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Change is on the Way

President Obama’s proposals for estate planning in 2013 and beyond

Since President Obama released his 2012 budget, much has been written about his intention to raise taxes on higher income individuals and families beginning in 2013. The president also proposed changes to the estate, gift and generation-skipping transfer (GST) taxes and exemptions when the current law expires at the end of 2012.

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Tax Act) expanded the estate exemptions and provided unique planning opportunities for 2011 and 2012. The 2010 Tax Act increased the estate exemption from $3.5 million in 2009 to $5 million in 2010, 2011 and 2012 (although settlors of estates for 2010 may elect the 2010 rules and avoid paying estate taxes but be subject to modified carryover basis rules). The 2010 Tax Act also increased the gift and GST tax exemption from $1 million in 2009 to $5 million in 2011. Here’s a summary of the important estate planning modifications proposed by President Obama in his 2012 budget.

Tax Exemptions
Depending on how you view it, the president’s budget aims to either increase or decrease estate taxes in 2013. The 2010 Tax Act expanded estate, gift and GST tax exemptions and lowered tax rates but only through 2012. Without Congressional action to change the law, the estate, gift and GST tax exemptions will revert back to 2001 levels for everyone in 2013, which would effectively be a tax increase and affect many families.

President Obama proposes to bring the estate tax exemption back to 2009 levels, at $3.5 million with a maximum 45 percent estate tax rate. He wants to make the gift and GST tax exemption $1 million, and set the tax rates for all at 45 percent. While this would save many families from being affected by estate taxes, it will “increase” taxes if existing rates aren’t extended.

Many practitioners were pleasantly surprised that the 2010 Tax Act included a portability provision for spouses. Portability allows for a surviving spouse of an individual who dies after Dec. 31, 2010 and before Jan. 1, 2013 to be eligible to increase his exclusion amount by the portion of the deceased spouse’s exclusion that remained unused at the time of the deceased spouse’s death—up to $5 million, minus lifetime gifts or transfers at death.

To preserve the unused exemption of a deceased spouse, the surviving spouse must file a federal estate tax return and elect this option within six months of the spouse’s death (including extensions). The 2010 Tax Act specifies that if a spouse remarries, and her new spouse dies, she loses the exemption of the first deceased spouse. President Obama proposes to make the portability provision permanent so that in 2013, married couples may continue to carry over unused exemptions. The exemption amount that would be preserved will be limited to the estate and gift exemption in effect in 2013 and beyond.

It’s important to note, however, that several states assess their own estate tax, which could be much lower than the federal estate exemption, thus requiring a married couple to establish a trust to preserve the state estate exclusion. Credit shelter trusts also offer the benefit of creditor protection.

Valuation Discounts
Many wealthy families rely on certain techniques that allow them to discount assets to reduce their estates and pass assets in a more tax-efficient manner. The use of valuation discounts, used in family-owned businesses and family limited partnerships (FLPs), is extremely popular, especially in arrangements in which lack of marketability and lack of control can result in discounting of assets up to 45 percent. However, the courts have become wary of the potential for abuse in FLP and other arrangements, and legislation has been introduced over the past few years in an effort to limit valuation discounts. The budget proposal aims to create an additional category of restrictions that would be applied in the valuation of an interest in a family-controlled entity and would also limit certain rights of the holder.

Another tax-saving technique commonly used by wealthy families is a grantor retained annuity trust (GRAT). GRATs are established to transfer wealth between family members while minimizing the gift tax cost of transfers, as long as the grantor survives the GRAT term, and the trust assets don’t depreciate in value. Over the past few years, several bills were introduced in Congress to limit GRATs and specifically to do away with zeroed-out GRATs and GRATs with two- or three-year terms. The president’s budget proposes to impose a minimum of 10-year terms on all GRATs and to require that the remainder interest have a value greater than zero.

GST Tax Exemption Term
The budget also recommends limiting GST trusts to 90-year terms. Currently, most states have repealed or changed their rule against perpetuity laws that would set term limits on such trusts. The proposal would enforce a 90-year maximum term on any new trusts established after the legislation is passed or on new money/assets added to established trusts.

Basis Value
The president also proposes requiring basis for estate and gift tax to be valued and reported using consistent methods.

It’s very likely that any legislation that would extend or change the existing estate taxes and exemptions won’t be passed until after the 2012 elections. With the deficit, federal budget and economic troubles hampering progress on other issues, Congress could push any decisions on tax changes until after the election, or even into 2013, possibly passing another comprehensive bill similar to the 2010 Tax Act.

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