WEALTH TRANSFER PLANNING: FORECAST FOR 2012 CLEAR AND...FOGGY

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1 WEALTH TRANSFER PLANNING: FORECAST FOR 2012 CLEAR AND...FOGGY MICHAEL J. BALDWIN Jackson Walker L.L.P. 100 Congress Avenue, Suite 1100 Austin, Texas (512) R. THOMAS GROVES, JR. Jackson Walker L.L.P. 901 Main Street, Suite 6000 Dallas, Texas (214) SAM K. HILDEBRAND Jackson Walker L.L.P. 100 Congress Avenue, Suite 1100 Austin, Texas (512) THE 8TH ANNUAL DALLAS CPA SOCIETY EDUCATION CONFERENCE May 4, 2012 Dallas

2 TABLE OF CONTENTS I. Introduction...1 II. Overview of TRA A. EGTRRA and TRA 2010 a brief history The Economic Growth and Tax Relief Reconciliation Act of 2001 ( EGTRRA )...1 a. EGTRRA basics...1 b. Sunset on EGTRRA....2 c. 2010, the year to Die The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ( TRA 2010 )...2 a. The Baucus Bill....2 b. Compromise Tax Act....2 B. The Return Of The Estate, Gift and Generation Skipping Tax! Say Hello To The Estate Tax And Goodbye To Carryover Basis!...2 a. Remarkable Legislation...2 b. Repeal of the Repeal....2 c. End of Carry-over Basis...3 d. Decedents Dying in e. Extensions to file/pay/disclaim...3 f. Full Section Text: Some Terms Of The New Temporary Deal....4 a. Increase in Applicable Exclusion Amount to $5,000, b. Applicable Exclusion Amount Indexed to Inflation....4 c. Maximum Estate Tax Rate Equal to 35%....4 d. Reunification of Estate and Gift Tax Exemptions....4 e. Generation Skipping Transfer Tax Rate in f. Technical Corrections....5 g. Full Section Text Exemption Portability...6 a. Portability of Exemption....7 b. Full Section Text...7 i

3 4. TRA 2010 SEC a. Extension of Sunset of EGTRRA Two Years....8 b. Full Section Text:...8 III. Current Indications of the Future of Transfer Taxes...9 A. President Obama s Fiscal Year 2013 Revenue Proposals Proposals Carried Over from Prior Fiscal Year Proposals (Some with some tweaks.)...9 a. Return Transfer Taxes to 2009 Levels....9 b. Permanent Portability...9 c. Requirement of Consistency in Value for Transfer Tax and Income Tax Purposes....9 d. Modification of Rules Regarding Valuation Discounts...10 e. Require a Minimum Term for GRATs f. Limit the Duration of the Generation-Skipping Transfer Tax Exemption New Proposals in 2012 Budget a. Coordinate Certain Income and Transfer Tax Rules Applicable To Grantor Trusts...13 b. Extend the Lien on Estate Tax Deferrals Provided Under Code Section B. Death Tax Repeal Permanency Act House: H.R. 1259, Death Tax Repeal Permanency Act of 2011; Introduced 3/30/2011; Referred to Committee 3/30/2011; Sponsor: Senate: Repeal of Estate Tax...14 a. Effective Date b. Special effective date with respect to Qualified Domestic Trusts Repeal of Generation-Skipping Transfer Tax Retain Basis Adjustment at Death Retain Gift Tax...14 a. $5 million gift tax exemption...14 b. 35% gift tax rate...14 ii

4 7. Probability of Passage a. H.R. 1259:...15 b. S. 2242:...15 C. H.R. 3467, Sensible Estate Tax Act of Introduced 11/17/2011; Referred to Committee Contains interesting draft language that may form the basis for future transfer tax legislation Features:...15 a. Reduce estate tax exemption to $1 million (with inflation adjustments since 2000);...15 b. Increase estate tax rates above 35%, with broadening of brackets (which would be indexed for inflation), and application of 55% rate to estates in excess of $10 million;...15 c. Elimination of possibility of clawback for donors who make gifts of $5 million using gift tax exemption;...15 d. Re-institution of state death tax credit and elimination of the deduction for state death taxes;...15 e. Limitation of valuation discounts on nonbusiness assets;...15 f. Required consistency of basis for estate and gift tax purposes and income tax purposes and required reporting by executors/donors regarding values of interests reported on estate or gift tax returns;...15 g. Revision of GRAT rules to require 10-year minimum term, a valuation of the remainder interest at greater than zero, and a prohibition of declining GRAT payments;...15 h. Limit on effectiveness of allocation of GST exemption for trusts to 90 years Effective Date: Probability of Passage D. So, What s the Buzz? Rumors Regarding Supercommittee When Will Congress Act?...16 a. Very unlikely any action before November elections...16 b. Elections, and possible shifts in control, will have a significant impact on the transfer tax issues...16 c. Predictions this year of the results of the election are extremely difficult because of many factors, such as Occupy Wall Street, unemployment rates, international finances, gas prices, etc...16 iii

5 3. What Will Congress Do?...16 a. Nothing...16 b. Follow President s Budget Proposals c. Maintain 2012 Rules d. Eliminate Estate Tax Retroactive Law?...16 IV. For Big Estates, 2012 is Opportunity of a Lifetime...17 A. Gifts Using the $5.12 Million Exclusion the Opportunity...17 B. Opportunity or Trap Recapture/Clawback Source of the Issue...18 a. Adjusted Taxable Gifts/Gift Exemption/Estate Exemption b. Form 706 Computation Instructions Potential Problems with Clawback...19 a. Donor/Decedent s Estate Passes to Spouse or Charity b. Insufficient Assets in Decedent s Estate to Pay Additional Estate Tax c. Use of Portability Exemption d. Conflicts Among Beneficiaries Does Clawback Apply Under TRA 2010? Gift Planning With Possibility that Clawback Applies a. No Worse Off in Terms of Estate Tax Liability b. Significant Benefits of Gifts...20 c. Possibility of Permanent $5 Million Exemptions or Elimination of Possibility of Clawback d. Tax Apportionment/ Net Gifts C. Three Primary Techniques Dynasty Trusts Exclusion Trust for Spouse Self Settled Trusts D. Gift Enhancers Transfers Involving Valuation Discounts Grantor Trusts E. Additional Planning Ideas for the Very Wealthy...26 iv

