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President Obama "Steps Up" Attack On Estate Planning Techniques

President Obama "Steps Up" Attack On Estate Planning Techniques

Thoughts on the 2016 Greenbook

On Feb. 2, 2015, on the heels of the State of the Union Address, the Obama Administration released its budget proposal for the 2016 fiscal year, accompanied by the Treasury Department's General Explanation of the Administration's Fiscal Year 2016 Revenue Proposals (colloquially known as the Greenbook).[1]  Given the percentage of his previous proposals that have been passed and the newly-elected Republican majority in both houses of Congress, the vast majority of the proposals in the Greenbook are unlikely to become law during President Obama's last two years in office. However, they are worth noting, as they identify the focus points of the President's revenue initiatives and may ultimately become bargaining chips in the legislative process.  

The President's proposal includes a suite of tax reforms primarily aimed at increasing the tax burden borne by wealthy individuals.  The President couched these proposals in a populist tone, arguing that his proposals "close the loopholes that lead to inequality by allowing the top one percent to avoid paying taxes on their accumulated wealth."[2]  This may sound like a familiar tune—it echoes the last year's plan to "reduce inefficient and unfair tax breaks," fiscal year 2014's plan to have "the wealthiest pay their fair share" and fiscal year 2013's plan to ensure that "everyone shoulders their fair share."

Given the President's persistent focus on extracting revenue from successful individuals, it should come as no surprise that the 2016 Greenbook's transfer tax proposals largely restate those set forth in previous editions.  However, two proposals warrant special attention.  The first intensifies last year's assault on the use of grantor retained annuity trusts (GRATs) and leveraged transactions with intentionally defective grantor trusts (IDGTs).  The second, while not housed in the Greenbook's transfer tax section, proposes a recognition event on the gift or bequest of appreciated property, which would have a significant impact on estate planning.    


One of this year's proposals is a repackaging of two proposals from last year's Greenbook in a manner that would further eliminate or restrict common estate planning techniques. The Obama administration has long targeted GRATs,  as well as the use of leveraging techniques with IDGTs.

This is the fourth time that the Obama Administration has targeted IDGTs in its Greenbook proposals. Once again, there’s an attempt to “coordinate” the income and transfer tax rules by treating assets that are sold or otherwise exchanged with a grantor trust as includible in the grantor’s estate on the grantor’s death or as a taxable gift on the termination of grantor trust status or  the distribution of assets from the trust during the grantor’s life. The value included in the estate or treated as the gift is the value of the assets put into the trust, including income and appreciation that exceeds the consideration received by the grantor in the transaction. Any transfer tax liability is payable from the trust. This proposal wouldn’t apply to certain trusts already includible in the grantor’s estate, such as qualified personal residence trusts and revocable trusts; though,  it wouldn’t apply to life insurance trusts. While this proposal doesn’t go as far as repealing the grantor trust rules, which allow for effect of tax-free contributions to an IDGT by the grantor paying the income tax liability, it would eliminate the incentive to engage in common estate planning techniques, such as sales to grantor trusts.

There’s an evolution to this "coordination" proposal, though, as the proposal will not apply to a type of trust that has been a consistent target of the Obama Administration—the GRAT. Many planners use the grantor trust rules with GRATs by substituting assets of equivalent value into a GRAT for a variety of reasons, such as locking in the appreciation by replacing assets with cash, assuring continued appreciation by removing one asset and replacing it with another of equal value at the time of transfer that will appreciate at a greater rate, or simply reacquiring the asset because the grantor wishes to retain it, as opposed to letting it pass to the remainder beneficiary. This ability to "swap" assets is especially important with long term GRATs to ensure they carry out the goal of shifting appreciation to future generations. Even in the previous three Greenbooks, which sought to eliminate the use of the grantor trust rules to ultimately reduce transfer taxes as discussed above, GRATs were explicitly excluded from those proposals. This year, the Greenbook proposal "would prohibit the grantor from engaging in a tax-free exchange of any asset held in the [GRAT]."[3] Whether this prohibits any transaction between the grantor and the trust or simply makes such a transaction a taxable event is unclear—either way, it will take an important tool out of the estate planner's toolbox and expose longer term GRATs to additional market risk.

