Intentionally Defective Budget Proposal: President Obama’s Attack on Grantor Trusts

 By Erica Opitz

On February 13, 2012, President Obama proposed the budget for 2013.  The budget proposal has been reported to be dead on arrival.  Notably, however, President Obama’s budget proposal went after intentionally defective grantor trusts, which is not a proposal that we have seen previously.  If this were to pass, the results would wreak havoc on a top estate planning tool. With the sun setting of the current estate tax code provisions at the end of this year, it is possible that President Obama’s grantor trust proposal will be used as a bargaining chip and could potentially reappear in future legislation.

Under the proposal, the legislation would only be effective for transfers on or after the date of enactment.  As a result, transfers to a grantor trust prior to enactment would remain outside of the grantor’s estate.  For this reason, it is important to take advantage of the grantor trust while the benefits remain available.

Current Law:

In an intentionally defective grantor trust, the grantor retains certain rights and powers over the property held by the trust.  For income tax purposes, a grantor trust is not a separate entity from the grantor, and as a result, the grantor pays all income taxes on the trust earnings.  Under the current regime, the assets placed in the grantor trust are held outside of the grantor’s estate.  The transfer of property into the trust is treated as a completed gift for estate and gift tax purposes.  As a result, future appreciation on the assets placed in the trust is not subject to estate or gift tax.  Furthermore, a sale from the grantor to the grantor trust is ignored for income tax purposes.

Proposed Law:

President Obama’s budget proposal would include the assets of the grantor trust in the grantor’s gross estate.  Additionally, any distributions from a grantor trust would be subject to gift tax as would the assets of the trust if the grantor ceased to be the owner of the trust.  President Obama’s proposal would apply income tax to a sale from the grantor to the grantor trust if the sale would be subject to capital gains tax if the sale was made by someone other than the grantor.  The Department of Treasury’s green book states the reasoning behind the proposal.  “Taxpayers should be required to take consistent positions in dealing with the Internal Revenue Service.  The basis of property acquired from a decedent generally is the fair market value of the property on the decedent’s date of death.”

Explore posts in the same categories: Estate Planning, Gift Taxes, Tax

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