6 1. Grantor Retained Annuity Trusts Qualified Personal Residence Trusts Life Insurance Planning Charitable Gifts a. IRA Charitable Rollover...28 b. Conservation Easements...28 c. CLAT...29 V. Planning for Estates of $5 million to $10 Million...29 A. Medium Sized Estates It s a Moving Target Currently Included in Top 1% Economic Tier...29 B. Lifetime Planning The Problem: If I Die Planning Until Client Has a When I Die Mindset...30 a. Review Or Execute And Organize Documents And Gather Information b. Update Wills/Revocable Trust/Other Disposition Instruments to Reflect Client s Current Wishes c. Does Client Need To Pre-Plan For Probate Contest?...33 d. Review State Law Issues...33 e. Review Assets Planning When Client Has a When I Die Mindset a. Gift Planning Some Other Matters...36 a. Marriage in contemplation of death b. Planning To Meet 35% Tests...36 c. Recognize Losses...36 d. Loans from Grantor Trusts...36 e. Sell Assets For Long-Term Notes C. Planning For Dispositions at Death Marital/Exemption Formula and Non-Formula Dispositions D. Asset Ownership in Planning for Spouses who have a Middle Sized Estate...36 v

7 1. Asset Ownership Impacts Success of Plan Transfers from Wealthier Spouse to Less Wealthy Spouse Are You Nuts?...37 a. Portability b. Dealing with Asset Control Issues In Connection with Transfers from Wealthier Spouse for Less Wealthy Spouse...38 E. Planning of Retirement Plan Distributions for Client with Middle Sized Estate Dealing with the Double Whammy of Income Tax and Estate Tax Retirement Assets can be the Most Significant Asset Planning for Married Couple Not Covered Overview of Income Tax Rules a. As a General Rule b. Inherited Accounts Estate Tax and QRPs/IRAs Income Tax Deduction for Federal Estate Tax on IRD...42 a. Amount of Estate Tax Attributable to the IRD...42 b. Reduction of Deduction for Estate Tax Credit c. Itemized Deduction...42 d. Distribution Received by Estate or Trust e. Special Rules Planning Opportunities a. For Clients Whose Estates Will Likely be Near the $5 Million Exemption, Consider a Pre-Mortem Roth IRA Conversion...43 b. Charitable Bequests of IRD, Especially if the Income Tax Rates and Estate Tax Rates are Higher in Future Years VI. Planning for Estate Less than $5 Million...44 A. Flexibility is the Key...44 B. Disclaimer Planning...44 vi

8 1. Disclaimer Basics IRC Brief Disclaimers in Texas - Texas Probate Code 37A Planning with Partial Disclaimers a. Undivided Portion of Property. Pursuant to 2518(c)(1), a qualified disclaimer may be made of an undivided portion of property b. Severable Property c. Powers of Appointment...47 d. Pecuniary Disclaimers Traditional Disclaimer Trust Planning C. Portability Rationale The Basic Rule Definition of Deceased Spouse Unused Exclusion Amount Required Estate Tax Return Effect on Statute of Limitation Limited to Surviving Spouse s Last Deceased Spouse s Amount Effect of Divorce Can Portable Amount be Passed to Successive Spouses? Applies to Gift Tax Too Does Not Apply to GST Tax Exemption Only Applies During 2011 and Advantages of Bypass Trust Planning Over Portability Advantages of Portability Over Bypass Trust Planning The Basis Adjustment Factor Important Benefit for Qualified Plans and IRAs...51 D. Use of Formulas Historical Perspective Potential for Not Achieving Testator s Intent Potential Loss of Basis Adjustment Without Estate Tax Savings Develop Better Formulas The Single QTIP-able Trust Other Means of Achieving Basis Adjustment Also Need to Analyze GST Exemption Formula Allocations E. Powers of Appointment...53 F. Discretionary distributions...54 G. Trust Protectors...54 VII. Conclusion...55 vii

9 WEALTH TRANSFER PLANNING: FORECAST FOR 2012 CLEAR AND... FOGGY! I. Introduction On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of According to the statute, that is the legislation s short title. In this article, the authors will refer to this legislation in an even shorter name, TRA 2010, which seems vastly superior to some other attempts to shorten the name, such as TRUIRJCA. The article will first give a brief overview of the new legislation. After this overview, the article will turn to its primary focus: planning for 2012 and beyond. This portion of the article is divided into three parts: (1) planning for for ultra-wealthy through use of large lifetime gifts, (2) planning for the moderately wealthy, and (3) planning for the clients with more modest means (you know, those who are merely millionairs, but not really rich people). In this article, the term estate tax exclusion amount means the applicable exclusion amount defined in Section 2010 of the Internal Revenue Code. This term is often referred to as the estate tax exemption and sometimes somewhat incorrectly as the unified credit. For 2012, this amount is $5.12 million. Also, this article uses the term gift tax exclusion amount to refer to the exclusion amount applicable for gift tax purposes, which is determined in Section 2505(a)(1) of the Internal Revenue Code by reference to Section In accordance with unification, this amount is also $5.12 million for II. Overview of TRA 2010 A. EGTRRA and TRA 2010 a brief history. 1. The Economic Growth and Tax Relief Reconciliation Act of 2001 ( EGTRRA ). a. EGTRRA basics. The most significant and far reaching changes to the federal estate, gift and generation skipping tax (certainly since 1986) came to practitioners in 2001 in the form of EGTRRA. Under EGTRRA, the amount that an individual could transfer at death on a tax-free basis (the applicable exemption amount ) was immediately increased to $1,000,000 per person (from $675,000). From 2001 to 2009, the applicable exemption amount gradually increased to $3,500, In 2010, the estate tax and generation skipping tax were completely repealed. In addition to the increase in applicable exemption amount, the highest marginal estate tax rates were decreased from 55% in 2000 to 45% in The gift tax exemption was similarly increased under EGTRRA to $1,000,000 in However, presumable to prevent individuals from making gifts for income tax planning purposes, the gift tax applicable exemption remained at $1,000,000, effectively de-unifying the gift and estate tax. The top marginal rate for gifts was also decreased from 55% in 2000 to 35% 1