Speaking of increased risk, the proposal is not only targeting market risk but mortality risk as well. In every one of President Obama's Greenbook proposals, the Administration has criticized the use of short-term GRATs to reduce the risk of the grantor dying before the GRAT term expires, which would cause a portion of the GRAT's assets to be included in the grantor's estate. By using short-term zeroed out GRATs, a donor can eliminate both the imposition of gift taxes and reduce the risk of paying estate taxes on the GRAT's appreciation. All of the Obama Administration's proposals have suggested that GRATs have a minimum term of ten years "to impose some downside risk in the use of a GRAT."[4]

This year's proposal adds that not only must a GRAT have increased market and mortality risk—it must now also have a significant cost. Beginning in the Obama Administration's second Greenbook[5], each of the GRAT proposals has called for a requirement that the remainder interest be greater than zero. While this would trigger a gift tax reporting obligation, it would not create a large tax liability as the proposal read literally could lead to a remainder interest of a single dollar. For the first time, an Obama Greenbook sets what the remainder in the GRAT (i.e. the taxable gift amount) will be and it’s substantially greater than zero. This year's proposal calls for there to be a minimum remainder value which is the greater of (1) 25 percent of the value of the assets contributed to the GRAT or (2) $500,000.

Interestingly, the proposal does have a limit that the $500,000 minimum is reduced for trusts where the initial contribution is less than $500,000 to the value of the contribution. For example, a GRAT funded with $300,000 must have a minimum retained interest of $300,000. One problem—that’s mathematically impossible, as if you have any annuity payment back to the grantor, even one just above zero percent, the result is that the remainder interest is less than the amount contributed.

Taken together with the rest of the President's proposals, GRATs would become far less attractive. The 10-year minimum term proposal would increase the risk of death during the GRAT. The prohibition on tax-free exchanges with the GRATs would make these longer term vehicles even more risky by taking away the grantor's ability to adjust the assets held in trust to produce the best transfer tax results and protect against mortality risk. Further, the high required minimum gift of the greater of 25 percent of the value of initial assets or $500,000 would make it far more likely that gift taxes would be triggered. Having only a $1 million lifetime gift tax exclusion and a 45 percent transfer tax rate (discussed below), makes using the small exclusion amount or paying significant gift taxes in a non-GST exempt structure unattractive in many situations.


The other notable reform, and one to which the Obama Administration has devoted significant marketing attention, is housed in a proposal titled "Reform the Taxation of Capital Income."  In broad strokes, the proposal abrogates what President Obama has curiously dubbed the "trust fund loophole" by requiring a donor or decedent to recognize gain on a gift or bequest of appreciated property. Under the new proposal, a donor or decedent would face a recognition event on the gift or bequest of appreciated property.  Any gain realized would be taxable to the donor or decedent at increased capital gains rates up to 24.2 percent under the proposal (a total of 28%, factoring in the 3.8% net investment income tax).  Taking into account the mountain of unwanted side-effects produced by the proposal, such as increased taxes for less-wealthy individuals, the Greenbook deviates from the President's stated goal of "simplify[ing] the system" and sets forth nearly a dozen caveats and carve outs.[6]

Certain transactions, including transfers of tangible personal property (excluding collectibles), transfers to a spouse, transfers to charity and transfers of qualified small business stock, would be exempt from the recognition requirement.  In addition, a $100,000 per person exclusion from capital gain recognized upon death would be available and would be portable to a decedent's surviving spouse. With respect to real property, the Greenbook proposal attempts to save the family home by extending the $250,000 per person exclusion for gain on the sale of a principal residence to all residences and making the exclusion portable to a decedent's surviving spouse.   However, between 1940 and 2000, median home values in the United States (after adjusting for inflation) rose by approximately 4.9% annually, meaning a home purchased in 1980 for $125,000 may now be worth almost $667,000.[7]  Factoring in the proposed exclusion, a surviving spouse's estate would be required to recognize approximately $167,000 in long term capital gain, a substantial burden for most estates outside "the top 1 percent."

The mechanics for these portable income tax exclusions appear burdensome. A press release states that the real estate exclusion is "automatically portable between spouses."[8] However, the Greenbook states that the $100,000 exclusion would be available "under the same rules that apply to portability for estate and gift tax purposes" (i.e. an estate tax return would be required to elect portability).[9] Query how effective this rendition of portability will be, given that it would require the cost of a return – a cost many middle-class families may not wish to incur. 

The White House recognizes that "most middle-class retirees spend down their assets during retirement" and, under the new proposal, would not be able to satisfy their federal income tax obligation without liquidating the family business or selling the family home.[10]  With respect to family businesses, the Greenbook proposal provides that the payment of tax on appreciated family businesses would be deferred "until the business is sold or ceases to be family owned and operated."  Among the many questions the proposal leaves unanswered are whether the tax liability would be fixed at death or upon subsequent disposition of the business and what ownership or operational thresholds would be required to qualify a "family owned and operated" business.  It is unclear, for example, whether a family limited partnership holding investment assets would qualify as a "family owned and operated business" eligible for deferral. The proposal also calls for a 15 year fixed payment plan for the tax liability created for all non-liquid assets to allow for deferral.

