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August 2009 Economy, Expiring Provisions Affect Estate PlanningTax law changes, low asset values and low interest rates may make this an optimal time to update your estate planIs your current estate plan sufficient, in light of the upcoming estate tax changes? Consider this: At present, the federal estate tax exemption is $3.5 million. With proper planning, under the current law a taxpayer can transfer out of their estate up to $3.5 million ($7 million for a married couple) without incurring estate tax liability (assuming no taxable gifts have been made during their lifetime). Any cumulative lifetime gifting utilizing the $1 million lifetime gifting exemption would reduce the $3.5 million available at death. For example, a taxpayer who has fully utilized their $1 million lifetime gifting exemption may, at their death, transfer tax-free only the remaining $2.5 million. If Congress does not take action to the contrary, in 2010 the federal estate tax will be completely repealed. However, lifetime gifting will remain at $1 million, and gifts that are made after that limit is reached will be taxed at 35%. In conjunction with the repeal of the estate tax, beneficiaries will receive a carryover basis rather than a step-up in basis. • For more see Kelly White's May 2010 article, Estate Planning in the Year of Estate Tax Repeal In 2011 the estate tax is set to revert to an exemption amount of $1 million. Therefore, a taxpayer who has fully utilized their $1 million lifetime gifting exemption will not have any remaining exemption, and the entire estate will be taxed (unless otherwise reduced by the unlimited marital deduction or unlimited charitable deduction). Congress will likely change the current tax law, and the easiest change would be to continue the current exemption of $3.5 million to 2010 and beyond. Planning in Uncertain TimesIf the estate tax is repealed for 2010, many couples’ existing estate planning documents would be defective, as most funding clauses refer to a “taxable estate.” What would the surviving spouse receive, and what would be the future estate tax implications for the surviving spouse’s estate? Also, the carryover basis rules have special provisions for property passing to the surviving spouse, and many estate planning documents do not address those rules. (If you have a living trust, ask your trust attorney whether it should be amended.) Reducing estate value. As the estate tax will “go away” for only one year – if at all – reducing your taxable estate is still an important objective. Gifting. Utilizing annual exclusion gifting (limited to $13,000 per donor per donee for 2009) is especially effective in today’s market if gifts are of securities, real estate and business interests. Making gifts now while many asset values are depressed will transfer the future appreciation out of the estate. Also, utilization of the lifetime gift tax exemption of $1 million for gifts of securities, real estate and business interests would also be advantageous in the current market.
Direct payments to medical care providers and
educational institutions on behalf of someone else are not considered
gifts and are not included in the calculation of the $13,000 annual
exclusion. Loans. Another timely estate reduction technique is the use of loans and installment sales. A loan is not considered a gift if it is documented with a note bearing an interest rate at the applicable federal rate (AFR). The July 2009 AFR (semiannual compounding) for a short-term note (three years or less) was 0.82%. The rates for mid-term loans (four to nine years) and long-term loans (nine-plus year) are, respectively, 2.74% and 4.31%. Freezing. Especially effective is an estate-freezing technique whereby you can sell an asset that has a low fair market value in exchange for a promissory note that bears at a low AFR, thereby “freezing” the value of your estate at today’s low value. The underlying asset is no longer included in the estate (only the remaining balance of the note); thus, all post-sale appreciation of the asset is outside the estate and not subject to estate tax. There are income tax consequences to this transfer, as the seller will recognize interest income and capital gains as payments are made on the note. IDGT. An “intentionally defective grantor trust” to which you gift and/or sell assets can be another estate planning technique in a troubled economy. As mentioned above, certain assets can be gifted or sold at today’s low value, transferring future appreciation of out the estate. If the transfer is to an IDGT, the result is similar. However, in addition to the appreciation being removed from the estate, if the transfer is structured as a sale, the interest and gain on the sale do not need to be currently recognized by the seller, and future income tax liabilities are taxable to the grantor. Therefore, payment of taxes by the grantor will further reduce the grantor’s estate without being considered a gift to the trust or beneficiaries. IRD. Finally, consider providing for transferring to a charity any assets that are considered “income in respect of a decedent.” IRD assets will be subject to both the estate tax and then income tax (taxable to the beneficiary), thereby subjecting the asset to approximately 75% tax. A transfer of those assets at death will reduce the taxable estate as a result of the unlimited estate tax charitable deduction. Timing. Change in the tax laws, low asset values, and low interest rates may make this a good time to update your estate plan. To gain a clearer understanding of your planning opportunities, contact your Schmidt Westergard & Company tax professional. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |
