The State of the Federal Estate Tax: What Does it Mean to You and Your

Clients?

Lew Dymond, Esq.

Oh My! What a Mess!

• Assumed Congress would do something before 2010?

• Most current plans do not address planning for no federal estate tax and §1022

• Your clients are not alone

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Good News!

• The current state of the law creates the greatest estate planning marketing opportunity in at least 10 years.

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Where are we and how did we get here?

• Taxpayer Relief Act of 1997– Prior to EGTRRA 2001 we were in the middle of the

phase in of the Taxpayer Relief Act of 1997• Changed name from Unified Credit to Applicable Exclusion

Amount• Increase Unified Credit from $600,000 in 1997 to $1M for

2006 and thereafter; Graduated rates up to 55%• GST Exemption $1M with inflation adjustment; flat rate 55%

(maximum estate tax rate)• QFOBI – up to $675,000 but coordinated with the amount of

the unified credit (applicable exclusion amount) - $1.3M limit• State death tax credit – most state death taxes were

“coupled”

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Where are we and how did we get here?

• Economic Growth and Tax Relief Reconciliation Act of 2001 (2002 – 2009)– “Phase out” of the federal estate tax

– Immediate increase of unified credit to $1M

– Immediate reduction of maximum rate to 50%

– Staged increases in unified credit to $3.5M for 2009

– Annual 1% decrease in maximum rate to 45% by 2007

– $1M of unified credit could be applied to lifetime gifts

– GST Exemption equal to the unified credit and maximum estate tax rate

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EGTRRA – Year 2010

• Estate Tax Repealed – Section 2210– Chapter 11 (Estate Tax) does not apply to the

estates of decedents dying after 12/31/2009– Property remaining in QDROs will not be included in

surviving spouse’s estate. Tax on distributions continue through 2010

• GSTT Repealed – Section 2664– Chapter 13 (Tax on Generation Skipping Transfers)

does not apply to generation-skipping transfers after 12/31/2009

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EGTRRA – Year 2010

• Section 1022 – Treatment of property acquired from a decedent dying after 12/31/2009– 1022(a) – In general

• Carry over basis• Treated same way as property transferred by gift. • Basis is the lesser of decedent’s adjusted basis or fair

market value on date of death

– 1022(b) – Basis increase for certain property• $1.3M of basis increase. $60K for non-resident non-citizens• No restrictions on who can receive• Must be “acquired from a decedent” – won’t apply to QTIP

property or Section 2041 power of appointment property7

EGTRRA – Year 2010

• Section 1022 – Treatment of property acquired from a decedent dying after 12/31/2009– 1022(c) –Additional $3M basis increase for “qualified

spousal property.” • Outright transfers to spouse or QTIP. • Spouse has a “qualified income interest”• All income on at least an annual basis• No person has a power to appoint to any person other than

spouse• Apparently doesn’t apply to general appointment trusts or

even survivor’s trust on a joint RLT

– Different coupons; different rules8

EGTRRA – Year 2010

• Section 1022 – Treatment of property acquired from a decedent dying after 12/31/2009– $1.3M, $60K and $3M are adjusted for inflation– Basis increase not available for gifts received by

decedent within 3 years of death• Exception for gifts received from spouse unless spouse

received by gift within 3 years of decedent’s death

– Section 6018 – Returns relating to large transfers at death –

• required for transfers on death exceeding $1.3M. • Allocated by decedent’s executor.

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EGTRRA – After 2010

• Section 901 of EGTRRA – Sunset Provisions– Provisions of EGTRRA do not apply to:

• Taxable, plan or limitation years after 12/31/2010• Estates of decedents dying, gifts made or generation-

skipping transfers, after 12/31/2010

– Application of Internal Revenue Code after 12/31/2010

• shall be applied and administered to years, estates, gifts and transfers as if provisions and amendments to EGTRRA had never been enacted

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Years 2011 and Beyond

• Law prior to EGTRRA 2001– $1M applicable exclusion amount (Unified Credit);

Graduated rates from 41% to 55% applies to estates and lifetime gifts

– GST Exemption $1M with inflation adjustment ($1.3M); flat rate 55% (maximum estate tax rate)

– QFOBI– State death tax credit restored – economic good

news for a number of states

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GSTT and Trusts Created Under EGTRRA?

• Taxable distributions and terminations– §2641 – product of maximum federal estate tax rate

and the inclusion ratio– What is the inclusion ratio of trusts created in 2010?

• §2642 – 1 minus the applicable fraction; applicable fraction numerator = GST exemption allocated to the trustdenominator = amount of transfer (1-0=1)

– Creates risks for gifting strategies in 2010– Trusts created between 2004 and 2009?

• Sunset – IRC applied as if EGTRRA never enacted• EGTRRA GST exemption larger than $1M pre-EGTRRA

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What will Congress Do Now?

• Extend 2009 EGTRRA – Retroactively– HR 4154 – Passed in the House on 12/3/2009 by

vote of 225 - 200– Probably what most practitioners, Democratic

congressmen and the Service believe will happen

• Extend 2009 EGTRRA – Prospectively– Longer Congress takes the more likely any change

will be prospective only; avoid uncertainty of constitutional challenge; Political unpopular action to apply a tax retroactively

• Extend 2009 EGTRRA for two years13

What will Congress Do Now?

• Extensive Estate Tax Reform– Use opportunity to address extensive, meaningful

estate tax reform.• Short Term GRATS – minimum 10 year term• Discounts on non-operating businesses• Legislative overrule of Crummey• Higher applicable exclusion amount (Unified Credit)• Lower federal estate tax rates (20% - 35%)• Portability

– Involve major political differences, not likely to happen quickly and therefore not likely to be retroactive.

