2013 Gift & Estate Planning Opportunities

Gift/Estate Planning
Opportunities in 2013 & Beyond
Amy Joyce, CPA, J.D.
Senior Tax Manager – Trusts & Estates
The Power of Trust. The Power of Growth. The Power of Teamwork.

U.S. Transfer Tax Exemptions & Rates
2013 2014
Exemption Rate Exemption Rate
Gift Tax
(Annual Exclusion)
$5,250,000
($14,000)
40% $5,340,000
($14,000)
40%
GST Tax
(Annual Exclusion)
$5,250,000
($14,000)
40% $5,340,000
($14,000)
40%
Estate Tax $5,250,000 40% $5,340,000 40%
2

Generation-Skipping Transfer (“GST”) Tax Basics
GST Tax Generally
Designed to tax transfers to recipients two or more generations below the person making the transfer
so that property cannot be passed through successive generations free of federal estate taxes.
Example: Dad dies in 1950 leaving $1,000,000 outright to Child 1 and $1,000,000 in trust for the benefit
of Child 2 for life, and descendants of Child 2. Each of the $1,000,000 bequests is subject to tax in Dad’s
estate.
Child 1 dies in 2000 when the $1,000,000 bequest has grown to $20,000,000 and the entire
$20,000,000 is included in the estate of Child 1. Child 2 also dies in 2000 when the $1,000,000 bequest
has grown to $20,000,000; however, none of the trust assets is included in the estate of Child 2 because
estate tax is not imposed on an interest in property in which the decedent (Child 2) held a life interest
created by someone else (Dad). Furthermore, the trust assets will not be again subject to transfer tax
until after the trust terminates and the property has been distributed to Child 2’s descendants.
Without the GST tax, the property in Child 2’s trust would be insulated from the reach of transfer taxes
for several generations.
3

Which Assets Should be Gifted?
• Assets increasing in value – Appreciating assets held until death may
produce greater estate tax. Goal of estate planning techniques is to
remove appreciation from decedent’s estate.
• High basis assets – Since the donor’s income tax basis carries over to the
donee, gifting higher basis assets reduces potential income tax to the
donee upon his later disposition of the assets.
• Valuation discounts – Take advantage of discounts when available, such as
lack of marketability & lack of control (e.g., limited partner or non-
managing member interests).
4

Lifetime Gifting Can Result in Estate “Freeze”
• Freeze = Planning device which allows one to freeze the present value of
his estate and shift future growth to successors.
• Basic Technique (outright gift): Parent gives real property worth $100,000
to Child. Parent dies 25 years later when asset is worth $500,000. Only
$100,000 is includable in Parents' estate.
• Advanced Techniques: GRATs, IDGTs & other trust arrangements.
• State Gift Taxes – Gifted assets may be removed from one’s estate (not
just frozen in value) since nearly all states (except CT & MN) do not impose
gift tax.
5

Gift Planning – Basic Techniques
• Annual Exclusions – $14,000 per donee annual gift/GST exclusion
($28,000 for married couple) for outright gifts:
Example: Grandma & Grandpa have 3 married children and 6
grandchildren. Together Grandma & Grandpa can gift $336,000
($28,000 x 12 donees) of assets every year free of gift and GST
taxes and without depleting their lifetime exemption amounts.
• Tuition – Unlimited exclusion for tuition payments.
• Medical – Unlimited exclusion for medical payments.
• Loan Foregiveness – If a family member has borrowed money,
consider forgiving the loan. Especially useful with current inflation
indexing of lifetime exemption amounts.
6

Benefits of Using Trusts in Gift/Estate Planning
• Leverage annual gift tax exemptions – withdrawal powers for
multiple beneficiaries.
• Leverage lifetime gift/GST exemptions.
• Provide for spouse and children.
• Preserve some control over what happens to transferred assets.
• Grantor Trusts – Cornerstone of most sophisticated estate plans.
7

Grantor Trusts - History
• Perceived Abuse – 1940s Case law
Grantor trust rules developed in response to perceived abuses resulting from income shifting
by taxpayers in very high tax brackets to trust beneficiaries in lower brackets.
• Grantor Trust Concept – IRC of 1954
 Income earned by the trust is taxed to the grantor if the grantor (or grantor’s spouse)
retains certain powers in the trust deemed to be retained control/enjoyment of property.
 In 1954, incentives to shift income were significant as there were 24 income tax brackets
ranging from 20% to 91%.
• 1986 Tax Reform Act (Current Law)
Despite grantor trust rules, non-grantor trusts still used to split income & take advantage of
lower brackets. As a result, the 1986 Act introduced:
 Severely compressed tax brackets – highest bracket reached at $11,950 – essentially a
flat tax at the highest marginal rate.
 Mandatory calendar year.
8

