Archive for the ‘Gift Taxes’ category

President Obama’s Estate Plan Reminds Us of the Power of the Annual Exclusion

April 17, 2012

 by David Kovsky

On April 13, 2012, The Washington Free Beacon ran an article deriding President Obama’s reliance Section 2503(b) of the Internal Revenue Code to transfer $48,000 to his daughters, free of any federal wealth transfer taxes.  Under that section of the Code, each taxpayer may transfer $10,000 to any number of individuals on an annual basis, free of the federal gift tax.  This is the so-called “annual exclusion.”  Section 2503(b) further provides that the annual exclusion will be indexed for inflation.  As such, the amount that may be transferred to each donee in 2012, free of the federal gift tax, is $13,000.”

The rationale behind the annual exclusion is to not mire the taxpayer or the IRS in tracking the aggregate of annual birthday presents, holiday gifts or dinners on “mom and dad.”  Only when the amount rises to the level of what is deemed wealth transfer, will the gift tax be triggered.

Although the article run by The Washington Free Beacon had a political slant, it is also a great reminder of how useful the annual exclusion can be from an estate planning perspective.  Take, for example, the following hypothetical:  Grandmom and Grandpop have three married children and six grandchildren.  By utilizing the annual exclusion, Grandmom and Grandpop can transfer an aggregate of $312,000 of wealth to Generation 2 and Generation 3, without incurring a gift tax or a generation-skipping transfer tax (another federal wealth transfer tax with its own set of annual exclusion rules), every single year.  If these gifts are made in December of year 1 and January of year 2, our hypothetical Grandmom and Grandpop can transfer over $600,000 during a several week period, free of any federal wealth transfer taxes.  Here is breakdown of the transfers in year 1 (which may be replicated in year 2):

Donee:

Grandmom

Grandpop:

Child 1

$13,000

$13,000

Spouse 1

$13,000

$13,000

Child 2

$13,000

$13,000

Spouse 1

$13,000

$13,000

Child 3

$13,000

$13,000

Spouse 3

$13,000

$13,000

Grandchild 1

$13,000

$13,000

Grandchild 2

$13,000

$13,000

Grandchild 3

$13,000

$13,000

Grandchild 4

$13,000

$13,000

Grandchild 5

$13,000

$13,000

Grandchild 6

$13,000

$13,000

TOTAL:

$156,000

$156,000

This type of estate planning could be as simple as writing checks to all of your immediate family.  However, for many clients, these transfers should be made in conjunction with the establishment of a specially designed trust that qualifies for the annual exclusion and assists clients in meeting their goals of providing the children (and grandchildren) with a measure of asset management assistance, creditor protection and future transfer tax savings.

In whatever form it takes, outright transfers or in trust, fully utilizing the annual exclusion is a powerful estate planning tool that is often overlooked.

Fractional Interests in Real Estate: The Unintentional But Effective Partnership

March 14, 2012

 by Jeff Waddell

A gift of a small interest in real estate can have a greater benefit than intended.  So you decided to transfer a one percent interest in the family farm to your daughter last year.  The values were such that the 1% worked out to about $13,000 so you were within your annual exclusion and that was the plan.  You may have done a lot better than you thought from an estate tax perspective.

By creating a fractional interest situation, the farm is now effectively owned by a partnership between you and your daughter.  No third party is going to buy your 99% interest without the ability to obtain her separate 1% interest so effectively you have created a non-marketable interest in real estate.  Additionally, you cannot independently obtain financing on the property or enter into agreements affecting the property without your daughter’s consent. That means you also have a lack of control over the property.  Both of these factors, lack of marketability and lack of control, are recognized discounts which, at present, can be taken for estate and gift tax return purposes.  The amount of the discount depends on a number of factors; but, even with a discount as low as 20%, the effect of your 1% gift can be dramatic, as illustrated below.

Property Value: $1,300,000 prior to gift.  Transfer 1% for $13,000.  Undiscounted remaining value in estate $1,287,000.

Property Value: $1,300,000 prior to gift. Transfer 1% for $13,000. Discount for lack of control and marketability 20%. Remaining value in estate $1,029,600.

Fractional ownership of real estate can be burdensome, but when used effectively can have significant transfer tax benefit as illustrated above.  Consideration of this technique in a fully developed estate and business plan is certainly appropriate for those who have significant real estate holdings.

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

February 21, 2012

 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.”

IRS Guidance Anticipated for Tax Effects of Trust Decanting

January 25, 2012

 By Rose Drupiewski

The IRS announced that it would place the issue of trust “decanting” on its priority list of items to focus on in 2011 and 2012 for purposes of providing taxpayer guidance.   Decanting occurs when a trustee, pursuant to authority provided in the trust agreement or under state law, transfers property from one trust to another.  Decanting powers have recently become popular with trust drafters as a way to provide additional flexibility to trustees when managing trust assets on behalf of beneficiaries.

The reason for the popularity of decanting powers is that such powers can provide flexibility to otherwise inflexible irrevocable trust agreements.  For example, if a trust agreement provides for an outright distribution of assets to a trust beneficiary at age 25 and the trustee has determined that the beneficiary lacks enough maturity at that age to handle a large distribution, the trustee could (if permitted under the trust agreement or state law) transfer the assets to another trust for the benefit of such beneficiary that will not terminate at age 25 but at a later date.