10 in The gift tax remained after the repeal of the estate tax in order to dissuade income tax motivated gifts. b. Sunset on EGTRRA. In order for EGTRRA (or any other tax act having an effect lasting more than 10 years) to be made permanent, 60 votes were needed in the Senate. Because the Senate couldn t muster the needed 60 votes, EGTRRA was schedule to go the way of the dinosaur on December 31, c. 2010, the year to Die. Since the passage of EGTRRA practitioners have nearly universally thought that Congress would act to prevent a complete repeal of the estate tax in 2010, followed by the reinstatement of the estate tax and generation skipping tax at 2000 rates, pursuant to the sunset provisions. Amazingly, despite the planning (and public policy) nightmare of the above scenario, Congress failed to act and we were in exactly this situation. 2. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ( TRA 2010 ). a. The Baucus Bill. Setting the stage for the compromise bill, in early December, Sen. Max Baucus (D-MT) introduced a bill that permanently reinstated the estate, generation skipping and gift tax at the 2009 applicable exemption level and rates. The bill failed to achieve a filibuster proof total. b. Compromise Tax Act. President Obama and the GOP leadership reached a consensus on a compromise tax plan on December 6, 2010, TRA TRA 2010 extended the majority of EGTRRA for two additional years, and made significant changes to the estate, gift and generation skipping tax. TRA 2010 was signed into law on December 17 th by President Obama. B. The Return Of The Estate, Gift and Generation Skipping Tax! (TRA TITLE III Temporary Estate Tax Relief.) 1. Say Hello To The Estate Tax And Goodbye To Carryover Basis! (TRA SEC REINSTATEMENT OF ESTATE TAX: REPEAL OF CARRYOVER BASIS.) a. Remarkable Legislation. Credit should be given to Congress when credit is due. And frankly, Title III of TRA 2010 is a remarkable piece of legislation. With a big assist from the AICPA, the American Bar Association and the American College of Trust and Estate Counsel ( ACTEC ), Congress, for the most part got it right. b. Repeal of the Repeal. Subtitle A of title V of EGTRRA effectively repealed the estate tax and generation skipping tax by making both the estate tax and generation skipping tax inapplicable to decedent s who died after December 31, Section 301(a) of TRA 2010 repeals the repeal as follows, Each provision of law amended by subtitle A... of title V of the Economic Growth and Tax Reconciliation Act of 2001 is amended to read as such provision would read if such subtitle had never been enacted (emphasis added). 2

11 c. End of Carry-over Basis. The image of a renewed carry-over basis regime caused many a sleepless night for both accountants and attorneys. Subject to some special rules for 2010, with the reinstatement of the estate tax, TRA 2010 also reinstated the decedent s basis adjustment by repealing EGTRRA subtitle E, Title V. d. Decedents Dying in In order to avoid a constitutional battle in relation to a retroactive reinstatement of the estate tax effective as of January 1, 2010, the legislation creatively gives the executor a choice of the law under EGTRRA of the law under Sec. 301(c) of TRA This provision is explored in much greater detail in Section III within. e. Extensions to file/pay/disclaim. For those decedent s who died prior to December 17 th, 2010, an extension of 9 months is granted from the date of enactment (September 19, 2012) to file estate tax returns, pay estate taxes and make disclaimers (subject to State law). f. Full Section Text: SEC REINSTATEMENT OF ESTATE TAX; REPEAL OF CARRYOVER BASIS. (a) IN GENERAL. Each provision of law amended by subtitle A or E of title V of the Economic Growth and Tax Relief Reconciliation Act of 2001 is amended to read as such provision would read if such subtitle had never been enacted. (b) CONFORMING AMENDMENT. On and after January 1, 2011, paragraph (1) of section 2505(a) of the Internal Revenue Code of 1986 is amended to read as such paragraph would read if section 521(b)(2) of the Economic Growth and Tax Relief Reconciliation Act of 2001 had never been enacted. (c) SPECIAL ELECTION WITH RESPECT TO ESTATES OF DECEDENTS DYING IN Notwithstanding subsection (a), in the case of an estate of a decedent dying after December 31, 2009, and before January 1, 2011, the executor (within the meaning of section 2203 of the Internal Revenue Code of 1986) may elect to apply such Code as though the amendments made by subsection (a) do not apply with respect to chapter 11 of such Code and with respect to property acquired or passing from such decedent (within the meaning of section 1014(b) of such Code). Such election shall be made at such time and in such manner as the Secretary of the Treasury or the Secretary s delegate shall provide. Such an election once made shall be revocable only with the consent of the Secretary of the Treasury or the Secretary s delegate. For purposes of section 2652(a)(1) of such Code, the determination of whether any property is subject to the tax imposed by such chapter 11 shall be made without regard to any election made under this subsection. (d) EXTENSION OF TIME FOR PERFORMING CERTAIN ACTS. (1) ESTATE TAX. In the case of the estate of a decedent dying after December 31, 2009, and before the date of the enactment of this Act, the due date for (A) 3

