Overview Inherited Retirement Plan Benefits – Possible Minimum Distribution Rule Changes Committee Update - Uniform Trust Code in Minnesota Portability Proposals for Fiscal Year 2012 Federal Legislation Drafting for Qualified Small Business and Farming Deduction Planning for Income Tax Basis Step Up In The Bypass Trust
INHERITED PLANBENEFITS- ARE THE TAXRULES ABOUT TOCHANGE?
Inherited retirement plans –minimum distributions Proposal by Sen. Max Baucus of the Senate Finance Committee 5 year rule is the general rule for all distributions after death for all plans and all IRA’s. Exceptions for the following beneficiaries: spouse, disabled and “chronically ill persons”, persons less than 10 years younger than the deceased person, minor children of the deceased plan participant. Effective date proposed: death’s occurring after 2012.
Portability: Requirements Surviving spouse can use deceased spouse’s unused unified credit for gift and estate tax purposes (NOT GST) deceased spousal unused exclusion amount (DSUEA) 1st Spouse dies in 2011 or later 2nd Spouse dies before 2013 Not allowed for noncitizen and nonresident alien spouses.
Basic Example H dies in 2011 with a $3 million estate which passes to his children W’s exclusion becomes $7 million $5 million from her own exemption $2 million from her husband’s unused unified credit
Electing Portability Elected: file timely and complete Form 706 Statute of Limitations Cannot increase tax due for predeceased spouse Service can review predeceased spouse’s return anytime for purposes of determining DSUEA Electing out Following instructions on Form 706 Do not file Form 706
Multiple Spouses Can only claim DSUEA of last deceased spouse H1 and W married. H1 dies. H2 and W married. H2 dies. W has DSUEA from H2 IF H2 made election.
Multiple Spouse: Divorce Divorce revives DSUEA of first deceased spouse H1 and W married. H1 dies. H2 and W married. H2 and W divorce. H2 dies. W has DSUEA from H1
Recapture with ReducedExemption? Exemption is $5M H1 dies with $2M estate W receives $3M in DSUEA Exemption is reduced to $1M W dies Does W have exemption of $2M or $4M? $2M: Section 2010(c)(4)(A) limits DSUEA to the basic exclusion amount
Recapture with Gifts? W gets $5M DSUEA from H1. W makes $10M in gifts W remarries H2 H2 dies leaving W with $0 DESUEA W has no assets at death W’s taxable estate of $5M ($10M lifetime gifts - $5M exemption) Result: will create estate tax that exceeds decedent’s estate (who pays the tax?)
Advantages of Credit ShelterTrusts Asset protection during surviving spouse’s life Can protect children’s inheritance Shelter appreciation and income from estate tax, DSUEA not indexed for inflation Preservation of predeceased spouse’s exemption if exemption is reduced Minnesota’s estate tax has no portability
Advantages of Credit ShelterTrust Use of predeceased spouse’s GST Exemption Avoid filing estate tax return if estate is not so large Portability lost if surviving spouse remarries and outlives second spouse Less risk of audit at second death if trust is funded with non-publicly traded assets that are difficult to value Portability may sunset in 2013
Advantages of Portability Simplicity (no segregation of assets) Property depreciates after first spouse’s death (like retirement assets) Second step-up in basis for appreciated assets Acts as back up if couple fails to fully implement asset retitling
Predictions No significant modifications of estate plans currently needed Gift planning using DSUEA Could have direction in estate plans to file a Form 706 Wealthy spouses should treat DSUEA like basic exclusion and use as soon as possible so assets begin appreciating outside of estate Premarital agreements Require surviving spouse’s estate to file an estate tax return and elect portability.
