Americans are free to dispose of their property at death in any manner that they see fit, as a general rule (with the exception that a surviving spouse may not be disinherited). There is no requirement, for example, that children or grandchildren be treated fairly, or even rationally. On the other hand, conditions on an inheritance that have the tendency to induce spouses to get divorced or live apart are void because they are against public policy, and so will not be enforced. The Illinois Supreme Court was recently called upon to balance these two competing interests.
Max Feinberg’s will established two trusts for his wife, Erla, for her life. By so doing, he secured for the family the benefit of two exemptions from the federal estate tax. At Erla’s death the trusts were to
Showing posts with label Wealth transfer. Show all posts
Showing posts with label Wealth transfer. Show all posts
Sunday, November 1, 2009
Thursday, October 1, 2009
GRATs
The Grantor Retained Annuity Trust (GRAT) has been getting quite a bit of attention from estate planners recently. The reason is that low market interest rates create a window of opportunity for passing assets to heirs without incurring much, if any, estate or gift tax.
The GRAT is established for a set number of years. During the term of the trust, the grantor is paid an annuity, a fixed dollar amount, every year. When the trust terminates, the assets left in the trust pass to the grantor’s heirs. A gift tax, due when a GRAT is funded, is imposed upon the actuarial value of what the heirs will receive when the trust terminates. Estate planners can use two factors to reduce that tax exposure almost to zero: They can lengthen the term of the GRAT, or they can increase the annuity retained by
the grantor.
The value of the retained income interest and the value of the remainder for the heirs must take current interest rates into account. If the trust earns more than the IRS tables predict it will earn, the excess will pass to the heirs free of estate or gift tax. During a period of very low interest rates, such as we have today, the chance of beating the IRS interest rate is very good.
On the other hand, if the trust’s investments underperform, it may be exhausted before the end of the term, leaving nothing for the heirs. Finally, if the grantor dies before the trust comes to an end, the assets will be included in the grantor’s estate, defeating the estate planning objectives.
Future considerations
The advantages of GRATs have become so pronounced in the current market environment that the President’s tax proposal to Congress earlier this year included a new restriction for such trusts in the future. They will have to have a trust term of at least ten years in order to be effective for federal tax purposes.
If such a change to the tax code is made, it very likely will be part of a larger estate tax reform plan that keeps the federal exempt amount at $3.5 million, freezing the estate tax rates at 2009 levels. For married couples, that means $7 million can be sheltered from federal estate tax with some basic planning. Such a move could limit the need for more sophisticated strategies, such as GRATs, for wealthier families.
(October 2009)
© 2009 M.A. Co. All rights reserved.
The GRAT is established for a set number of years. During the term of the trust, the grantor is paid an annuity, a fixed dollar amount, every year. When the trust terminates, the assets left in the trust pass to the grantor’s heirs. A gift tax, due when a GRAT is funded, is imposed upon the actuarial value of what the heirs will receive when the trust terminates. Estate planners can use two factors to reduce that tax exposure almost to zero: They can lengthen the term of the GRAT, or they can increase the annuity retained by
the grantor.
The value of the retained income interest and the value of the remainder for the heirs must take current interest rates into account. If the trust earns more than the IRS tables predict it will earn, the excess will pass to the heirs free of estate or gift tax. During a period of very low interest rates, such as we have today, the chance of beating the IRS interest rate is very good.
On the other hand, if the trust’s investments underperform, it may be exhausted before the end of the term, leaving nothing for the heirs. Finally, if the grantor dies before the trust comes to an end, the assets will be included in the grantor’s estate, defeating the estate planning objectives.
Future considerations
The advantages of GRATs have become so pronounced in the current market environment that the President’s tax proposal to Congress earlier this year included a new restriction for such trusts in the future. They will have to have a trust term of at least ten years in order to be effective for federal tax purposes.
If such a change to the tax code is made, it very likely will be part of a larger estate tax reform plan that keeps the federal exempt amount at $3.5 million, freezing the estate tax rates at 2009 levels. For married couples, that means $7 million can be sheltered from federal estate tax with some basic planning. Such a move could limit the need for more sophisticated strategies, such as GRATs, for wealthier families.
(October 2009)
© 2009 M.A. Co. All rights reserved.
Ask a trust officer: Federal estate taxes
DEAR TRUST OFFICER:
What’s up with the federal estate tax? I heard that it’s suspended next year, for one year only? Should I review my will?
—DEATH TAX TARGET
DEAR TARGET:
You heard correctly. As of January 1, under current law, the federal estate tax will be suspended, replaced by a complex new tax regime with the shorthand name “carryover basis.” In effect, greater capital gains tax receipts would offset, to some extent, the loss of estate tax revenue at the death of wealthy individuals. After one year of that experience, the federal estate tax roars back in 2011, with a $1 million exemption and a top tax rate of 60%. (In contrast, this year the exemption is $3.5 million, and the top rate is 45%.)