12 filing any return under section 6018 of the Internal Revenue Code of 1986 (including any election required to be made on such a return) as such section is in effect after the date of the enactment of this Act without regard to any election under subsection (c), (B) making any payment of tax under chapter 11 of such Code, and (C) making any disclaimer described in section 2518(b) of such Code of an interest in property passing by reason of the death of such decedent, shall not be earlier than the date which is 9 months after the date of the enactment of this Act. (2) GENERATION-SKIPPING TAX. In the case of any generation-skipping transfer made after December 31, 2009, and before the date of the enactment of this Act, the due date for filing any return under section 2662 of the Internal Revenue Code of 1986 (including any election required to be made on such a return) shall not be earlier than the date which is 9 months after the date of the enactment of this Act. H. R (e) EFFECTIVE DATE. Except as otherwise provided in this section, the amendments made by this section shall apply to estates of decedents dying, and transfers made, after December 31, Some Terms Of The New Temporary Deal. (TRA SEC MODIFICATION TO ESTATE, GIFT, AND GENERATION SKIPPING TRANSFER TAXES) a. Increase in Applicable Exclusion Amount to $5,000,000. Under TRA 2010 Sec. 302(a)(1) the amount an individual may pass estate tax free upon death (the Applicable Exemption Amount ) is increased to $5,000,000. b. Applicable Exclusion Amount Indexed to Inflation. Pursuant to TRA-2010 Sec. 302(a)(1), the Applicable Exemption amount is now indexed to inflation and will increase in $10,000 increments. c. Maximum Estate Tax Rate Equal to 35%. Pursuant to TRA 2010 Sec. 302(a)(2), the maximum estate tax rate is now 35%. d. Reunification of Estate and Gift Tax Exemptions. Pursuant to TRA 2010 Sec. 302(b)(1), the gift tax exemption and the estate tax exemption are once again reunified at $5,000,000. Pursuant to Sec. 302(b)(2), the provisions of EGTRRA limiting the gift tax to the maximum income tax rate are no longer applicable and are thus repealed. It is important to note however that the effective date for the increased gift tax exemptions is January 1, e. Generation Skipping Transfer Tax Rate in Pursuant to TRA 2010 Sec. 302(c), the generation skipping transfer tax was reinstituted effective January 1, 2010, however, the tax rate for generation skipping transfers was zero. All other rules pertaining to the generation skipping transfer tax do however apply. 4

13 f. Technical Corrections. Sec. 302(d) and Sec. 302(g) provide a rather complicated formula/mechanism for calculating estate and gift taxes when prior gift taxes have been paid. g. Full Section Text. SEC MODIFICATIONS TO ESTATE, GIFT, AND GENERATION- SKIPPING TRANSFER TAXES. (a) MODIFICATIONS TO ESTATE TAX. (1) $5,000,000 APPLICABLE EXCLUSION AMOUNT. Subsection (c) of section 2010 is amended to read as follows: (c) APPLICABLE CREDIT AMOUNT. (1) IN GENERAL. For purposes of this section, the applicable credit amount is the amount of the tentative tax which would be determined under section 2001(c) if the amount with respect to which such tentative tax is to be computed were equal to the applicable exclusion amount. (2) APPLICABLE EXCLUSION AMOUNT. (A) IN GENERAL. For purposes of this subsection, the applicable exclusion amount is $5,000,000. (B) INFLATION ADJUSTMENT. In the case of any decedent dying in a calendar year after 2011, the dollar amount in subparagraph (A) shall be increased by an amount equal to (i) such dollar amount, multiplied by (ii) the cost-of-living adjustment determined under section 1(f)(3) for such calendar year by substituting calendar year 2010 for calendar year 1992 in subparagraph (B) thereof. If any amount as adjusted under the preceding sentence is not a multiple of $10,000, such amount shall be rounded to the nearest multiple of $10,000.. (2) MAXIMUM ESTATE TAX RATE EQUAL TO 35 PERCENT. Subsection (c) of section 2001 is amended (A) by striking Over $500,000 and all that follows in the table contained in paragraph (1) and inserting the following: Over $500, $155,800, plus 35 percent of the excess of such amount over $500,000., (B) by striking (1) IN GENERAL., and (C) by striking paragraph (2). (b) MODIFICATIONS TO GIFT TAX. (1) RESTORATION OF UNIFIED CREDIT AGAINST GIFT TAX. (A) IN GENERAL. Paragraph (1) of section 2505(a), after the application of section 301(b), is amended by striking (determined as if the applicable exclusion amount were $1,000,000). (B) EFFECTIVE DATE. The amendment made by this paragraph shall apply to gifts made after December 31, (2) MODIFICATION OF GIFT TAX RATE. On and after January 1, 2011, subsection (a) of section 2502 is amended to read as such subsection would read 5

