More than halfway through 2010, most unresolved estate and gift
issues present in January remain. Congress has not altered the
estate and gift tax. No formal procedure exists for allocating
basis to assets inherited in 2010. Legislation regarding short-term
grantor retained annuity trusts (GRATs) and valuation discounts in
family-held entities is pending. And section 2511(c) of the
Internal Revenue Code1 has wreaked
havoc on certain gifting strategies. With this uncertainty, it is
vital for practitioners to understand the status of these issues,
what lies ahead, and current opportunities.
1) Estate and gift tax. The federal estate tax
is repealed for 2010. In 2011, the federal estate tax exemption
returns to its pre-EGTRRA2 amount of $1
million, with a maximum estate tax rate of 55
percent.3 The House of Representatives
passed a bill in December indefinitely extending the 2009 estate
tax exemption of $3.5 million and a 45 percent estate tax rate. The
Senate has been unable to pass a bill. With the November elections
looming, it will be unlikely that Congress addresses the estate tax
prior to that time. If 2011 arrives with a $1 million estate tax
exemption and 55 percent tax rate, there will be a greater need for
credit shelter trusts, irrevocable life insurance trusts and other
estate tax-saving trusts.
One of the major impacts of the absence of estate tax is on
drafting and funding of trusts for married couples. Many trusts
include funding formulas based on the current estate tax law and
require the use of a marital trust only when needed to eliminate
estate taxes. Thus, in 2010, all trust assets would be allocated to
the credit shelter trust. This may leave the surviving spouse with
less access and control than originally expected, and create
conflicts of interest between the surviving spouse and the
deceased's children. The use of disclaimer trusts is one solution,
allowing the surviving spouse to accept trust assets or disclaim
all or a portion of them to fund the credit shelter trust.
The gift tax is not repealed in 2010. Taxpayers have a $1
million lifetime gift tax exemption. The maximum gift tax rate in
2010 is 35 percent.4 In light of the
2009 gift tax rate of 45 percent and 2011 rate of 55 percent,
donors intending to make significant gifts could take advantage of
the 35 percent rate.
2) Pending legislation regarding GRATs and valuation
discounts. A donor transferring assets to a GRAT must
retain an annuity interest for a term of
years.5 For gift tax purposes, the
amount of the transfer is the present value of the annuity plus a
statutory imputed rate of return. If the actual rate of return
exceeds the statutory rate, then the assets remaining at the end of
the term pass to the remaindermen gift tax-free.
If the donor dies during the GRAT term, the assets are included
in the donor's estate. To minimize this risk, a short annuity term,
such as two years, is used. Further, short-term GRATs capture rapid
upswings in valuation. The Small Business and Infrastructure Jobs
Tax Act of 2010, however, would impose a minimum 10-year term. The
House passed the bill on March 24, 2010, but the Senate has not
voted on the bill. Because the bill would not be retroactive,
practitioners should take advantage of short-term GRATs now for
The use of minority and/or lack or marketability discounts in
family-held entities such as Family Limited Partnerships can yield
significant gift and estate tax savings. H.R. 436, introduced in
January 2009, provides that minority interests in a family-held
entity that owns non-business assets are not entitled to such
discounts. In its March 2010 budget report, the Joint Committee On
Taxation again referenced elimination of these discounts. Again,
practitioners contemplating the use of valuation discounts should
consider implementation now.
3) Carryover basis and allocation of basis.
Prior to 2010, the basis of an inherited asset equaled the asset's
fair market value as of the decedent's date of death (stepped-up
basis).6 In 2010, the basis of an
inherited asset equals the decedent's original basis in the asset
(carryover basis). The impact of this rule is mitigated for smaller
estates. Property passing to those other than the surviving spouse
receives a basis increase of $1.3 million and property passing to
the surviving spouse, including QTIP property, receives a basis
increase of an additional $3 million (not to exceed fair market
value in both cases).7
The carryover basis rules pose administrative problems. For
estates exceeding the basis increase amounts, the executor must
allocate basis asset by asset on Form 8389 and attach the form to
the decedent's final income tax return. There is a $10,000 penalty
for failure to file this form. The Internal Revenue Service,
however, has not issued the form yet. There is the additional
challenge of determining the carryover basis, as original basis
information is often unascertainable. Counsel to fiduciaries must
consider tax filing positions carefully.
Fiduciaries and family members should be advised to locate and
maintain any records that substantiate basis. Conflicts of interest
could arise and fiduciaries should consider obtaining releases from
beneficiaries before allocating basis to particular assets.
4) Section 2511(c). Effective only in 2010,
section 2511(c) provides that if a transfer is made to a trust that
is not a wholly-owned grantor trust, the transfer will be treated
as a gift for gift tax purposes. Certain planning techniques are
impacted by this rule. Transfers to non-grantor Medicaid trusts
will be completed gifts, even if structured to result in an
incomplete gift. The inclusion of grantor trust
provisions8 over both income and
principal should comply with section 2511(c) and still render the
principal non-countable for Medicaid
Section 2511(c) also eliminates for 2010 a planning technique
for business owners selling businesses. To avoid state income tax,
a business owner may transfer ownership of the business to a
properly structured asset protection trust created in New Hampshire
(or a few other states), and the out-of-state trust sells the
ownership interest. The trust can be drafted such that transfers to
the trust are complete for income tax purposes but incomplete for
gift tax purposes. Because the trust must be a non-grantor trust to
avoid state income tax, the business owner will need to utilize
gift tax exemption and might pay gift tax. Drafting the trust as a
grantor trust to comply with section 2511(c), however, will result
in state income taxation. Business owners contemplating the sale of
a business and the use of the strategy are well-advised to postpone
the sale, if possible, until 2011.
Whether these issues will be resolved by the end of 2010 remains
to be seen. One thing is certain - their resolution will have a
significant impact on the estate and gift planning environment.
William V.A. Zorn is a director at McLane,
Graf, Raulerson & Middleton, Professional Association, and
chair of the Trust and Estate Department. He works in McLane's
Woburn, Massachusetts, and Manchester, New Hampshire, offices. He
can be reached at (781) 904-2700.
Ryan J. Swartz is an attorney in the Trust and
Estate Department at McLane, Graf, Raulerson & Middleton,
Professional Association, and works in its Woburn, Massachusetts,
office. He can be reached at (781) 904-2712.
- All references to the code and section refer to the Internal
Revenue Code of 1986, as amended.
- Economic Growth and Tax Relief Reconciliation Act of 2001.
- IRC section 2001(c).
- IRC section 2502(a)(2).
- IRC section 2702(b).
- IRC section 1014(a).
- IRC sectionsection 1022(b) and (c).
- See IRC sectionsection 671-679.
- Careful attention should be given to which grantor trust
provisions are utilized in light of Doherty v. Director of the
Office of Medicaid, Case No. 08-P-939 (App. Ct. June 18,