Grantor Trusts – Advantages
• Grantor Trust = Income Tax “Nothing”
Transactions between grantor and trust are disregarded (e.g., sales,
interest payments).
• More Rapid Appreciation
Assets appreciate more rapidly in grantor trust since not depleted
by income taxes.
• Tax-Free Gifts from Grantor
Payment of income tax by grantor is not deemed an indirect gift to
trust beneficiaries [LTR 9543049].
9

Installment Sale to Intentionally Defective
Grantor Trust (“IDGT”)
• Mechanics:
 Trust intentionally drafted to be disregarded for income tax purposes
but not for gift, estate or GST purposes.
 Grantor “seeds” the trust with a gift equal to 10% of the value of the
property to be sold.
 Grantor sells appreciating assets to the trust and takes back an
installment note at a low interest rate.
 Since the trust disregarded for income taxes, no capital gain on sale of
assets and no tax on interest collected.
10

Installment Sale to IDGT – cont’d
• Grantor achieves indirect gift-tax free transfers to trust via paying tax on
income earned by the trust, thus allowing trust assets to compound on tax
favorable basis.
• Trust can have tax reimbursement clause if grantor’s income tax liability
causes cash flow concern.
• Sale freezes value of transferred assets for estate tax purposes, thus, no
matter how much growth assets experience after sale, only payments
received (or uncollected at death) included in estate.
• Sale to IDGT can still be very effective with $1 million or less of gift
exemption.
11

Installment Sale to IDGT – cont’d
Assumptions:
$1 million seed gift
$10 million property sale
5% annual property appreciation
9-year note, annual interest @ 1.65% (Dec. 2013 mid-term AFR), balloon payment
Year Beginning Assets Interest Appreciation Balloon Ending Assets To Bene’s
1 11,000,000 (165,000) 550,000 n/a 11,385,000 n/a
2 11,385,000 (165,000) 569,250 n/a 11,789,250 n/a
3 11,789,250 (165,000) 589,463 n/a 12,213,713 n/a
4 12,213,713 (165,000) 610,686 n/a 12,659,398 n/a
5 12,659,398 (165,000) 632,970 n/a 13,127,368 n/a
6 13,127,368 (165,000) 656,368 n/a 13,618,736 n/a
7 13,618,736 (165,000) 680,937 n/a 14,134,673 n/a
8 14,134,673 (165,000) 706,734 n/a 14,676,407 n/a
9 14,676,407 (165,000) 733,820 (10,000,000) 5,245,227 5,245,227
12

Personal Residence Trust
• No Loss of Cash Flow
Residence is excellent choice where liquidity is a concern.
• Direct Gift vs. Qualified Personal Residence Trust (“QPRT”)
 QPRT produces smaller gift due to “retained” interest.
 QPRT has mortality feature.
 QPRT doesn’t require rent until term ends.
• Use/Possession of Residence after Gift
Requires FMV rental payments to avoid estate inclusion, resulting in additional tax-
free gifts.
• Appraisals
Real estate appraisal, possible TIC valuation and rental appraisal needed.
13

Nonreciprocal Trusts Created by Married Couples
• Spouses can create trusts for each other’s benefit.
• Assets transferred to such trusts, plus appreciation, are removed
from the spouses estates.
• If the grantor-spouse needs access to assets, the beneficiary-spouse
can receive a distribution from the trust.
• If descendants are included as trust beneficiaries, the trustee can
make distributions to the descendants free from gift tax.
14

Nonreciprocal Trusts Created by Married Couples –
cont’d
Reciprocal Trust Doctrine (“RTD”)
• If trust leaves donor in essentially same economic position as if he simply
named himself beneficiary of his own trust, then gift transfer is
disregarded and trust for beneficiary spouse is included in his estate.
• Avoid RTD by varying terms of each trust:
 Different trustees
 Different beneficiaries (useful in personal residence trusts)
 Different distribution standards
 Different assets
 Different funding dates – allow as much time as possible to elapse between funding two
trusts.
15

Irrevocable Life Insurance Trust (“ILIT”)
• Tax-Free Insurance Proceeds
Life insurance proceeds not subject to estate tax or income tax.
• Gift/GST Tax Leverage
Value of “gift” equal to premium payments but eventual exclusion of
policy’s full face value from transfer taxes.
• Gift of Income-Producing Assets
Permits ILIT to pay its own premiums, thus no further gifts needed from
donor.
• Creditor/Divorce Protection (as with most trusts)
Spendthrift and other provisions may protect proceeds from claims of
creditors & beneficiaries’ ex-spouses.
16