14 if section 511(d) of the Economic Growth and Tax Relief Reconciliation Act of 2001 had never been enacted. H. R (c) MODIFICATION OF GENERATION-SKIPPING TRANSFER TAX. In the case of any generation-skipping transfer made after December 31, 2009, and before January 1, 2011, the applicable rate determined under section 2641(a) of the Internal Revenue Code of 1986 shall be zero. (d) MODIFICATIONS OF ESTATE AND GIFT TAXES TO REFLECT DIFFERENCES IN CREDIT RESULTING FROM DIFFERENT TAX RATES. (1) ESTATE TAX. (A) IN GENERAL. Section 2001(b)(2) is amended by striking if the provisions of subsection (c) (as in effect at the decedent s death) and inserting if the modifications described in subsection (g). (B) MODIFICATIONS. Section 2001 is amended by adding at the end the following new subsection: (g) MODIFICATIONS TO GIFT TAX PAYABLE TO REFLECT DIFFERENT TAX RATES. For purposes of applying subsection (b)(2) with respect to 1 or more gifts, the rates of tax under subsection (c) in effect at the decedent s death shall, in lieu of the rates of tax in effect at the time of such gifts, be used both to compute (1) the tax imposed by chapter 12 with respect to such gifts, and (2) the credit allowed against such tax under section 2505, including in computing (A) the applicable credit amount under section 2505(a)(1), and (B) the sum of the amounts allowed as a credit for all preceding periods under section 2505(a)(2).. (2) GIFT TAX. Section 2505(a) is amended by adding at the end the following new flush sentence: For purposes of applying paragraph (2) for any calendar year, the rates of tax in effect under section 2502(a)(2) for such calendar year shall, in lieu of the rates of tax in effect for preceding calendar periods, be used in determining the amounts allowable as a credit under this section for all preceding calendar periods.. (e) CONFORMING AMENDMENT. Section 2511 is amended by striking subsection (c). (f) EFFECTIVE DATE. Except as otherwise provided in this subsection, the amendments made by this section shall apply to estates of decedents dying, generation-skipping transfers, and gifts made, after December 31, Exemption Portability. (TRA SEC APPLICABLE EXCLUSION AMOUNT INCREASED BY UNUSED EXCLUSION AMOUNT OF DECEASED SPOUSE.) 6

15 a. Portability of Exemption. Portability is described in detail in Article VI of the paper. Sufficed to say however, practitioners have for years discussed the prospects of a system that would allow a spouse to use his or her deceased spouse s unused exemption. Sec. 303 does its best to accomplish this goal. b. Full Section Text. SEC APPLICABLE EXCLUSION AMOUNT INCREASED BY UNUSED EXCLUSION AMOUNT OF DECEASED SPOUSE. (a) IN GENERAL. Section 2010(c), as amended by section 302(a), is amended by striking paragraph (2) and inserting the following new paragraphs: (2) APPLICABLE EXCLUSION AMOUNT. For purposes of this subsection, the applicable exclusion amount is the sum of (A) the basic exclusion amount, and (B) in the case of a surviving spouse, the deceased spousal unused exclusion amount. (3) BASIC EXCLUSION AMOUNT. (A) IN GENERAL. For purposes of this subsection, the basic exclusion amount is $5,000,000. (B) INFLATION ADJUSTMENT. In the case of any decedent dying in a calendar year after 2011, the dollar H. R amount in subparagraph (A) shall be increased by an amount equal to (i) such dollar amount, multiplied by (ii) the cost-of-living adjustment determined under section 1(f)(3) for such calendar year by substituting calendar year 2010 for calendar year 1992 in subparagraph (B) thereof. If any amount as adjusted under the preceding sentence is not a multiple of $10,000, such amount shall be rounded to the nearest multiple of $10,000. (4) DECEASED SPOUSAL UNUSED EXCLUSION AMOUNT. For purposes of this subsection, with respect to a surviving spouse of a deceased spouse dying after December 31, 2010, the term deceased spousal unused exclusion amount means the lesser of (A) the basic exclusion amount, or (B) the excess of (i) the basic exclusion amount of the last such deceased spouse of such surviving spouse, over (ii) the amount with respect to which the tentative tax is determined under section 2001(b)(1) on the estate of such deceased spouse. (5) SPECIAL RULES. (A) ELECTION REQUIRED. A deceased spousal unused exclusion amount may not be taken into account by a surviving spouse under paragraph (2) unless the executor of the estate of the deceased spouse files an estate tax return on which such amount is computed and makes an election on such return that such amount may be so taken into account. Such election, once made, shall be irrevocable. No election may be made under this subparagraph if such return is 7

16 filed after the time prescribed by law (including extensions) for filing such return. (B) EXAMINATION OF PRIOR RETURNS AFTER EXPIRATION OF PERIOD OF LIMITATIONS WITH RESPECT TO DECEASED SPOUSAL UNUSED EXCLUSION AMOUNT. Notwithstanding any period of limitation in section 6501, after the time has expired under section 6501 within which a tax may be assessed under chapter 11 or 12 with respect to a deceased spousal unused exclusion amount, the Secretary may examine a return of the deceased spouse to make determinations with respect to such amount for purposes of carrying out this subsection. (6) REGULATIONS. The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out this subsection.. (b) CONFORMING AMENDMENTS. (1) Paragraph (1) of section 2505(a), as amended by section 302(b)(1), is amended to read as follows: (1) the applicable credit amount in effect under section 2010(c) which would apply if the donor died as of the end of the calendar year, reduced by. (2) Section 2631(c) is amended by striking the applicable exclusion amount and inserting the basic exclusion amount. (3) Section 6018(a)(1) is amended by striking applicable exclusion amount and inserting basic exclusion amount. (c) EFFECTIVE DATES. H. R (1) IN GENERAL. Except as provided in paragraph (2), the amendments made by this section shall apply to estates of decedents dying and gifts made after December 31, (2) CONFORMING AMENDMENT RELATING TO GENERATIONSKIPPING TRANSFERS. The amendment made by subsection (b)(2) shall apply to generation-skipping transfers after December 31, THIS TITLE. 4. TRA 2010 SEC APPLICATION OF EGTRRA SUNSET TO a. Extension of Sunset of EGTRRA Two Years. The sun set on EGTRRA on December 31, Sec. 304 references the amended Section 901 of EGTRRA. Oddly, the amendment to section 901 of EGTRRA is contained within TRA 2010 Section 101! b. Full Section Text: SEC APPLICATION OF EGTRRA SUNSET TO THIS TITLE. Section 901 of the Economic Growth and Tax Relief Reconciliation Act of 2001 shall apply to the amendments made by this section. 8

