Summer time is big at Cedar Point, in Sandusky, Ohio, has long been known as the haven for roller coasters, more than any other park in the world. Rides like the “Disaster Transport,” thrill visitors. Their website describes the ride: “Take a journey into the unknown! Disaster Transport takes you through time and space – and in complete darkness!” Tell me doesn’t that sound like a description of the state of the estate tax. Double dare ya!
Wherever You Go, There You Are
Mindfulness and tax planning: Repeal; Retroactive reinstatement; $1 million exclusion next year… Wherever you go for estate planning, there you are…confused. Well, there is no estate tax today, we’re living under the so called carry over basis regime under which assets held on death are not subject to the estate tax. The quid pro quo is that the tax basis (investment) in assets is not increased at death but retains the same tax or cost basis as the decedent had. There are a host of complex exceptions to this that permit a limited amount of appreciation to be eliminated (i.e., a step up) at death. In simple terms, $1.3 million of appreciation on any estate plus $3 million on property passing to a spouse. A detailed analysis of these rules can be found on www.laweasy.com in a white paper initially published by www.leimbergservices.com. While everyone was convinced that the absurdly complex carry over basis rules would retroactively repealed, the same everybody was positive that we’d never have estate tax repeal. So much for positive thinking!
Roller Coaster Tax Bills
The Rolling Thunder roller coaster at Six Flags is a dual-track wooden roller coaster with a nearly 8- story drop and 10 great hills. Kids stuff. Consider these drops and hills: The estate tax exemption in 2001 was $675,000. It rose up hill to a whopping $3.5 million in 2009, then a drop to oblivion in 2010 with repeal (try to beat that Six Flags!) and now a cliffhanger of potentially $1 million in 2011. Boy, depending on when you checkout what the kids get will vary dramatically. The federal estate tax on a $4 million estate in 2009 would have been about $225,000. If the kids kept you on the respirator until 2010 the tax would be zip when you code [sorry!]. If the kids forgot about you too long and you squeaked into 2011, the tax on the same $4 million estate would nearly hit $1.5 million in 2011.
Food Court Fun
After a wild morning on the roller coasters, its time to hit the food court for some refreshments to get you through what a taxing afternoon might bring. What might you do not knowing what’s around the next bend?
GRATs. Gifts to grantor retained annuity trusts have received so much press that we won’t belabor them here again but suffice to say that most advisers believe that this technique will be restricted significantly in the near future (perhaps before you read this!). So if GRATs are on your planning menu, eat quickly! Consider whether there is an advantage to you to using a longer than two year GRAT to lock in today’s low interest rates.
Crummey Gifts. Gifts to trusts are often structured so that the beneficiaries have a right to withdraw the money for a brief period of time. This enables the gift to qualify for the annual gift tax exclusion, $13,000 this year. There are some rumblings about Crummey’s being restricted so consider maxing out on their use while you can.
Gift of Property. Gift the vacation home to your kids to get it out of your estate. So your condo on the beach is worth about ½ of what it was a few years back so perhaps you give that away to the kids. ◙ If the gift won’t exceed what remains of your million dollar gift exemption that might be a shrewd move. ◙ Even if it does, paying gift tax at 35% might itself be tax beneficial if the estate tax rate in fact climbs to 55% next year. But what if your estate is worth $4.5 million? If the estate tax exclusion is $1 million next year getting the condo out of your estate might be looking good, especially if it appreciates in value. However, if Congress gooses the exclusion up to $5 million you’ll might have possibly paid a gift tax to save an estate tax that no longer applies to you. That’ll leave you with the same feeling as a ride on the Corkscrew (that’s three inversions!) after a Big Mac at the food court. ◙ The focal point shouldn’t be the decline in value, that’s history. Will the condo appreciate post-gift? That will depend not only on inflation generally but the sales overhang for similar properties. If your resort area has hundreds of depressed vacant condos on the market, getting the condo out of your estate at a value less than what it was worth a few years ago may not be a winner since it may take many years for the market to recover and the property to appreciate. ◙What about probate and domicile? If you gift away a vacation condo in another state, that might save your heirs the cost and hassle of probate in that state. But if it’s a close call as to whether you may qualify as domiciled in that other state, gifting away the condo might undermine your ability to claim domicile there. That could have a far more costly impact. ◙Giving away a condo is not quite as simple as writing out a check. You’ll need a deed prepared by counsel in that state. There may be transfer taxes, estimated or withholding taxes, etc. depending on state law. ◙ If there is a mortgage you’ll need lender approval. It might be advisable to sign a gift letter confirming the transfer by gift. If you’re giving the condo to one kid, do you want to equalize the other kids? ◙ You’ll have to obtain an independent written appraisal of the value of the condo given. Your property tax bill don’t cut the mustard. ◙ You will probably have to file a gift tax return for this. ◙ The property will have carryover basis so if your kids later sell it they’ll pay capital gains on the excess of the sales proceeds over what you paid. If capital gains increase enough that could offset much of the perceived tax benefit.
Split-Dollar Life Insurance Loans. If you loan $1 million to your daughter’s insurance trust so that it can buy life insurance on your daughter’s life, how does that help your estate? Split-dollar life insurance loans, under Treasury Regulation §1.7872-15(d) might just provide that unexpected thrill when you thought the ride was nearly over. The split-dollar loan can accrue interest and mature on the death of the child/insured. Both the borrower and the lender must sign a written representation. This must be included with their tax returns filed not later than the last day (including extensions) for filing the Federal income tax return of the borrower or lender, whichever is earlier, for the taxable year in which the lender makes the first split-dollar loan under the split-dollar life insurance arrangement. ◙ The estate tax vig might come from the determination of what the fair value of the loan is in parent’s estate on death. If daughter is age 40 and mom age 84, on mom’s demise her estate will hold a loan that pays no interest or principal until daughter’s death when the insurance policy pays. ◙ What is a reasonable market based rate of interest would be as of the valuation date? ◙ What will the present value of the split-dollar note be? ◙ Given the estate tax uncertainty, if the few plays out differently the loan might be repaid to unwind the loan transaction.
Beneficiary Defective Inheritor’s Trust (BDIT). The key to the BDIT is that someone other than you sets up the trust to benefit you. If mom establishes your trust and makes a $5,000 gift, and you never gift to the trust, you may have more flexibility to be a beneficiary and trustee of the trust as compared to the more common grantor trust arrangement. For example, if you gave gifts to fund the trust and retained rights to enjoy the assets transferred, the full value of those assets will be included in you estate. The BDIT uses the annual Crummey power in your favor to make the trust a grantor trust for income tax purposes as to you, even though mom was the settlor. This structure permits you to sell assets to the BDIT a still depressed prices, for a note at today’s still historically low interest rates, be a discretionary beneficiary of the trust (with an independent preferably institutional trustee making distribution decisions), yet freeze the value included in your estate in case the $1 million exclusion becomes a reality.
Conclusion. Taxpayers considering estate planning should wear Nike’s “Just Do It!”
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