2013 Year End Estate Planning Advisory

Looking beyond the ATRA 2012 horizon, relative calm

Market analysis and opinion form Kattan Muchin Rosenman LLP


Last year’s looming fiscal cliff crisis and the 13th hour passage of the American Taxpayer Relief Act of 2012 (ATRA 2012), have resulted in a period of relative calm in the estate planning world. For the first time in over 11 years, we may not have to plan with imminent change on the horizon. Under ATRA 2012, the estate and gift applicable exclusion amounts and the generation skipping transfer (GST) exemption amount (the “applicable exclusion amounts”) were initially set at $5 million, and are indexed for inflation in 2013 and future years, resulting in the current $5.25 million applicable exclusion amounts.

Although the applicable exclusion amounts and the tax rates are said to be permanent, the Obama Administration’s latest budget proposal already seeks to make changes to them. ATRA 2012 made permanent the so-called “portability” provisions of the federal gift and estate tax laws, whereby a surviving spouse is entitled to use any portion of the deceased spouse’s unused applicable exclusion amount (DSUE), allowing the surviving spouse to make tax-free gifts and/or reduce the amount of estate taxes owed upon the surviving spouse’s death by adding the DSUE to the surviving spouse’s own applicable exclusion amounts (note, however, that the DSUE does not increase the surviving spouse’s federal GST exemption). The historically high exclusion amounts and the portability provisions under ATRA 2012 create many new estate planning opportunities.

At the same time, income tax rates were significantly increased by ATRA 2012, thus placing a new emphasis on achieving basis step-ups wherever possible as well as other techniques that decrease income tax liability. There is a certain tension now between income tax and estate tax planning. In fact, some commentators say that, conceptually speaking, income tax is becoming the new estate tax in terms of effective tax planning.

Though ATRA 2012 was a tough political act to follow, the US Supreme Court (Supreme Court) did its best to upstage Congress and grant a major victory to the marriage equality movement by striking down Section 3 of the federal Defense of Marriage Act (DOMA) as unconstitutional in the case of United States v. Windsor (Windsor). Relatedly, the Supreme Court dismissed an appeal from the federal district court ruling that struck down California’s Proposition 8 (which prohibited marriages of same-sex couples in California) as unconstitutional in the case of Hollingsworth v. Perry (Perry), thus judicially adding California to the list of states that permit marriage for same-sex couples. In addition to California, seven other states, including Delaware, Hawaii, Illinois, Maryland, Minnesota, New Jersey and Rhode Island, decided to permit marriages between same-sex couples in 2013.

The federal and state recognition of marriages between same-sex couples has significant tax consequences (positive and negative) for married same-sex couples, among them the ability to take advantage of the marital deduction from federal estate, gift and GST taxes. Note that, pursuant to federal guidance implementing the Windsor decision, the federal government will recognize as “married” only those couples that were lawfully married in any jurisdiction. Same-sex couples that are in so-called “marriage equivalent” legal relationships, e.g., civil unions, registered domestic partnerships and domestic partnerships, will not be treated as married.

These are just a few of the significant developments at the federal, state and international levels this year.

Federal Estate, GST and Gift Tax Rates

For 2013, the exclusion amount is $5.25 million. For 2014, the exclusion amount will be $5.34 million. The maximum rate for estate, gift and GST taxes will remain at 40%.

Annual Gift Tax Exemption

Each year individuals are entitled to make gifts of a certain amount (the “Annual Gift Tax Exemption Amount”) without incurring gift tax or using any of their lifetime applicable exclusion amount against estate and gift tax. The Annual Gift Tax Exemption Amount will remain at $14,000 per donee in 2014. Thus, a married couple together will be able to gift $28,000 to each donee. However, gifts made to noncitizen spouses are limited to a different Annual Gift Tax Exemption Amount, which will increase from $143,000 to $145,000 in 2014.