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What will Congress Do Now?

• Nothing – let 2010 and Sunset play out– Politics makes strange bedfellows and strange results– Republicans – “kill the golden goose”– Democrats – significant source of funds for major

political priorities• Committee on Taxation 2005 estimates; $290B for 2011 –

2015; $1T for decade of 2011 – 2020 (includes interest on debt reduction

– States – economic boost when very much needed– Corrective legislation

• Grandfathering of GST exemption for trusts created under EGTRRA; Repeal of Section 1022 retroactively

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Solutions to Dealwith Uncertainty

• The law hasn’t changed for the last 8 years; it just failed to change.– Documents relying on formula dividing into Marital

and Non-Marital shares referring to federal estate tax or QTIP allocations may have different results depending on how worded and how interpreted.

• Even if all were designed to achieve same result - maximum reduction of estate tax

• Subject to ambiguity• Service may not be bound by a state court determination

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Solutions to Dealwith Uncertainty

• The law hasn’t changed for the last 8 years; it just failed to change.– If a client’s documents don’t directly deal with

possibility of no federal estate tax and §1022, may need to be amended or restated

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Solutions to Dealwith Uncertainty

• “If there is no federal estate and §1022 is in effect . . .”

• All to the Marital Share, with spousal disclaimer funding the Non-Marital Share– Marital Share must be a QTIP or outright– Simple solution; maximum benefit to spouse; still

provides flexibility of a “second look” at time death of first to die

– Lose flexibility of granting spouse a limited testamentary power of appointment in the CST

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Solutions to Dealwith Uncertainty

• “If there is no federal estate and §1022 is in effect . . .”

• The WealthCounsel Back-and-Forth Approach– Allocate to the Non-Marital Share sufficient assets

to use the $1.3M §1022(b) step-up in basis– Allocate to the Marital Share sufficient assets to use

the $3M §1022(c) step-up in basis (QTIP or outright)– Allocate balance to Non-Marital Share– Maximizes amount going to Non-Marital Share and

makes use of spousal $3M step-up in basis

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Solutions to Dealwith Uncertainty

• Other Considerations– Absent change in IRC,

• if Marital Share allocated to QTIP should not be included in surviving spouse’s estate §2044 – no marital deduction taken

• GSTT inclusion ratio of CST = “1”

– Possible legislation that could affect planning• Possible retroactive repeal of §1022• Complete or partial grandfathering for GSTT purposes• Include QTIP property elected for §1022(c) step-up in the

estate of the surviving spouse

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Solutions to Dealwith Uncertainty

• Planning team must determine client’s fact-based objectives as to Marital and Non-Marital division

• Design the plan based on best guess as to permanent estate tax law ($1M - $3.5M Unified Credit and GST Exemption)

• Then determine if need to specifically address possibility of no federal estate tax and Section 1022 basis adjustment

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Solutions to Dealwith Uncertainty

• All to Marital Share – outright or QTIP (one-lung QTIP)

• All to Marital Share – outright or QTIP, with disclaimer funding of Marital Share

• May not need to specifically address no federal estate tax and Section 1022

• If Marital Share is to general appointment trust or even to Survivor’s Trust in a joint trust?

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Solutions to Dealwith Uncertainty

• If Marital Share is to general appointment trust or even to Survivor’s Trust in a joint trust– Property may not qualify for §1022 basis adjustment

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Solutions to Deal withState Death Tax

• If the state allows a QTIP election separate from the federal QTIP election– Allocating the Marital Share to a QTIP provides

great flexibility• Insure that the Marital Share is large enough to reduce

both federal and state death taxes to lowest possible amount;

• Elect QTIP treatment for federal purposes only to extent necessary for federal estate tax purposes; if no federal estate tax nothing is elected for QTIP treatment for federal purposes

• Make a separate QTIP election for the amount necessary to eliminate state death taxes

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Solutions to DealState Death Tax

• If the state doesn’t allow a QTIP election separate from the federal QTIP election– Two QTIPs– QTIP One – large enough to reduce federal estate

taxes to lowest possible amount– QTIP Two – additional amount necessary to reduce

state death taxes to lowest possible amount.– Both QTIP One and Two elected for QTIP treatment

both federal and state– Rely on Rev. Proc. 2001-38 to have the federal

QTIP election for QTIP Two considered void upon death of surviving spouse

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Other Solutions to Deal with Uncertainty

• Consider including a provision allowing distributions from trust to a beneficiary for purpose of allowing a Section 1022 basis adjustment on death of the beneficiary

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Other Solutions to Deal with Uncertainty

• Consider a flexible (hybrid) testamentary power of appointment granting a general power of appointment to any share subject to GSTT and a limited power of appointment to any share not subject to GSTT

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Other Solutions to Deal with Uncertainty

• Decanting provisions• Expanded use of Trust Protectors

– Grant the Trust Protector (or an Independent Trustee) the authority to grant a beneficiary a general testamentary power of appointment over property

– Grant the Trust Protector broad amendment powers to deal with estate and income tax uncertainties

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What Should You Do?

• The current state of the law creates the greatest marketing opportunity in at least 10 years.

• Great opportunity to review existing estate plans and approach them with the “if we only knew then what we know now, hindsight.”

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What Should You Do?

• Advise your clients of the issues involved – They have been reading about it– They want to hear from you

• General Client letter• Client only / Public workshop

– Get them into your office and review their estate plan in light of the current situation

– In a large number of cases there will be a good reason to restate their plan

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What Should You Do?

• Advise clients that if Congress acts differently than you expect, they may need to restate their plans again – History has shown that Congress does not always

do what we expect.– Clients should be made aware of this fact.– It’s not your fault.

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