 2007, allowing a taxpayer who has attained age 70-1/2 to direct up to $100,000 to be paid from an IRA to any one or more qualifying charities without incurring an income tax liability on the distribution and, accordingly, without having to claim an offsetting charitable deduction. As a result, the charity receives a tax free gift, the distribution counts toward the minimum amounts required to be distributed from the IRA each year, the gift is not subject to the individual limitations on deductions for charitable gifts based upon gross income, and the charitable deduction is not subject to the phase out of itemized deductions based upon gross income. Only certain publicly supported charitable organizations are eligible recipients. If you qualify and this appeals to you, leave plenty of time for the money to actually be delivered to the designated charity before end of the year. Unlike gifts to charities paid by check (which only have to be in the mail on December 31 to qualify for a charitable deduction in the year mailed), we believe that the charity must actually receive the payment from the IRA for the payment to qualify for this treatment in the year received. 2. You may not have to receive a minimum required distribution in The new Worker, Retiree, and Employer Recovery Act of 2008 ( WRERA ) suspends required distributions from defined contribution Page 3

4 plans (including 401(k) and profit sharing plans) and IRAs for A participant or beneficiary who would otherwise be required to take a distribution based on the age of the participant can skip the payment this year due to a temporary provision included in WRERA to provide relief to investors whose plan values collapsed in Proposition 8 may impact planning for same-sex couples in California. Due to the passage of Proposition 8 in California and the ensuing legal challenges, it is currently unclear what status will apply to same-sex couples who married in However, under the Defense of Marriage Act, the federal government does not provide the same beneficial tax treatment to same-sex married couples and registered domestic partners as traditional married couples enjoy. Accordingly, we recommend custom planning for same-sex couples and we will continue to follow the legal developments in this area. 4. The legislature tells us how to create a trust for your pets. New legislation enacted in California that became effective in 2009 provides how to establish trusts for domestic animals and pets, specifically authorizes the trust to last for the pet s lifetime, and provides how such a trust can be enforced and who has the right to make sure the pet is being properly cared for. We have established pet trusts before, but now California tells us how to do it. If a trust for a pet is or should be an important part of our estate plan, now is a good time to address the issues in light of the new legislation. When should I review and update my estate plan? As a general rule, we recommend that you review your estate plan with us every three to four years to be sure it still reflects your intentions, to make sure your assets have been properly transferred to your living trust, and to review beneficiary designations for life insurance, retirement plans and other payable on death accounts. In addition, changes to your plan may be appropriate if there are changes in your family or financial position, such as birth of a child or grandchild; death of a spouse, partner, or child; change in citizenship; divorce (either your own or a family member s); marriage; or the sale of a business. Also, we find that clients commonly change successor trustees or other fiduciary positions when updating their existing document since the person or company that seemed like the ideal candidate to serve as trustee or executor five or ten years ago may no longer be the best choice (or even be in existence). Accordingly, you might want to think about who you have appointed as trustee, executor, guardian, or power of attorney and make changes accordingly, even if nothing else in your estate plan will be changed. If your revocable trust or will makes specific bequests that were based on the size of your estate or particular assets you owned at the time, you might decide to adjust the gifts to reflect your current holdings and net worth. Similarly, if you have made bequests tied to the significantly increased estate or generation-skipping exemption amounts, you might want to determine if the plan leaves sufficient assets to provide support for a surviving spouse or partner and to achieve your other planning goals. Finally, if you and your spouse have a taxable estate of less than $3.5 million, you might decide that your trust should be simplified due to the increase in the estate tax exemption amount and the potential step up in income tax basis on the surviving spouse s assets. Page 4

5 The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact one of the attorneys listed below or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions. George Short T Steve Jung T Christine Ray Santa Barbara Office 21 East Carrillo Street T Santa Barbara, CA Brownstein Hyatt Farber Schreck, LLP. All Rights Reserved. Page 5