17 III. Current Indications of the Future of Transfer Taxes A. President Obama s Fiscal Year 2013 Revenue Proposals. The General Explanations of the Administration s Fiscal Year 2013 Revenue Proposals the Greenbook providing details of President Obama s budget proposals, was released on 2/13/ Proposals Carried Over from Prior Fiscal Year Proposals (Some with some tweaks.) a. Return Transfer Taxes to 2009 Levels. i. Estate and GST Exemptions: $3.5 million, with an essentially flat tax of 41% above the exemption ii. iii. Gift Exemption: $1 million with an almost flat gift tax (starting at 41%) for cumulative taxable gifts over the exemption. Effective Date: Estates of decedents and transfers made after 12/31/2012. b. Permanent Portability. Exemption portability between spouses enacted in December 2010 would be made permanent i. Estate exemption would be set $3.5 million and gift exemption at $1 million. ii. Effective Date: Estates of decedents and transfers made after 12/31/2012. c. Requirement of Consistency in Value for Transfer Tax and Income Tax Purposes. This proposal would require the value of property transferred at death or by gift that is used to compute the recipient s basis (in the case of transfers by gift, where the donor s basis exceeds fair market value) to be the value that for estate or gift tax purposes. i. Based in fair market value as finally determined for estate or gift tax purposes. ii. iii. Imposes a reporting requirement on the executor of the decedent s estate and on the donor of a lifetime gift to provide the necessary valuation and basis information to both the recipient and to the IRS. Grants regulatory authority to provide details regarding implementation and administration, including rules for situations in which no estate tax return is required to be 9

18 filed or gifts are excluded from gift tax under Code section 2503, for situations in which the surviving joint tenant or other recipient may have better information than the executor, and for the timing of the required reporting in the event of adjustments to reported values subsequent to filing an estate or gift tax return. iv. Effective Date: Transfers on or after date of enactment. d. Modification of Rules Regarding Valuation Discounts. The Greenbook notes that (a) the purpose of Chapter 14 of the Code (sections 2701 through 2704) were enacted to prevent the reduction of taxes through the use of estate freezes and other techniques designed to reduce the value of the transferor s taxable estate and discount the value of the taxable transfer to the beneficiaries without reducing the economic benefit to the beneficiaries, and that (b) generally Code section 2704(b) provides that certain applicable restrictions (that would normally justify discounts in the value of the interests transferred) are to be ignored in valuing interests in family-controlled entities if those interests are transferred by gift or on death to or for the benefit of other family members. The Greenbook also notes that (a) judicial decisions and the enactment of new statutes in most states have, in effect, made section 2704(b) inapplicable to many situations by recharacterizing restrictions such that they no longer fall within the definition of an applicable restriction (b) the IRS has identified other arrangements designed to circumvent the application of section i. The proposal would create an additional category of restrictions, which the Greenbook defines as disregarded restrictions ) that would be ignored in valuing an interest in a family-controlled entity that is transferred to a member of the family, if after the transfer the restriction would lapse could be removed by the transferor or the transferor s family. ii. iii. iv. In such cases, the transferred interests would be valued by substituting for the disregarded restrictions certain assumptions to be specified in regulations. Disregarded restrictions would include limitations on a holder s right to liquidate that holder s interest that are more restrictive than a standard to be identified in regulations and would also include any limitation on a transferee s ability to be admitted as a full partner or to hold an equity interest in the entity. In determining whether a restriction may be removed by members of the family after the transfer, certain interests, to be identified in regulations, held by charities or others who are not family members of the transferor would be deemed to be held by the family. 10

19 v. Regulatory authority would be granted, including the ability to create safe harbors to permit taxpayers to draft the governing documents of a family-controlled entity so as to avoid the application of section 2704 if certain standards are met. vi. vii. The proposal would make conforming clarifications with regard to the interaction of this proposal with the transfer tax marital and charitable deduction. Effective Date: Transfers, after the date of enactment, of property subject to restrictions created after 10/8/1990, the effective date of Code section e. Require a Minimum Term for GRATs. The Greenbook notes that taxpayers have become adept at maximizing the benefit of this technique, often by minimizing the term of the GRAT (thus reducing the risk of the grantor s death during the term), in many cases to two years, and by retaining annuity interests significant enough to reduce the gift tax value of the remainder interest to zero or to a number small enough to generate only a minimal gift tax liability. i. The proposal would amend Code section 2702 to require a minimum term of ten years and a maximum term equal to the life expectancy of the annuitant plus 10 years. This would limit the use of very long-term Walton style : GRATs with a low annual payout that would result in a reduced inclusion in the gross estate under Treasury Regulation section (c)(2)(i). ii. iii. iv. The remainder interests in the GRAT would be required to have a value greater than zero at the time the interest is created, and would prohibit any decrease in the annuity during the GRAT term. The proposal confirms that a minimum term would not prevent zeroing-out the gift tax value of the remainder interests (obviously, near zeroing-out is what is meant), the Greenbook notes that it would increase the risk that the grantor fails to outlive the GRAT term and the resulting loss of any anticipated transfer tax benefit. Effective Date: GRATs created after the date of enactment. f. Limit the Duration of the Generation-Skipping Transfer Tax Exemption. The Greenbook notes that at the time of the enactment of the GST provisions of the Code, the law of most (all but about three) states included the common law Rule Against Perpetuities or some statutory version of it, and that many states have either repealed or limited the application of their Rule Against Perpetuity statutes, with the effect that trusts created subject 11