Although decanting can be extremely useful from the standpoint of flexibility, such flexibility may come with undesirable tax consequences.  The gift, estate, GST and income tax consequences of decanting are less than clear.  For example, there has been some concern that the presence of a decanting power may transform an otherwise irrevocable trust into a revocable trust for estate tax purposes, thus causing the assets in the trust to be included in the grantor’s gross estate.  This is obviously an undesirable consequence because many irrevocable trusts are created for the purpose of enabling a grantor to make gifts to family members in trust without causing estate tax inclusion.  There is also some concern as to whether, if the trustee is a beneficiary of the trust, the trustee’s decanting power might be deemed a general power of appointment for estate tax purposes, which might cause unwanted estate tax consequences for the trustee.  These are just a few examples of multiple unresolved gift, estate, GST and income tax issues relating to trust decanting powers.  Because of the lack of clarity regarding the tax effects of decanting and the hope for favorable guidance, the IRS’s announcement is welcome news for many tax planners and their clients.

In connection with the IRS priority plan, the IRS has recently requested comments from the general public regarding the tax implications of decanting powers.  Comments should be submitted to the IRS by April 25, 2012.

Resolving to Succeed

January 12, 2012

 by Jeff Waddell

The end of the year and beginning of the new year is a time when many of us reflect on that which has passed and that which is to come.  Resolutions are made regarding exercise, fiscal responsibility and other personal items.  Personal health is a primary theme in this introspective endeavor, but for the business owner, what about the long-term health of your business?

An often quoted and almost equally often overlooked adage says that “failing to plan is planning to fail.”  While that sentiment is true during our lifetimes, just stop for a moment and consider what happens when a small business owner does not have a business succession plan in place.  More often than not, the next generation was either not involved in the business or not ready to “take command.”  If proper planning has not occurred, the estate tax burden on the estate of the deceased business owner could cripple the business moving forward.  Do not let this happen to your business.

Take the time to review the health of your business and determine your goals for the business after you retire, in one form or another.  Once you have a general plan, visit with your accountant and estate/business planning attorney to refine your goals through a variety of available vehicles including trusts, corporate restructuring, stock sales, and many others, to achieve a clear cohesive plan of action and begin to implement it.  Hopefully you will “tone those abs” in 2012, but also take the time to resolve to succeed for your business this year.

Jingle Bells or Ringing Out the Year Gone By – Time Is Short to Complete Annual Planning

November 14, 2011

 by Jeff Waddell

Each year at this time our section of the office begins to get really busy.  Clients we have reached out to all year but who have not responded suddenly begin appearing.  Yes, its year end annual gifting time.  Pay heed to the sounds of the approaching holiday season, for in all the merriment those sounds signal the last days to take advantage of annual exclusion gifting or the last opportunity to capture a loss to offset a gain in the same tax year.

Take the opportunity to be proactive.  Review what you have done and what can, or should, be done before year-end.  Be aware that the annual gifting exclusion for each individual is currently $13,000.  Consider consulting your accountant (now is a relatively quiet period for them) to determine whether you are likely to experience an unpleasant April surprise on your tax bill and if so what might help offset that unwanted occurrence.  Then give your estate planning attorney a call to discuss what needs to occur before year end.

Just as with holiday giving, estate planning gifts come in all shapes and sizes.  Annual gifting is something, as the name implies, to consider every year.  This year and next, unless and until the law changes, larger opportunities exist than ever before in the gifting arena (with lifetime $5 million dollar gifting exemptions) so, if your current financial situation allows, consider making it a truly memorable holiday season for yourself and your loved ones.

IRS Tests Imposition of Gift Taxes on Contributions to 501(c)(4) Social Welfare Organizations

May 20, 2011

 By Rose Drupiewski

Nonprofit social welfare organizations may be exempt from federal income taxes under Code section 501(c)(4).  Unlike contributions to public charities, contributions to social welfare organizations are not entitled to income tax charitable deductions under the Code. While it is clear that charitable deductions are not allowed for contributions to social welfare organizations, it is not clear whether such contributions will be subject to gift taxes.

The Code contains no specific gift tax exemptions for contributions to 501(c)(4) organizations as it does for contributions to certain other tax exempt entities such as 501(c)(3) public charities. While the law may allow the imposition of gift taxes on such transfers, the real question is whether or not the IRS will attempt to impose gift taxes. Many organizations, including the ABA’s Exempt Organizations Committee, have urged the IRS not to impose gift taxes on such contributions.

Recently, the IRS issued letters to certain contributors claiming that their donations to 501(c)(4) organizations were subject to gift taxes. The actions have prompted a swift response from Republican members of the Senate Finance Committee, who issued a letter to the IRS Commissioner on May 18 requesting additional information about the IRS’s intent to enforce gift taxes in these situations.

For those considering contributions to social welfare organizations, the IRS’s recent actions may stall future contributions. For everyday taxpayers, this may serve as a reminder that gift taxes can arise outside the family context.