Trust and Estate Planning Update

In last year’s article, we wrote that legislation was pending that might prevent minority interest and lack of marketability discounts for certain family-owned entities. On August 2, 2016, the U.S. Treasury and Internal Revenue Service issued proposed regulations covering that topic. Specifically, the proposed regulations provide new rules which would value transfers of interests in a closely held business without considering certain restrictions placed on those interests. These rules may significantly reduce “lack of control and marketability” discounts for gift, estate, and generation skipping transfer (GST) tax purposes.

Ultimately, the proposed regulations will effectively eliminate discounts available to transferors of interests in partnerships and corporations. Certain provisions are effective upon issuance of final regulations and certain sections are effective 30 days after that. Since there is a 90-day comment period and a public hearing scheduled December 1, final regulations will not be issued until December 2016 and possibly not until 2017.

It is likely that a good portion of these proposed regulations will pass in final form, possibly before the end of the year. They will cause a substantial reduction in the types of valuation discounts to which donors have become accustomed; so 2016 may present the last opportunity to take advantage of the maximum benefit of valuation discounts.

Additionally, estate plans should be reviewed since smaller discounts may now apply, causing increases in potential gift, estate and GST tax. These estates may wish to review life insurance coverage and/or its liquidity position to determine if potential estate taxes will be covered.

Of course, changes produce winners as well as losers. Although larger discounts would be eliminated, higher values will create higher income tax bases for assets transferred from an estate. This may produce a significant benefit for heirs of estates falling under the lifetime exclusion amount.

Increase in New York Estate Tax Exemption
On April 1, 2016, the amount of property that can pass free of New York estate tax was increased to $4,187,500. This was part of New York legislation passed in 2014. In 2019, when the law is completely phased in, the exemption amount will be equal to the federal exemption (as indexed for inflation). Estates valued in excess of the federal exemption will continue to pay New York estate taxes.

Gift, Estate and Generation Skipping Transfer Tax
In 2016, each individual can transfer up to $5,450,000 during life without incurring a gift tax. This amount increases each year as it is indexed for inflation. (The amount increased $20,000 from 2015). Upon death, each individual has the same exemption amount available, less what he or she used of the gift tax exemption during his or her lifetime.

The annual gift tax exclusion for 2016 remains at $14,000 per person per calendar year, or $28,000 for married couples, if gift splitting is elected. Individuals may also make direct and unlimited payments of tuition or medical expenses directly to the applicable institution.

The Generation Skipping Transfer (GST) tax applies to those transfers made from an individual to his or her grandchild or more remote descendants or to a trust for their benefit. The GST tax prevents a taxpayer from avoiding the transfer tax by bypassing the generation below them (e.g., children). The rate of the GST tax is the highest applicable estate tax rate. The exemption amount applicable to each individual in 2016 is $5,450,000 and is also indexed for inflation.

Gifting Techniques
The substantial gift tax exemption creates opportunities to make lifetime transfers to avoid estate taxes on post-transfer income and appreciation and to transfer assets to grandchildren and future generations. Furthermore, the current low interest rate environment affords a number of effective techniques for transferring significant wealth to the next generation with minimal gift tax consequences. Some of the planning opportunities that work well in a low interest environment include:

Planning Opportunity – 01

Loans to family members – An individual can make a low interest rate loan to another person (e.g., a child) who can invest the money and earn an amount greater than the interest he or she is required to pay on the loan

Planning Opportunity – 02

Grantor Retained Annuity Trusts (“GRATs”) – GRATs allow a donor to transfer assets with high appreciation potential out of their estate, provided certain conditions are met. The donor will fund the GRAT with highly appreciating assets and must receive an annuity payment from the trust each year. If the assets in the trust appreciate in excess of the interest rate prescribed by the Internal Revenue Service, that excess amount gets passed onto others (e.g., children) at the end of the trust term.

Planning Opportunity – 03

The sale of assets to an intentionally defective grantor trust allows the donor to transfer or sell appreciated assets to a trust in return for an installment note. The transaction allows the grantor to freeze the value of the estate at the value of the promissory note, without ncome and gift tax consequences. If the assets in the trust appreciate in value beyond the interest rate prescribed by the IRS, the excess is transferred free of transfer tax to the remainder beneficiaries of the trust (i.e., children and grandchildren).

Portability
Under the portability provision of the Internal Revenue Code, the surviving spouse can use the unused portion of the deceased spouse’s estate tax exemption. The surviving spouse can use the unused portion for both gift and estate tax purposes but not for GST tax purposes, and it does not apply to state death tax exemptions.

In order to preserve the unused estate tax exemption amount for the surviving spouse, an election must be made on a timely filed estate tax return for the deceased spouse.

Changes on the Horizon
Other than the proposed regulations preventing discounts referenced above, there has been little change in the trusts and estates tax provisions. The American Taxpayer Relief Act of 2012 brought stability to the estate and gift tax area, and the continued low interest rate environment makes the above gift techniques a still-effective way of transferring wealth with minimal gift tax consequences. The Presidential and Congressional elections on November 8 (yet to occur as of this writing) will most certainly bring discussions on changing these laws from outright repeal to a reduction of the lifetime exemption amounts and an increase in the tax rate.