This roller-coaster ride was built in 2001 for political and budgetary reasons. Unfortunately, the focus on health care reform has left precious little time for Congress to devote to estate tax reform. Consequently, the emerging scenario considered most likely is a one-year patch, extending the 2009 tax rules into 2010 only. That would permit the Congress to take more time next year to work out a comprehensive plan for taxation at death.
Cynics point out that it also gives Congress the opportunity to allow a major tax increase to be implemented through simple inaction. As resistance to deficit spending has mounted, the need for new tax revenue has grown.
What does all this mean for your estate plans? Vigilance will remain important, but a one-year patch will be less disruptive than the alternative of implementing carryover basis. Given the near-term revenue loss associated with doing nothing, Congress seems very likely to push something through late in the year.
Do you have a question concerning wealth management or trusts? Send your inquiry to [trustofficer@bankname.com].
(October 2009)
© 2009 M.A. Co. All rights reserved.
What’s up with the federal estate tax? I heard that it’s suspended next year, for one year only? Should I review my will?
—DEATH TAX TARGET
DEAR TARGET:
You heard correctly. As of January 1, under current law, the federal estate tax will be suspended, replaced by a complex new tax regime with the shorthand name “carryover basis.” In effect, greater capital gains tax receipts would offset, to some extent, the loss of estate tax revenue at the death of wealthy individuals. After one year of that experience, the federal estate tax roars back in 2011, with a $1 million exemption and a top tax rate of 60%. (In contrast, this year the exemption is $3.5 million, and the top rate is 45%.)
This roller-coaster ride was built in 2001 for political and budgetary reasons. Unfortunately, the focus on health care reform has left precious little time for Congress to devote to estate tax reform. Consequently, the emerging scenario considered most likely is a one-year patch, extending the 2009 tax rules into 2010 only. That would permit the Congress to take more time next year to work out a comprehensive plan for taxation at death.
Cynics point out that it also gives Congress the opportunity to allow a major tax increase to be implemented through simple inaction. As resistance to deficit spending has mounted, the need for new tax revenue has grown.
What does all this mean for your estate plans? Vigilance will remain important, but a one-year patch will be less disruptive than the alternative of implementing carryover basis. Given the near-term revenue loss associated with doing nothing, Congress seems very likely to push something through late in the year.
Do you have a question concerning wealth management or trusts? Send your inquiry to [trustofficer@bankname.com].
(October 2009)
© 2009 M.A. Co. All rights reserved.
Tuesday, September 1, 2009
Estate tax reform options
The federal estate tax needs to be changed, that much everyone agrees upon. Today the federal estate tax exemption is $3.5 million, which means that with some careful planning married couples can shelter $7 million from taxation over two deaths. President Obama has proposed freezing those rules, as it would keep this tax targeted to the most affluent Americans.
If Congress does nothing, current law calls for the complete elimination of the federal estate tax for 2010 only. Then in 2011 the tax comes back with only a $1 million exemption. This “nightmare scenario” has been in place since 2001, and many observers expected it to be corrected before now.
In August the nonpartisan Congressional Budget Office presented a comprehensive review of tax and spending choices to the Congressional Budget Committees. The 284-page document included an analysis of four alternatives for restoring certainty to the federal estate tax. The “cost” of each of the alternatives, in terms of projected revenue loss, was estimated based upon a comparison to current law.
Exemption Top tax rate Carryover basis? Taxable estates (in 2014) Five-year revenue cost
Alternative 1 $5 million 20% No 5,300 $128 billion
Alternative 2 $5 million 30% No 5,300 $117 billion
Alternative 3 $3.5 million 45% No 9,400 $65 billion
Alternative 4 No estate tax N.A. Yes None $163 billion
Source: Congressional Budget Office, Budget Options Volume 2, August 2009
Alternative 1 boosts the exempt amount to $5 million, adds inflation indexing, and drops the deduction for state death taxes (and does not restore the state death tax credit). In 2014, under this scenario, only 5,300 estates would be required to pay federal estate tax, compared to 58,000 under current law. The tax rate would be set equal to the top rate on capital gains, 15% through 2010 and then 20%. This approach reduces revenues by just $128 billion over the next five years.
Alternative 2 is exactly the same, but with higher tax rates. Only the first $25 million would be taxed at the capital gain tax rate, everything over that at 30%. That shaves the revenue cost to $117 billion.
Alternative 3 is similar to the President’s proposal, outlined in the budget. The exemption would be left at $3.5 million, indexed for inflation, the deduction for state death taxes would be retained, and the tax rate set at 45%. With this approach the number of taxable estates in 2014 increases by more than 50%, to 9,400, and the revenue reduction falls to $65 billion.
Alternative 4, probably the least likely to be adopted, would make the changes for 2010 permanent. That is, repeal the federal estate tax, keep the federal gift tax with a $1 million exemption, and implement carryover basis for inherited assets. This approach costs $163 billion over five years.
