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Since the enactment of the Economic Growth and Tax Relief and Reconciliation Act of 2001 ("EGTRRA") up until the enactment in December 2012 of the American Taxpayer Relief Act of 2012 ("ATRA"), estate planners have had to plan around tax provisions that were expressly stated to be temporary in nature. ATRA has now provided rules governing the estate tax, the gift tax, and the generation skipping transfer tax ("transfer taxes") that are,  at least according to ATRA, permanent (i.e., not subject to "sunsetting" at some fixed date in the future). In view of this presumed new-found  certainty in the tax rules governing estate planning, estate planners should be mindful of the need to review and revise, if necessary, the estate plans structured under the pre-ATRA "temporary" estate planning rules. Some of the more significant estate planning that should at least be considered post-ATRA by estate planners are discussed below.

  1. On The One Hand, Take Advantage of Available Post-ATRA Discount Planning While It Lasts

    Over the years, well tested techniques have been developed that can discount, for transfer tax purposes, the taxable value of assets being transferred below the fair market value of these assets absent the implementation of these techniques. The obvious effect of discount planning is to reduce the transfer taxes due on account of asset transfers since these taxes are a function of the taxable value of the assets being transferred. Some of the more interesting discount techniques involve:

    • placing assets likely to appreciate in value over time in a family limited partnership and then transferring limited partnership interests in the partnership, rather than the assets themselves, to family members;
    • placing assets (again, which are likely to appreciate in value over time and/or which are likely to generate a relatively high yield stream of periodic income)  in a trust, with the transferor retaining an annuity interest in the trust for a predetermined period of time, after which the trust assets pass to family members (referred to as a "Grantor Retained Annuity Trust" or "GRAT"); and
    • funding an irrevocable trust that, for federal income tax purposes, is a "Grantor Trust", with a small amount of cash or other assets and then having the trust purchase assets (which, again, are expected to appreciate in value over time and/or are likely to generate a high yield periodic stream of income) from the trust creator, i.e., grantor, on an installment basis. The trust would be irrevocable (and thus no longer included in the grantor's gross estate), but is "intentionally" designed to be treated as a "Grantor Trust" for federal income tax purposes (and thus causing any income recognized by the trust to be currently taxed to the grantor). This latter feature of the trust produces no recognized gain for Federal Income Tax purposes on account of the sale to the trust, since, the grantor is treated as selling the asset to himself under the Grantor Trust rules. This technique is referred to as a sale to an "Intentionally Defective Grantor Trust" or "IDGT". The requisite amount of cash or other assets typically used in establishing the IDGT is intended to have a value of at least 10% of the purchase price of the assets being purchased. For those grantors who have already established an IDGT, consideration should be given to increasing the "cash/other asset" funding of the IDGT, if necessary, to enable the trust to enter into another purchase from the grantor. An IDGT can be thought of as a GRAT on steroids.
    Fortunately, ATRA did not address the continued use of these types of discount planning. Nevertheless, President Obama and the Department of Treasury have been asking Congress for the past several years to eliminate, or at least limit, the use of these techniques to achieve the size of valuation discounts which have historically been approved by the courts. Accordingly, if these discount planning techniques make sense for a taxpayer, there may be a limited amount of time left in which these types of discount planning can still be implemented.
  2. On The Other Hand, Consider Mitigating Certain Discount Planning Already Implemented Prior To 2010

    Interestingly, ATRA's "permanent" increase in the amount of assets not subject to (i.e., excluded from) transfer taxes to $5,250,000 (subject to future increases for inflation) has made some prior discount planning counter-productive.

    To see how this could occur, it should be noted that the assets that have been successfully discounted through various asset transfer techniques (some of which are noted above) will not have their adjusted basis stepped-up to their fair market value at the death of the transferor since they are no longer part of the transferor's estate. In other words, the ultimate recipient of the asset uses the asset's historical basis as it existed at the time of the transfer (usually a carryover basis), not as stepped up to its fair market value as of the transferor's death. Therefore, should the recipient want to sell the asset, the sale will generate a larger gain than would have occurred absent the discount, and thus, a greater income tax on account of the sale. This increased income tax makes tax sense only if the increased income tax is more than offset by the transfer tax savings generated by the discount - transfer tax savings that may now not occur in view of the increased exemption amounts made permanent by ATRA.

    For example, suppose that, in 2009, a single individual, A, would have had a $4,000,000 gross estate absent some sort of discount planning. In 2009, the applicable exclusion amount was $3,500,000, A wanted to prevent his estate from having to pay any transfer taxes upon his death. A, therefore, undertook a discount planning technique that reduced the total amount that would have been subject to federal estate tax at his death to $3,500,000, thus preventing A's estate from paying any federal estate tax if he would have died with no law changes having been made in the interim. By implementing a discount planning technique in 2009, A believed that A had saved 50% of $500,000 (or $250,000) in federal estate taxes. But, with ATRA's applicable exclusion amount now being $5,250,000, A will now save no federal estate taxes on account of the discount planning done in 2009. Yet, A's beneficiaries now face a potential capital gains tax of 20% of $500,000, or $100,000, solely because of the reduction in the adjusted basis in the asset that occurs as a result of the discount planning. Not a good result!

    In view of this change in circumstances, A should be looking to see if anything can be done to mitigate the discount planning since it will potentially cost A's beneficiaries $100,000 as is. Some of the ways in which A can mitigate the planning undertaken in 2009 are discussed in Item 3, below.
  3. Consider The Possibility of Changing or Modifying  2012 Transfers Primarily Undertaken By Transferors In the Mistaken  Belief That the 2012 Applicable Exclusion Amounts Would Revert to the Lower 2001 Exclusion Amount of $1,000,000

    It is possible that many of the gifts that occurred in 2012 were motivated primarily by the belief that the $5,120,000 applicable exclusion amount in effect in 2012 was going to be reduced to as low as $1,000,000 beginning in 2013. Now that we know that the applicable exclusion amount will not be reduced for 2013, but will actually increase to $5,250,000, it may be that some of those gifts that occurred in 2012 would not have been made had that been known. Under the laws of many states, as well as the Internal Revenue Code, there are techniques available to modify, and in some cases, revoke these gifts. The methods for accomplishing this might include the use of judicially sanctioned techniques to modify or revoke gifts in trusts, state laws authorizing that gifts in trust be transferred from the trustee of the trust receiving the initial gift to another trust that better fits the grantor's true wishes (the so-called "decanting" of the transferred assets), and disclaimers under the Internal Revenue Code. Another possibility is the exercise by the trust grantor of a right reserved to the grantor to substitute assets held in the trust for other assets, provided the trust expressly allows such right of substitution (a right frequently found in IDGTs).
  4. Taking Advantage of the Increased Gift Tax and Generation Skipping Transfer Tax Exemption Amount and the Increased Federal Gift Tax Annual Exclusion Amount

    For 2013, the Exemption Amount for both the federal Gift Tax and the Generation Skipping Transfer Tax has increased from $5,120,000 to $5,250,000. Also, the federal Gift Tax Annual Exclusion Amount for gifts of present interests in property has increased from $13,000 to $14,000 per year per donee. For those that did make gifts in 2012 to take full advantage of the exemption/exclusion amounts in effect for 2012, they should consider making additional gifts to take advantage of the additional exemption/exclusion amounts in effect for 2013.
For additional information, please contact your local UHY LLP professional.