Lahti, Lahti & O'Neill, P.C. Blog

By Michael T. Lahti

As part of our goal of keeping you informed of breaking news in Estate Planning and Elder Law, Lahti, Lahti & O’Neill, P.C. will be sending you occasional blogs via email.  As we hear of the changes in federal and state laws, we will send you notices of areas of law that we think you may find relevant or interesting.

Below I have provided excerpts from President Obama's fiscal 2016 budget proposal that have to do with estate and gift taxation.  Personally, I feel that considering the turbulence among lawmakers at this point, the chance of these being implemented in their presented form is extremely remote.  Nevertheless, if they were to pass, the proposals would have a profound effect on the taxes some estates would pay.  And, even if the proposals do not go anywhere, these excerpts show us what some lawmakers are thinking at this point.

Modify Estate and Gift Tax Provisions

Restore the estate, gift, and generation-skipping transfer (GST) tax parameters in effect in 2009. -- Under current law, estates, gifts, and GSTs are taxed at a maximum tax rate of 40 percent with a lifetime exclusion of $5 million, indexed for inflation after 2011. The Administration proposes to restore and permanently extend estate, gift, and GST tax parameters as they applied for calendar year 2009. Under those parameters, estates and GSTs would be taxed at a maximum tax rate of 45 percent with a life-time exclusion of $3.5 million. Gifts would be taxed at a maximum tax rate of 45 percent with a lifetime exclusion of $1 million. These parameters would be effective for the estates of decedents dying and transfers made after December 31, 2015, and would not be indexed for inflation.

Require consistency in value for transfer and income tax purposes. -- Current law provides generally that the basis of property inherited from a decedent is the property's fair market value at the decedent's death, and of property received by gift is the donor's adjusted basis in the property, increased by the gift tax paid on the transfer. (A special limitation based on fair market value at the time of the gift applies if the property subsequently is sold by the done at a loss.) Elsewhere in this Budget the Administration proposes to tax accrued capital gains (that is, fair market value in excess of the basis) when assets are transferred by death or gift. Although generally the same standards apply to determine the value subject to estate or gift tax as apply to computing basis under current law or to computing gain under the Administration's proposal, there is no explicit consistency rule that would require the recipient of the property to use for income tax purposes the value used for estate or gift tax purposes as the recipient's basis in that property when the basis is determined by reference to the fair market value on the date of death or gift. The Administration proposes to require that, for decedents dying and gifts made after enactment, the fair market value used for computing the recipient's basis or for computing capital gain generally must equal (but in no event may exceed) the value of the property as determined for estate or gift tax purposes, and a reporting requirement would be imposed on the decedent's executor or the donor to provide the necessary information to both the recipient and the IRS. The proposal also would grant regulatory authority for the development of rules to govern situations in which this general rule would not be appropriate. The proposal would be effective for transfers after the year of enactment.

Modify transfer tax rules for grantor retained annuity trusts (GRATs) and other grantor trusts. -- Current law provides that the value of the remainder interest in a GRAT for gift tax purposes is determined by deducting the present value of the annuity to be paid during the GRAT term from the fair market value of the property contributed to the GRAT. If the grantor of the GRAT dies during that term, the portion of the trust assets needed to produce the annuity is included in the grantor's gross estate for estate tax purposes. In practice, grantors commonly use brief GRAT terms (often of less than two years) and significant annuities to minimize both the risk of estate tax inclusion and the value of the remainder for gift tax purposes. The Administration proposes to add the following requirements for GRATs: (1) the GRAT must have a minimum term of 10 years and a maximum term of 10 years more than the annuitant's life expectancy, (2) the remainder interest must have a minimum value at the creation of the GRAT equal to the greater of 25 percent of the value of the property contributed to the GRAT or $500,000 (but not more than the value of the assets contributed), (3) no decrease in the annuity during the GRAT term is permitted, and (4) no tax-free exchange of any GRAT asset with the grantor is permitted.

This proposal also would address the sale of an asset to a grantor trust, specifically, a trust of which the seller is the deemed owner for income tax purposes. A grantor trust is ignored for income tax purposes, even though the trust may be irrevocable and the deemed owner may have no beneficial interest in the trust or its assets. The lack of coordination between the income tax and transfer tax rules applicable to a grantor trust creates opportunities to structure transactions between the trust and its deemed owner that are ignored for income tax purposes and can result in the transfer of significant wealth by the deemed owner without transfer tax consequences. The proposal would provide that a person who is a deemed owner of all or a portion of a trust engages in a transaction with that trust that constitutes a sale, exchange, or comparable transaction that is disregarded for income tax purposes by reason of the person's treatment as a deemed owner of the trust under the grantor trust rules, then the portion of the trust attributable to the property received by the trust in that transaction, net of the consideration received by the person in the transaction, will be: (1) subject to estate tax as part of the deemed owner's gross estate, (2) subject to gift tax at any time during the deemed owner's life when his or her treatment as a deemed owner of the trust is terminated, and (3) treated as a gift by the deemed owner to the extent any distribution is made to another (except in discharge of the deemed owner's obligation to the distributee) during the deemed owner's life. The transfer taxes would be payable from the trust. The proposal would be effective with regard to GRATs created after the date of enactment, and to other grantor trusts that engage in a described transaction on or after the date of enactment.