Moreover, the proposal would cause an inadvertent state income tax increase following a gift or death for individuals of all income levels. Currently, only Connecticut has a gift tax regime and most states do not impose taxes because of a person's death. However, many states impose state income taxes by referencing an individual's federal taxable income.  This Greenbook proposal would result in increased taxes for many by triggering state income tax liability in many jurisdictions through an increase in a taxpayer's federal taxable income. The impact of this will be most salient in a jurisdiction like California, which has no state level estate tax, but high state income tax rates. By making death a taxable event, California residents will go from having a step-up in basis with no tax event at the state level to a potentially large state income tax bill.

As the exact contours of the proposal are somewhat amorphous, it is unclear exactly what effect it may have on future planning or revenue generation.  Given the recent emphasis on basis planning in estate planning because of increased transfer tax exemptions, the elimination of the traditional transfer tax basis rules would, without question, drastically alter estate planning for wealthy families. Through the generous use of spousal and charitable gifts of appreciated property, as well as the funding of dynastic trusts with high basis assets earlier in life, there is no question that significant income tax deferral is still available under the new regime. The irony of this proposal to attack the "trust fund loophole" is that it may only further encourage the wealthiest individuals to create trusts that are unavailable to less affluent taxpayers. Taxpayers would be incentivized to gift high basis assets earlier in life, utilize the grantor trust rules to allow the trust to grow income tax free during the grantor's life, and avoid recognition upon the grantor's death. Given this and the fact that the basis step-up available under Section 1014 has very little to do with trusts, the President's catch phrase is likely the work of political speech writers and spin doctors, not the work of those advising the Administration on tax policy matters.


The seven remaining proposals in this year's Greenbook essentially restate proposals that have appeared in previous editions.  They are as follows:

1.     Restore 2009 Transfer Tax Rates and Exemptions.  The American Taxpayer Relief Act of 2012 (ATRA) made permanent the unified $5 million exemption for estate, gift and generation-skipping transfer (GST) taxes, indexed for inflation.  ATRA also set the estate, gift and GST tax rate at a flat 40%.  Each Greenbook since ATRA's enactment has proposed rolling back estate, gift and GST tax rates and exemptions to 2009 levels and this year's edition is no exception.  Under the proposal, the estate and GST exemption would drop to $3.5 million and the gift tax exemption would drop to $1 million, without indexing for inflation.  Unlike last year's proposal, which called for this reversion to 2009 levels to take effect for decedents dying in 2018 or later, this year's proposal would reintroduce this regime beginning in 2016. Portability would remain an option under the new proposal, and gifts in excess of the decreased exemption made prior to the December 31, 2015 enactment of the new regime would enjoy grandfathered status.

2.     Consistent Valuation for Income and Transfer Tax Purposes.  This proposal would require consistent valuation for estate, gift and income tax purposes.  This new limitation is imposed on both the transferee and transferor of property.  Under the proposal, the transferee of property cannot report a basis greater than (1) with respect to a decedent, the estate tax value of such property, or (2) with respect to a lifetime gift, the donor's initial basis in such property.  Compliance would be enforced by imposing a reporting requirement on executors (with respect to bequests) and donors (with respect to gifts) to report basis in formation to the IRS.  While this proposal is not a significant departure from the existing framework for determining basis, it does impose an additional reporting and compliance burden on taxpayers, thereby increasing the transaction cost of gifts and bequests.

3.     Limit Duration of GST Tax Exemption.  This proposal is aimed squarely at the elimination of dynasty trusts, which the Administration calls "transfer tax shields."  Dynasty trusts are currently an option in jurisdictions which have abrogated the common law Rule Against Perpetuities and allow estate planners to leverage a taxpayer's GST exemption to accomplish significant multi-generational planning.  Properly structured, such a trust can grow free of transfer taxes for an indefinite period of time.  While falling short of prohibiting such trusts, the Greenbook proposal limits a trust's GST exclusion to a period of no longer than 90 years, effectively subjecting multi-generational trusts to transfer tax approximately once every lifetime.

4.     Extend Estate Tax Liens on Closely Held Businesses.  Under current law, an estate may elect to defer the payment of estate tax on certain closely held business interests and pay the liability over time to forestall the forced sale or failure of a business.  However, the corresponding lien available under current law to secure such a liability extends for only ten years.  The current mismatch results in considerable collections difficulty because alternative enforcement mechanisms have proved unworkable for both debtor estates and the IRS.  The proposal seeks to unify these concepts by extending the estate tax lien throughout the fourteen-year deferral period.  It would be effective for decedents dying after the date of enactment, as well as for estates with currently unexpired liens.

5.     Apply GST Tax to HEETs.  This proposal takes aim at a long-term planning technique that leverages an exemption from gift and GST tax available for payments made for the education or medical care of another.  HEETs amplify this exemption by providing a pool of assets available for the medical and educational expenses of multiple generations of descendants.  Despite the ability of HEETs to provide education and security to American families for several generations, the Greenbook proposal takes the position that such planning is abusive.  The proposal would limit the exclusion from GST tax to payments made by a donor directly to a provider of medical care or to a school in payment of tuition.  Interestingly, White House budget estimates indicate that this is the only Greenbook transfer tax proposal that will actually fail to raise revenue in the coming years.

6.     Eliminate Crummey Powers.  A Crummey power allows a gift in trust to qualify for the gift tax annual exclusion by providing each trust beneficiary a limited power of withdrawal over contributed property, thereby giving the beneficiary a present interest in the gift that qualifies for the annual exclusion under Section 2503(b).  Some practitioners have stretched this concept to the limit, creating trusts with large pools of beneficiaries, many exceedingly unlikely to ever exercise the withdrawal power or benefit from the trust assets, but each increasing the exclusion amount available to the donor.  In a less abusive context, Crummey powers are frequently used to fund large insurance premiums on the life of a donor inside insurance trusts, which provide necessary liquidity to many estates.  The proposal, which has appeared in prior Greenbooks from both the Clinton and Obama Administrations, would eliminate the present interest requirement and limit the application of the current annual exclusion amount ($14,000) to transfers to individuals or to trusts for the exclusive benefit of the donee which would be includible in the donee's taxable estate (i.e. 2503(c) trusts).  The proposal further limits a donor's annual tax-free gifts in trust to an aggregate value of $50,000.[11]  Transfers in excess of the new $50,000 limit would be taxable.

7.     Expand the Applicability of the Definition of "Executor."  Under current law, the definition of the term "executor" applies only for estate tax purposes.  As a technical matter, this means that the Internal Revenue Code does not authorize any person to act on behalf of a decedent with respect to income or gift tax matters.  This limitation has become a particularly significant hurdle for estates looking to regularize a decedent's foreign financial account reporting under the Offshore Voluntary Disclosure Program.  The Greenbook proposal makes clear that an individual satisfying the definition of an "executor" has the authority to act on the behalf of a decedent in all tax matters and grants the IRS regulatory authority to issue rules to resolve conflicts among multiple persons satisfying the definition.


Given the Republican control of Congress, are these proposals likely to become law?  As President Obama noted, "I bet most Americans are thinking the same thing right now: nothing will get done this year, or next year, or maybe even the year after that."  It is hard to disagree with this sentiment.  Nonetheless, the Greenbook proposals once again affirm the President's consistent focus on extracting revenue from successful Americans. By the same token, while there is a new Republican congressional majority and increased rumblings to repeal the estate tax, that does not mean such legislation will become law, given the President's veto power. What the proposals from the President and calls for the repeal of transfer taxes highlight is the simple fact that ATRA did not make transfer tax laws permanent, but merely "permanent"—meaning that even if there is no sunset provision in the law, ATRA is only law until it isn't. This highlights the need for estate planners and successful individuals to remain vigilant of the legislative landscape to ensure their estate plans continue to protect their wealth.



[1] Office of Management and Budget, Executive Office of the President, Budget of the United States Government, Fiscal Year 2016 (2015); Department of the Treasury, General Explanations of the Administration's Fiscal Year 2015 Revenue Proposals (Feb. 2015) [hereinafter Greenbook]; Barack Obama, State of the Union Address, 113th Congress 2d Sess. (Jan. 20, 2015).

[2] Id. (State of the Union)

[3] Greenbook, at 198.

[4] Id.

[5] Department of the Treasury, General Explanations of the Administration's Fiscal Year 2011 Revenue Proposals 126 (Mar. 2010).

[6] Barack Obama, State of the Union Address, supra Note 2.

[7] United States Census Bureau, Historical Census of Housing Tables: Home Values (Jun. 6, 2012).

[8] The White House, Office of the Press Secretary, FACT SHEET: A Simpler, Fairer Tax Code That Responsibly Invests in Middle Class Families (Jan. 17, 2015), available at [hereinafter White House, Fact Sheet].

[9] Greenbook, at 157.

[10] Id.

[11] This year's Greenbook proposal clarifies that the $50,000 threshold is not an additional exclusion, but rather provides further restriction on annual exclusion gifts. This threshold would not only apply to trusts, but the gift of assets that may not otherwise qualify for the annual exclusion, such as gifts of LLC or partnership interests that have extensive restrictions on them that they would not qualify as a gift of present interest.


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