FISCAL YEAR 2012PROPOSALS
Administration’s Fiscal Year 2012Budget Proposals Federal Exemptions: 3.5Million Estate and GST Tax Exemptions 45% top tax rate 2013 proposal would limit gift tax exemption to $1 Million Continuing Portability: potentially costing $3.681 billion over the next 10 years
Administration’s Fiscal Year 2012Budget Proposals Consistency in Value for Transfer Tax and Income Tax Purposes: New subsections 1014(f)(1) & 1015(f)(1) New Section 6035 Basis Information Sheet Could add authorization for Treasury to issue regulations requiring reporting basis even where Forms 706 and 709 are not required Could raise $2.095 billion in revenue over 10 years
Administration’s Fiscal Year 2012Budget Proposals Grantor Retained Annuity Trust regulations 10 year minimum terms Remainder interest (the gift) must have value > 0 Annuity amounts not to decrease in any year of the annuity term Could raise $2.959 billion in revenue over 10 years
Administration’s Fiscal Year 2012Budget Proposals Limiting GST dynasty trusts to 90 years tax free The GST inclusion ratio is increased to 1 on the 90th anniversary of the date of the trust’s creation Would impact trusts created after the date of enactment plus the portion of pre-existing trusts with contributions after the date of enactment
Administration’s Fiscal Year 2012Budget Proposals Valuation Discount Modifications Attacking discounts primarily related to family transactions, potentially including minority and marketability discounts Could raise $18.166 billion in revenue over 10 years
Administration’s Fiscal Year 2013Budget Proposal Grantor Trust Coordination of Income and Transfer Tax Rules To the extent that income tax rules treat a grantor as the owner of the trust, the proposal: 1. Includes the assets of the trust in the gross estate of the grantor for estate tax purposes; 2. Subjects distributions from the trust to gift tax during the grantor’s life; and 3. Subjects remaining assets to gift tax during the grantor’s life if the grantor ceases to be an owner.
DRAFTING FOR THE NEWMINNESOTA QUALIFIEDSMALL BUSINESS ANDFARMING DEDUCTION
Drafting for Qualified Small Businessand Farming Deduction – MS 291.03 Statutory Requirements – For A Deduction Of Up To $4 Million Deathafter 6/30/2011 Decedent must own “Qualified Property”: Qualified Small Business Property or Qualified Farm Property The Qualified Property must pass to a Qualified Heir The statute does not address whether the ownership interest by the deceased person or his/her family members can be in a trust and if so, which beneficiaries of the trust (current, future, contingent, all of the above) must be qualified heirs.
Drafting for Qualified Small Business andFarming Deduction – MS 291.03 Definition of a Qualified Small Business Thevalue of the property was included in the federal adjusted taxable estate. There is no minimum percentage of the estate that must be comprised of the Qualified Small Business (i.e. no 25% or 50% test as is the case for IRC Section 2032A) The reference to the adjusted taxable estate prevents the deduction from applying in the case of property qualifying for the estate tax marital deduction.
Drafting for Qualified Small Businessand Farming Deduction – MS 291.03 Definition of a Qualified Small Business The property consists of the assets of a trade or business or shares of stock or other ownership interests in a corporation or other entity engaged in a trade or business. There is no requirement that the qualified small business property be real estate. Equipment, inventory and other personal property would appear to qualify. There is no requirement that the qualified small business be located in Minnesota.
Drafting for Qualified Small Businessand Farming Deduction – MS 291.03 Definition of a Qualified Small Business The decedent or the decedents spouse must have materially participated in the trade or business within the meaning of section 469 of the Internal Revenue Code during the taxable year that ended before the date of the decedents death. See Treasury Regulation 1.469-5T. Material participation requires satisfaction of one of 7 tests. The test which is most likely to apply requires the decedent or spouse to have participated in the activity for more than 500 hours during the taxable year.
Drafting for Qualified Small Businessand Farming Deduction – MS 291.03 This is a stricter test than the material participation test under IRC Section 2032A, which adopts the IRC Section 1402 standard for determining if an activity is sufficiently active to be subject to tax as net earnings for self-employment. There is no provision which permits the satisfaction of the material participation requirement for a retired or disabled individual.
Drafting for Qualified Small Businessand Farming Deduction – MS 291.03 Shares of stock in a corporation or an ownership interest in another type of entity do not qualify under this subdivision if the shares or ownership interests are traded on a public stock exchange at any time during the three-year period ending on the decedents date of death. The gross annual sales of the trade or business were $10,000,000 or less for the last taxable year that ended before the date of the death of the decedent. The property does not consist of cash or cash equivalents. For property consisting of shares of stock or other ownership interests in an entity, the amount of cash or cash equivalents held by the corporation or other entity must be deducted from the value of the property qualifying under this subdivision in proportion to the decedents share of ownership of the entity on the date of death.
Drafting for Qualified Small Businessand Farming Deduction – MS 291.03 The decedent continuously owned the property for the three-year period ending on the date of death of the decedent. A family member “continuously uses” the property in the operation of the trade or business for three years following the date of death of the decedent. What is the standard for the measurement of continuous use? Unlike IRC Section 2032A, this seems to require that the family member who inherits the property must be the same family member who continuously uses it. The estate and the qualified heir elect to treat the property as qualified small business property and agree, in the form prescribed by the Commissioner, to pay the recapture tax under subdivision 11, if applicable.