Portability
• Before Portability
Traditional estate plans called for a credit shelter trust and a marital trust
at the 1st spouse’s death.
 Credit Shelter Trust – Funded with deceased spouse’s unused
exemption amount. Assets, including any appreciation, escape tax at
surviving spouse’s death. Never subject to estate tax so long as assets
stay in trust. No basis step-up on death of surviving spouse.
 Marital Trust (QTIP) – Funded with remainder of deceased spouse’s
estate. Estate tax deferred until surviving spouse’s death when QTIP
assets become subject to estate tax. Basis step-up achieved since
assets are included in surviving spouse’s estate.
17

Portability – cont’d
• Example – Using Portability in lieu of traditional exemption planning:
 Jack & Jill are married with combined assets of $8 million & no prior
gifts.
 Jack dies first, leaving his assets outright to Jill.
 Portability is elected on Jack’s estate tax return & Jill receives his $5.25
million exemption.
 Jill then has a combined exemption of $10.5 million which she can use
for lifetime gifting and estate planning.
• Advantages of Portability
 Simplicity for couples with asset, including prior gifts, valued at less
than the threshold amount ($10,680,000 for 2013).
 Income Tax Benefits – Assets receive two basis adjustments: at the
death of the 1st spouse and again at the death of the 2nd.
18

Portability – cont’d
• Disadvantages of Portability
 No inflation adjustment – to avoid estate tax, surviving spouse’s exemption
plus ported amount must cover all asset appreciation. May not work if
many years between deaths of spouses.
Example:
• Jack & Jill have $8 million estate.
• Jill dies in 2013, leaving everything to Jack.
• Portability elected, giving Jack a total of $10.5 million (5.25 x 2) exemption.
• Jack lives another 20 years with appreciating assets.
 GST exemption not portable.
 State estate tax exemption not portable (except Hawaii).
 Lost trust benefits – trustee management, creditor protection, etc.
19

Pres. Obama’s 2014 Budget Proposals
• Transfer Tax Exemptions/Rates
Revert back to 2009 figures (starting in 2018):
 $3,500,000 Estate & GST Exemptions
 $1,000,000 Gift Tax Exemption
 45% Tax Rate
 No inflation indexing
• Dynasty Trust Duration
GST exempt status terminates after 90 years (under current law
some states, such as FL, allow trust to exist as long as 360 years).
Applicable to additions to pre-existing trusts.
20

Pres. Obama’s 2014 Budget Proposals
– cont’d
• GRATs
Minimum Term can’t be shorter than 10 years, effectively
increasing probability of GRAT failure.
• Grantor Trusts
Trust distributions treated as taxable gifts.
Estate inclusion in grantor’s estate for assets remaining in
trust at death.
21

Non-Grantor Trust Planning Considerations for 3.8%
Medicare Tax
BASIC STATUTORY STRUCTURE
INDIVIDUALS TRUSTS & ESTATES
3.8% OF THE LESSER OF: 3.8% OF THE LESSER OF:
Modified AGI in
excess of threshold:
$200,000* single
or
$250,000* couple
*NOT indexed for inflation
Net Investment
Income
AGI in excess of
highest income tax
bracket threshold:
$11,950* for 2013
$12,150* for 2014
*indexed for inflation
“Undistributed”
Net Investment
Income
22

Trust/Estate Planning Considerations for 3.8%
Medicare Tax – cont’d
Planning to Reduce the 3.8 Medicare Tax
1. Specifically Allocate Indirect Expenses
 Indirect expenses = those not directly attributable to income that gave rise to the
expense (e.g., rental expenses must be allocated to rental income.
 Regs under Sec. 652 permit fiduciary to allocate indirect expenses to any type of
income (provided there is pro-rata allocation to exempt income).
 Accordingly, indirect expenses may be allocated to 43.4% income to the exclusion of
23.8% income.
2. Distribution Income to Beneficiaries
 May reduce trust income subject to 3.8% Medicare tax if beneficiary does not have
AGI exceeding $200,000/$250,000 threshold.
 Beware – must consider:
 Distribution standards in trust agreement.
 Depletion of trust assets.
 Removing GST-exempt assets from trust.
 Increased AGI limitations for individual beneficiaries.
23

Trust/Estate Planning Considerations for 3.8%
Medicare Tax – cont’d
3. 65- Day Rule
 Trust may treat distributions within 65 days after close of tax year as made
on last day of tax year.
 65-day rule allows trust to accurately determine income by March 5th or 6th
(depending if leap year) & make post-12/31 distributions which are
deemed to occur on 12/31.
 Accordingly, 65-day rule allows trustee to make informed decision about
distributions to minimize surtax.
4. Passive vs. Nonpassive Trade/Business Income
 No rules in IRC 469 for trusts, but IRS official position is that only the
activities of a trustee may be considered in determining non-passive status.
 Consider naming as co-trustee an individual who is actively involved in the
business.
 Must consider appropriateness of trustee as well as whether trust
document authorized trustee to manage and participate in trust’s business.
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