Federal Income Tax Rates

  • Individual ordinary income tax rates will remain the same in 2014. The threshold amount for the maximum tax rate of 39.6% for 2014 will rise to $457,600 for married couples filing jointly, $228,800 for married couples filing separately, $432,200 for heads of households, and $406,750 for single filers.
  • For taxpayers whose ordinary income is taxed at the maximum 39.6% level, long-term capital gains will be taxed at 20%. Long-term capital gains for taxpayers in lower ordinary income tax brackets will be taxed at 15%, or 0% if the taxpayer’s ordinary income is taxed at 10% or 15%. Qualified dividends are taxed at the long-term capital gains rate.
  • The so-called “Pease Limitation,” whereby certain itemized deductions, including deductions for mortgage interest, property taxes, state and local taxes, and charitable contributions, are reduced by an amount equal to 3% of the excess of the adjusted gross income (AGI) over a threshold amount, indexed for inflation, but not by more than 80% of the itemized deductions, is expected to impact taxpayers with AGI above $305,050 (married filing jointly) or $254,200 (unmarried) for 2014. Taxpayers with AGI above the same thresholds will also be subject to the so-called “PEP Limitation,” whereby their personal and dependency exemptions will be reduced by 2% for every $2,500 or part thereof that the taxpayer’s AGI exceeds the threshold.
  • Certain itemized deductions, including the deduction for state and local sales taxes, were extended through 2013 under ATRA 2012, but will expire on December 31, 2013.
  • The thresholds for the imposition of the 3.8% Medicare surtax on investment income and 0.9% Medicare surtax on earned income will remain the same as they were in 2013 ($200,000 for single filers, $250,000 for married filers filing jointly, $125,000 for married filers filing separately, and $11,950 for trusts and estates).
  • The exemption amount from the alternative minimum tax (AMT) is projected to rise to $82,100 for married couples filing jointly and surviving spouses, $52,800 for unmarried single filers and heads of household and $41,050 for married couples filing separately in 2014.
There is a certain tension now between income tax and estate tax planning. In fact, some commentators say that, conceptually speaking, income tax is becoming the new estate tax in terms of effective tax planning


President’s Budget Proposal for Fiscal Year 2014

The President’s budget proposal for Fiscal Year 2014 includes a number of transfer tax-related items, some of which have been proposed in prior years. In contrast to the President’s budget proposals in prior years, the 2014 proposal does not include a proposal to limit the availability of valuation discounts on family limited partnerships, limited liability companie and other family entities—a very favorable development for taxpayers.

Subject Payments From Health and Education Exclusion Trusts (HEETs) to GST Tax
Payments made by a donor directly to a medical provider for medical expenses and/or directly to an educational institution for tuition are exempt from gift tax. When such payments are made on behalf of the donor’s grandchildren and subsequent generations, they are exempt from both gift tax and GST tax. A HEET, which is a trust designed to provide for the medical expenses and tuition of multiple generations of descendants, has historically been used to bypass the need to make direct payments from the donor to the provider in any particular year. Under the proposal, however, only qualifying payments for tuition and medical expenses by a living individual directly to the medical provider and/or school will be exempt from GST tax. Distributions from trusts, such as HEETs, for such purposes would not be GST-exempt. This proposal would apply to trusts created after the introduction of the bill and to transfers after that date that were made from preexisting trusts.

Reset Exclusion Amounts and Tax Rate
Just when we thought we could breathe a sigh of relief as to the new “permanent” applicable exclusion amounts and tax rates, the budget proposal provides for a permanent return of the estate, gift and GST tax regimes to their 2009 levels, i.e., a 45% top tax rate and $3.5 million exemption for estate and GST tax and $1 million for gift tax, beginning in 2018. Note that the proposal makes clear that there would be no “clawback” of transfer taxes for those who took advantage of higher applicable exclusion amounts prior to 2018.

Change the Treatment of Intentionally Defective Grantor Trusts (IDGTs)
The budget proposal contains a provision that would significantly undermine the utility of a highly effective planning technique. IDGTs are currently used as a central part of much tax planning, as they allow a grantor the ability to be taxed on all of the trust’s income, thus allowing the trust assets to grow undiminished by tax payments. Under the proposal, the assets in IDGTs would be included in the grantor’s estate and subject to estate tax. In addition, distributions from an IDGT would be subject to gift tax and if the trust ceases to be a grantor trust, the remaining assets would be subject to gift tax.

Require Consistency of Basis Valuation
The proposal to require consistency in value for transfer and income tax purposes requires that the basis for income tax purposes be the same as that determined for estate and gift tax purposes.

Impose New Requirements for Grantor Retained Annuity Trusts (GRATs)
The proposal adds three additional requirements that would be imposed on Grantor Retained Annuity Trusts (GRATs): (i) they must have a 10-year minimum term; (ii) they must have a remainder interest greater than zero; and (iii) the annuity amount cannot decrease in any year during the annuity term.

Limit the Duration of the GST Exemption
Under the proposal, the exclusion from the imposition of GST tax would last only 90 years for additions to pre-existing trusts and trusts created after the date of enactment, regardless of whether the trust has a longer duration under the trust instrument and/or state law.

Extend Liens on Estate Tax Deferrals
Currently, the law allows a deferral for estate tax on closely held business interests for up to 15 years and three months from the date of death. The proposal would extend the current 10-year lien that is imposed on estate assets to secure the full payment of the estate tax through the full period of the estate tax deferral.

Disallow Deductions for Contributions of Certain Conservation Easements
The proposal would prohibit a deduction for any contribution of a partial interest in property that is used as a golf course, and would also prohibit a charitable deduction for the contribution of a historic preservation easement associated with forgone upward development above a historic building.

It is impossible to say which if any of these proposals may ever be enacted, but it is important, in reviewing one’s planning options, to note which devices are on the President’s radar screen for change.


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