20 to the law of those jurisdictions may continue in perpetuity, so that the transfer tax shield provided by the GST exemption effectively has been expanded from trusts funded with $1 million (the GST exemption at the time of enactment) and a maximum duration limited by the Rule Against Perpetuities), to trusts funded with the current GST exemption, $5,12 million, and continuing and growing in perpetuity. i. The proposal would provide that 90 years after the creation of a trust the GST exemption allocated to the trust would terminate, by increasing the inclusion ratio of the trust to one, thereby rendering no part of he trust exempt from GST tax. ii. iii. Because contributions to a trust from a different grantor are deemed to be held in a separate trust under Code section 2654(b), each such separate trust would be subject to the same 90-year rule, measured from the date of the first contribution by the grantor of that separate trust. The special rule for pour-over trusts under Code section 2653(b)(2) would continue to apply to pour-over trusts and to trusts created under a decanting authority, and for purposes of this rule, such trusts are deemed to have the same date of creation as the initial trust, with one exception: (A) If, before the 90 th anniversary of the trust, trust property is distributed to a trust for a beneficiary of the initial trust and the distribute trust is as described in section 2642(c)(2), the inclusion ratio of the distribute truest will not be changed to one (with regard to the distribution from the initial trust) by reason of this rule. (B) The exception is intended to permit an incapacitated beneficiary s distribution to continue to be held in a trust without incurring GST tax on distributions to the beneficiary as long as that trust is to be used for the sole benefit of that beneficiary and any trust balance remaining on the beneficiary s death will be included in the beneficiary s gross estate for federal estate tax purposes. iv. An express grant of regulatory authority would be included to facilitate the implementation and administration of this provision. 12

21 v. Effective Date: Trusts created after enactment, and to the portion of a pre-existing trust attributable to additions to such truest made after that date (subject to rules substantially similar to the grandfather rules currently in effect for additions to trusts created prior to the effective date of the GST tax) 2. New Proposals in 2012 Budget. a. Coordinate Certain Income and Transfer Tax Rules Applicable To Grantor Trusts. Simply put, the proposal would include the date-of-death value of all grantor trusts in the grantor s gross estate and subject that value to estate tax. Specifically, the proposal states that to the extent that the income tax rules treat a grantor of a trust as an owner of the trust, the proposal would (1) include the assets of the trust in the gross estate of that grantor for estate tax purposes, (2) subject to gift tax any distributions from the trust to one or more beneficiaries during he grantors life, and (3) subject to gift tax the remaining trust assets at any time during the grantor's life if the grantor ceases to be treated as the owner of the trust for income tax purposes.... The proposal would reduce the amount subject to transfer tax by the value of any taxable gift made to the trust by the deemed owner. The transfer tax imposed by this proposal would be payable from the trust. The same rule would apply to trusts where, under Code section 678, a person other than the grantor is treated as the owner of the trust for income tax purposes, if that person sells assets to the trust (as to the sale transaction assets, the proposal would apply to the income and appreciation therefrom.) i. Very broad proposal (A) (B) Would apparently subject many ILITs to estate tax because the authority (at least implicitly) to use trust income to pay premiums could confer grantor trust status under Code section 677(a)(3) Grantor trust status for income tax purposes can come or go under Code section 674 with changes in the trustee or can depend on spousal attribution under Code sections 672(e) and 677(a), concepts that would be anomalies in the estate tax arena. ii. iii. No Change in Treatment of Trust Already Includible in Grantor s Estate Under Existing Code Provisions, including without limitation grantor retained income trusts, grantor retained annuity trusts, personal residence trusts, and qualified personal residence trusts. Effective Date: To trusts created on or after the date of enactment and to other trusts to the extent of contributions made on or after the date of enactment. With respect to contributions to pre-enactment trusts, the proposal states 13

22 that regulatory authority would be granted, including the ability to create transition relief for certain types of automatic, periodic contributions to existing grantor trusts. This is presumably aimed, for example, at ILITs, where the periodic payment of premiums, which not exactly automatic, is typically done under the terms of a preexisting insurance contract. b. Extend the Lien on Estate Tax Deferrals Provided Under Code Section Although this proposal would make no change to substantive tax rules, the proposal to extend the 10-year estate tax lien under Code section 6324(a)(1) to cover the last 4 years and 9 months of the potential deferral period under Code section 6166 will be very important as a practical matter to some successors to family businesses. Effective Date: To the estates of decedents dying on or after the date of enactment and the estates of decedents who died before the date of enactment if the 10-year lien under Code section 6324(a)(1) had not expired before the date of enactment. B. Death Tax Repeal Permanency Act 1. House: H.R. 1259, Death Tax Repeal Permanency Act of 2011; Introduced 3/30/2011; Referred to Committee 3/30/2011; Sponsor: Rep. Kevin Brady (R-TX); 206 Co-Sponsors: 3 Democrats and 203 Republicans 2. Senate: S. 2242, Death Tax Repeal Permanency Act of 2012; Introduced 3/28/2012; Sponsor: Sen John Thune (R-SD); 35 Co-Sponsors: All Republicans 3. Repeal of Estate Tax. enactment. a. Effective Date. Estates of decedent s dying on or after the date if b. Special effective date with respect to Qualified Domestic Trusts. With respect to a QDOT for a surviving spouse of a decedent dying before the date of enactment, the special estate tax applicable to distributions from the trust will apply for a period of 10 years after the date of enactment, and the estate tax on the property of the trust on the death of the surviving spouse will not apply on or after the date of enactment. 4. Repeal of Generation-Skipping Transfer Tax. Effective Date: Generation-skipping transfers on or after the date of enactment. 5. Retain Basis Adjustment at Death. 6. Retain Gift Tax. a. $5 million gift tax exemption b. 35% gift tax rate 14