Limit duration of GST tax exemption. -- Current law provides that each person has a lifetime GST tax exemption ($5,430,000 in 2015) that may be allocated to the person's transfers to or for the benefit of transferees who are two or more generations younger than the transferor ("skip persons"). The allocation of a person's GST exemption to such a transfer made in trust exempts from the GST tax not only the amount of the transfer (up to the amount of exemption allocated), but also all future appreciation and income from that amount during the existence of the trust. At the time of the enactment of the GST tax provisions, the law of almost all States included a Rule Against Perpetuities (RAP) that required the termination of every trust after a certain period of time. Because many States now either have repealed or limited the application of their RAP laws, trusts subject to the laws of those States may continue in perpetuity. As a result of this change in State laws, the transfer tax shield provided by the GST exemption effectively has been expanded from trusts funded with $1 million and a maximum duration limited by the RAP, to trusts funded with $5,430,000 and continuing (and growing) in perpetuity. The Administration proposes to limit the duration of the benefit of the GST tax exemption by imposing a bright-line test, more clearly administrable than the common law RAP, which, in effect, would terminate the GST tax exclusion on the 90th anniversary of the creation of the trust. An exception would be made for trusts that are distributed to another trust for the sole benefit of one individual if the distributee trust will be includable in the individual's gross estate for Federal estate tax purposes to the extent it is not distributed to that individual during his or her life. The proposal would apply to trusts created after enactment, and to the portion of a pre-existing trust attributable to additions to such a trust made after that date.

Extend the lien on estate tax deferrals where estate consists largely of interest in closely held business. -- There is a lien on nearly all estate assets for the 10-year period immediately following a decedent's death to secure the full payment of the Federal estate tax. However, the estate tax payments on interests in certain closely held businesses are deferred for 14 years after the due date of the return (or nearly 15 years after the date of death). Thus, this lien expires approximately five years before the due date of the final payment of the deferred tax. Existing methods of protecting the Federal Government's interest in collecting the amounts due are expensive and may be harmful to businesses. The Administration proposes to extend the existing estate tax lien throughout the deferral period to eliminate the need for any additional security in most cases in a manner that is economical and efficient for both taxpayers and the Federal Government. The proposal would be effective for the estates of all decedents dying on or after the date of enactment, as well as for all estates of decedents dying before the date of enactment as to which the lien has not then expired.

Modify GST tax treatment of Health and Education Exclusion Trusts (HEETs). -- Payments made by a donor directly to the provider of medical care for another or directly to a school for another's tuition are exempt from gift tax. These direct transfers also are exempt from the GST tax. However, payments made to a trust, to be expended by the trust for the same purposes, are not exempt from the gift tax. Some contributors to HEETs interpret the GST tax exclusion to apply also to distributions made from the HEET in payment of medical expenses or tuition, and claim that those distributions are exempt from the GST tax. The Administration proposes to provide that the GST tax exclusion for transfers exempt from the gift tax is limited to outright transfers by the donor to the provider of the medical care or education and does not apply to distributions for those same purposes from a trust. The proposal would apply to trusts created after the introduction of the bill enacting this change and to transfers after that date made to pre-existing trusts.

Simplify gift tax exclusion for annual gifts. -- The annual per-donee gift tax exclusion (currently $14,000) is available only for gifts of "present interests," but generally a transfer can be converted into a present interest by granting the donee an immediate right to withdraw the property ("Crummey power"). In an effort to simplify tax compliance and administration, and to prevent the possible abuse of such withdrawal powers, the Administration proposes to eliminate the present interest requirement, define a new category of transfers that will not be affected by withdrawal or put rights, and impose an annual per-donor cap of $50,000 (indexed for inflation) on the total amount of gifts in that new category that can be exempted from gift tax by the annual per-donee exclusion. The new category would include transfers in trust (other than to a trust described in section 2642(c)(2) of the Internal Revenue Code), transfers of interests in pass-through entities, transfers of interests subject to a prohibition on sale, and other transfers of property that, without regard to withdrawal, put, or other such rights in the donee, cannot be immediately liquidated by the donee. The proposal would be effective for gifts made after the year of enactment.

Expand applicability of definition of executor. -- Under current law, the statutory definition of executor applies only for purposes of the estate tax; therefore, an executor of an estate does not have the authority to extend a statute of limitations, claim a refund, agree to a compromise or assessment, or pursue judicial relief for a tax liability that arose prior to the decedent's death. To empower an authorized party to act on behalf of the decedent in such matters (whether arising before, upon, or after death), the Administration proposes to make the statutory definition of executor applicable for all tax purposes, and to authorize such executor to do anything on behalf of the decedent in connection with the decedent's pre-death tax liabilities or obligations that the decedent could have done if still living. In addition, because this definition frequently results in multiple parties being an executor, the proposal would grant regulatory authority to adopt rules to resolve conflicts among multiple executors authorized by that definition. The proposal would be effective upon enactment, regardless of the decedent's date of death.