So what will Congress do? The leading solution, according to The Wall Street Journal, is a one-year patch, as is done with the AMT, extending the 2009 rules only into 2010. Given the politics of health care, there may not be time for deliberation on permanent estate tax reform. At least one commentator has suggested that a revenue-hungry Congress might then let the exempt amount fall back to $1 million in 2011.
(September 2009)
© 2009 M.A. Co. All rights reserved.
If Congress does nothing, current law calls for the complete elimination of the federal estate tax for 2010 only. Then in 2011 the tax comes back with only a $1 million exemption. This “nightmare scenario” has been in place since 2001, and many observers expected it to be corrected before now.
In August the nonpartisan Congressional Budget Office presented a comprehensive review of tax and spending choices to the Congressional Budget Committees. The 284-page document included an analysis of four alternatives for restoring certainty to the federal estate tax. The “cost” of each of the alternatives, in terms of projected revenue loss, was estimated based upon a comparison to current law.
Exemption Top tax rate Carryover basis? Taxable estates (in 2014) Five-year revenue cost
Alternative 1 $5 million 20% No 5,300 $128 billion
Alternative 2 $5 million 30% No 5,300 $117 billion
Alternative 3 $3.5 million 45% No 9,400 $65 billion
Alternative 4 No estate tax N.A. Yes None $163 billion
Source: Congressional Budget Office, Budget Options Volume 2, August 2009
Alternative 1 boosts the exempt amount to $5 million, adds inflation indexing, and drops the deduction for state death taxes (and does not restore the state death tax credit). In 2014, under this scenario, only 5,300 estates would be required to pay federal estate tax, compared to 58,000 under current law. The tax rate would be set equal to the top rate on capital gains, 15% through 2010 and then 20%. This approach reduces revenues by just $128 billion over the next five years.
Alternative 2 is exactly the same, but with higher tax rates. Only the first $25 million would be taxed at the capital gain tax rate, everything over that at 30%. That shaves the revenue cost to $117 billion.
Alternative 3 is similar to the President’s proposal, outlined in the budget. The exemption would be left at $3.5 million, indexed for inflation, the deduction for state death taxes would be retained, and the tax rate set at 45%. With this approach the number of taxable estates in 2014 increases by more than 50%, to 9,400, and the revenue reduction falls to $65 billion.
Alternative 4, probably the least likely to be adopted, would make the changes for 2010 permanent. That is, repeal the federal estate tax, keep the federal gift tax with a $1 million exemption, and implement carryover basis for inherited assets. This approach costs $163 billion over five years.
So what will Congress do? The leading solution, according to The Wall Street Journal, is a one-year patch, as is done with the AMT, extending the 2009 rules only into 2010. Given the politics of health care, there may not be time for deliberation on permanent estate tax reform. At least one commentator has suggested that a revenue-hungry Congress might then let the exempt amount fall back to $1 million in 2011.
(September 2009)
© 2009 M.A. Co. All rights reserved.
Ask a trust officer: Blended families
DEAR TRUST OFFICER:
I’m planning to remarry, and I know that means I should take a look at my will. Right now I’ve left my property to my kids from my first marriage. I’d like to include my new spouse in my plan, yet I don’t want to cut out the children completely. Is there an easy solution?
—STARTING OVER
DEAR STARTING:
In situations such as yours, we’ve seen a lot of interest in the Qualified Terminable Interest Property Trust, or more commonly, QTIP Trust. The trust is “qualified” for the marital deduction from the federal estate tax, provided the surviving spouse is a U.S. citizen. The trust is “terminable” because it ends at the spouse’s death, and the spouse usually doesn’t have the right to change who gets the property at that point. In other words, the inheritance for your children is secure.
Another benefit of the QTIP trust is that the executor can elect a full or partial marital deduction, depending upon what’s best for tax purposes. That flexibility is especially welcome during these times when the federal estate tax may be undergoing major changes.
Do you have a question concerning wealth management or trusts? Send your inquiry to [trustofficer@bankname.com].
(September 2009)
© 2009 M.A. Co. All rights reserved.
I’m planning to remarry, and I know that means I should take a look at my will. Right now I’ve left my property to my kids from my first marriage. I’d like to include my new spouse in my plan, yet I don’t want to cut out the children completely. Is there an easy solution?
—STARTING OVER
DEAR STARTING:
In situations such as yours, we’ve seen a lot of interest in the Qualified Terminable Interest Property Trust, or more commonly, QTIP Trust. The trust is “qualified” for the marital deduction from the federal estate tax, provided the surviving spouse is a U.S. citizen. The trust is “terminable” because it ends at the spouse’s death, and the spouse usually doesn’t have the right to change who gets the property at that point. In other words, the inheritance for your children is secure.
Another benefit of the QTIP trust is that the executor can elect a full or partial marital deduction, depending upon what’s best for tax purposes. That flexibility is especially welcome during these times when the federal estate tax may be undergoing major changes.
Do you have a question concerning wealth management or trusts? Send your inquiry to [trustofficer@bankname.com].
(September 2009)
© 2009 M.A. Co. All rights reserved.
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