23 7. Probability of Passage. Per GovTrack.com: a. H.R. 1259: 1% chance of being enacted. b. S. 2242: 1% chance of being enacted. C. H.R. 3467, Sensible Estate Tax Act of Introduced 11/17/2011; Referred to Committee. 11/12/2011; Sponsor: Rep. Jim McDermott (D-WA) (who has introduced similar legislation in prior years, none of which has gone anywhere); Co-Sponsor: Rep. Charles Rangel (D-NY). 2. Contains interesting draft language that may form the basis for future transfer tax legislation. 3. Features: a. Reduce estate tax exemption to $1 million (with inflation adjustments since 2000); b. Increase estate tax rates above 35%, with broadening of brackets (which would be indexed for inflation), and application of 55% rate to estates in excess of $10 million; c. Elimination of possibility of clawback for donors who make gifts of $5 million using gift tax exemption; d. Re-institution of state death tax credit and elimination of the deduction for state death taxes; e. Limitation of valuation discounts on nonbusiness assets; f. Required consistency of basis for estate and gift tax purposes and income tax purposes and required reporting by executors/donors regarding values of interests reported on estate or gift tax returns; g. Revision of GRAT rules to require 10-year minimum term, a valuation of the remainder interest at greater than zero, and a prohibition of declining GRAT payments; 90 years. h. Limit on effectiveness of allocation of GST exemption for trusts to 4. Effective Date: January 1, Probability of Passage. Per GovTrack.com: 0% D. So, What s the Buzz? 15

24 1. Rumors Regarding Supercommittee. In November of 2011, there were rumors that the Supercommittee would recommend reducing the gift exemption below $5 million effective 11/23/2011; however, the rumors proved to be groundless. 2. When Will Congress Act? For those wealth planners who will still (notwithstanding the experience) make predictions regarding timing of action by Congress, the most popular prognostication is that it is unlikely that Congress will act before the end of a. Very unlikely any action before November elections. b. Elections, and possible shifts in control, will have a significant impact on the transfer tax issues. i. Senate now has 51 Democrats and 2 Independents that caucus with the Democrats (and 23 of those 53 are up for reelection), and there are 47 Republicans (with only 10 up for reelection). ii. House Republicans are defending a larger number of firstterm candidates. Historically, when a sitting President of one party is up for reelection the other party loses congressional seats. c. Predictions this year of the results of the election are extremely difficult because of many factors, such as Occupy Wall Street, unemployment rates, international finances, gas prices, etc. 3. What Will Congress Do? a. Nothing. Allow reversion to $1 million exemption, etc. etc. b. Follow President s Budget Proposals. $3.5 million exemption, c. Maintain 2012 Rules. $5 million exemption, etc. Hard to put the toothpaste back into the tube. generated. d. Eliminate Estate Tax. Cost of administration vs. revenue 4. Retroactive Law? Most planners have thought that estate legislation in 2013 could be retroactive to January 1 without a Constitutional challenge, because the law would be more favorable to taxpayers than a $1 million/55% system. However, Treasury officials have indicated concern that some beneficiary might challenge the validity of the retroactivity of the law (e.g., the lower rates may cause a shift in who receives benefits under a formula clause, or s a shift in amounts that a charity receives). Supreme Court resolution of a challenge would take 5 to 7 years, and during that period, there would be uncertainty for estates of persons who die. 16

25 IV. For Big Estates, 2012 is Opportunity of a Lifetime A. Gifts Using the $5.12 Million Exclusion the Opportunity The $5.12 million applicable exclusion amount for lifetime gifts presents a great opportunity for minimizing transfer taxes. From 2001 through 2009, the estate tax exclusion amount increased from $1 million to $3.5 million, but the gift tax exclusion amount stayed at $1 million. Individuals had to wait until death to fully utilize the estate tax exclusion amount. Now, the exclusion amounts are unified. Under TRA 2010, individuals can transfer during lifetime up to $5.12 million of value without incurring gift tax. And, married couples can transfer up to $10.24 million of value without incurring gift tax. The benefit presented by this new opportunity is not as straight forward as it seems. Using the $5.12 million gift tax exclusion does not mean that the transfer will be ignored for estate tax purposes. When calculating the estate tax for a deceased individual, the decedent s adjusted taxable gifts are added to the estate tax base. The estate tax is then calculated using the estate tax exclusion amount that is applicable for the year of the transferor s death (issues related to this rule are discussed more fully below). The advantage presented by the $5.12 million gift tax exclusion is the ability to remove the income and appreciation on the transferred assets from the estate of the donor. Depending on the income and appreciation rate and the length of time from the gift date to the death of the donor, this benefit can be substantial. It is optimal for an individual to utilize the new exclusion amount as soon as possible, because this will allow more time for the transferred asset to produce income and appreciation. Of course, there is already some urgency to move quickly, given that this opportunity is scheduled to terminate at the end of A potential tax drawback to utilizing the new gift tax exclusion is that its use will eliminate the income tax basis adjustment at the donor s death. TRA 2010 reinstates the basis adjustment rules of Section Generally, each asset owned by a decedent at death will acquire a new income tax basis equal to the asset s fair market value as of the date of death. For an asset that has a higher value than income tax basis, this basis adjustment eliminates the unrealized, pre-death gain. This income tax basis adjustment does not apply to assets given during lifetime. The impact of this loss of income tax basis adjustment can be manipulated to some extent. An individual who is considering making a substantial gift should look first to giving assets with high income tax bases. Also, an individual may consider giving an asset which the recipient is unlikely to sell, such as a family vacation home. And, if an individual employs a grantor trust (a trust the income of which is taxed to the grantor), the individual could buy back an asset that has highly appreciated after it was transferred to the grantor trust, this allowing the acquired asset to receive a fair market value income tax basis upon the individual s death. Losing this income tax basis adjustment may be acceptable, when the estate tax rate is greater than the capital gains tax rate. Of course, this assumes that the gifted assets would have been subject to estate tax if held by the donor at death. When the estate and gift tax law was more stable, it was easier to make this determination. It is much more difficult now, given that 17