Drafting for Qualified Small Businessand Farming Deduction – MS 291.03 The value of the property was included in the federal adjusted taxable estate. The property consists of: consists of a farm meeting the requirements of section 500.24. Note: this is the corporate farming statute which in turn regulates the ownership of trusts owning farm land. The statute excludes timber and poultry operations, and by ruling, the commissioner has exclude land in the CRP program, was classified for property tax purposes as the homestead of the decedent or the decedents spouse or both under section 273.124, and was classified as class 2a property under section 273.13, subdivision 23 [relating to vacant contiguous land]. The definition requires that the qualified property must consist of agricultural land, the farm home and farm buildings. Grain, livestock and equipment and other farm related personal property do not qualify.
Drafting for Qualified Small Businessand Farming Deduction – MS 291.03 The decedent continuously owned the property for the three-year period ending on the date of death of the decedent. There does not appear to be any material participation requirement during the period before the decedent’s death. A family member continuously uses the property in the operation of the trade or business for three years following the date of death of the decedent. The estate and the qualified heir elect to treat the property as qualified farm property and agree, in a form prescribed by the commissioner, to pay the recapture tax under subdivision 11, if applicable.
Recapture Tax The amount of the additional tax equals the amount of the exclusion claimed by the estate under subdivision 8, paragraph (d), multiplied by 16 percent. The additional tax under this subdivision is due on the day which is six months after the date of the disposition or cessation of the qualifying use.
Recapture Tax If, within three years after the decedents death and before the death of the qualified heir, the qualified heir disposes of any interest in the qualified property, other than by a disposition to a family member, or a family member ceases to use the qualified property which was acquired or passed from the decedent, an additional estate tax is imposed on the property.
Drafting Considerations With Respect ToThe Qualified Interest Deduction In the case of married clients, consider potential decrease of Federal exemption to $1 Million on 1/1/2013. Directing qualified interest to a share that does not qualify for the marital deduction may trigger an unexpected federal estate tax on the first spouse’s death. A gift to the marital share does not qualify for the qualified interest deduction. Note: if IRC Section 2032A planning is being considered for a married couple, a lead pecuniary marital formula is often selected under which the Section 2032A property is often passed under the marital share so that the valuation reduction may be achieved in both spouse’s estates. A formula gift could be employed which requires that the transfer occur only to the extent that no federal estate tax is triggered.
Drafting Considerations With Respect ToThe Qualified Interest Deduction Review the tax payment provision. Generally, the tax, including the recapture tax, should be apportioned to the qualified heirs receiving the qualified property. Consider alternatives to trust ownership by the property owner and the qualified heir until further guidance is received. To avoid probate, consider the use of TOD deeds for real estate, and TOD certification for partnership interests, LLC interests and corporate shares.
Drafting Considerations With Respect ToThe Qualified Interest Deduction Consider requiring each heir who receives an interest in the qualified property, other than a surviving spouse, upon the request of the personal representative, to: sign the election and recapture agreement (including any protective elections) before the due date of the return, as a condition to receiving their inheritance of the qualified property, and such signing should also be required with respect to any further matters required to perfect the election.
Drafting Considerations With Respect ToThe Qualified Interest Deduction If the qualified property will be transferred into a trust, consider a provision which requires the personal representative and trustee to designate a qualified heir to manage such property to secure qualification for the deduction. The fiduciary should be exonerated from liability for such delegation. Permit an independent trustee or trust protector to amend the trust to the extent necessary to permit qualification for the deduction.
WAIT & SEE PLANNING –ELECTING BASIS STEPUP IN THE BYPASSTRUST
Planning for Income Tax BasisStep Up In Bypass Trust Income tax basis step up at death under IRC Section 1014. Directing the independent trustee to consider IRC Section 1014. Creation and elimination of general powers by independent trustees. Problems with formula general powers.
Planning for Income Tax BasisStep Up In Bypass Trust Solution: The Delaware Tax Trap Section 2041(a)(3) provides that an exercise by a beneficiary of a limited power of appointment will be taxed as if it were a general power of appointment if the exercise of the power is to a further trust which “postpone(s) the vesting of any … interest in such property, or suspends the absolute ownership or power of alienation of such property, for a period ascertainable without regard to the date of the creation of the first power.”
Planning for Income Tax BasisStep Up In The Bypass Trust Technique to exercise a power of appointment which transfers property in further trust in a manner which postpones the vesting of an interest in trust: Problem: the law of most states – including the Minnesota version of the Uniform Statutory Rule Against Perpetuities (USRAP) – generally prohibits an exercise in further trust with a new measuring period. Solution – Minnesota and all other states with rules against perpetuities permit a transfer in a further trust in which the beneficiary of the appointed trust has a presently exercisable