Year End Estate Planning

Congress is back in session and the big question is whether this lame duck Congress is going to do anything on the tax front before the end of the year? Whether they do or do not, there are still some things that folks should consider:

1. Making taxable gifts in 2010. This year there is a "blue light special" on taxable gifts of 35% made in 2010. Next year the rate goes to 45%. And, if one does die next year or thereafter the death tax rates will be 55%. If there was ever a time to consider this option it is now.
2. Use of Rolling Grantor Retained Annuity Trusts ("GRATs"). While Congress has debated sticking a knife in this technique by requiring a minimum 10 year lifetime term (i.e. if a donor sets up a GRAT and dies within 10 years it gets sucked back into one's taxable estate) right now short term GRATs are still possible. This is a win-win situation that may not be with us much longer.
3. The Section 7520 rate dropped to 1.8% in December. This is a historic all time low rate of interest that makes some techniques like Charitable Lead Annuity Trusts very attractive for people looking to avoid the payment of Federal Estate taxes on estates over $1M in 2011.
4. Irrevocable Gift Trusts for children and grandchildren are still favorites to provide asset protection planning for future generations.
5. IRA Roth conversions from traditional Individual Retirement Accounts ("IRAs") in this month may be an appropriate move for many people with with the right mix of investment assets that can be used to pay the income taxes on the conversion. Coupled with a Retirement Benefits Trust as a Qualified designated beneficiary, one can get "stretch" IRA tax treatment for the beneficiary and asset protection planning under the right circumstances.

Our calendar is filling rapidly for planning in December. If you need help or assistance, please call soon.

November AFR Rates continue lower

The November Applicable Federal Rates continued their downward spiral for next month. The new annual short term rate is down to .35%. Mid-term rates on notes between 3 years and 9 years are now at 1.59% and the new annual long term rate is down to 3.35%. The Section 7520 rate is now a historic 2.0%. Loans to younger generation beneficiaries, Grantor Retained Annuity Trusts ("GRATS") and Charitable Lead Trusts are wonderful tools to lock in some these lower rates.

October Applicable Federal Rates ("AFR")

Every month the government establishes what is known as the Applicable Federal Rate for the charging of interest rates in related party transactions. The Section 7420 rate is now down to 2%. This is a historic all time low water mark for interest rates.

If one wanted to make a loan to a child over $10,000.00 the IRS requires that the loan bear interest at certain minimum rates. For loans repayable within three (3) years [the "short-term" rate] the minimum interest rate in October is .41%. The "mid-term rate" for loans over 3 years but less than nine (9) years to maturity is 1.71% for monthly payments. The "long-term rate" for loans over nine years to maturity is now 3.27%. The use of intra-family loans is a wealth shifting device that can be used to enable a younger generation's accumulation of wealth.

10 Things the IRS wants you to know about Charitable Giving

Did you make a donation to a charity this year? If so, you may be able to take a deduction for it on your 2010 tax return.

Here are the top 10 things the IRS wants every taxpayer to know before deducting charitable donations.

1. Charitable contributions must be made to qualified organizations to be deductible. You can ask any organization whether it is a qualified organization and most will be able to tell you. You can also check IRS Publication 78, Cumulative List of Organizations, which lists most qualified organizations. IRS Publication 78 is available at IRS.gov.

2. Charitable contributions are deductible only if you itemize deductions using Form 1040, Schedule A.

3. You generally can deduct your cash contributions and the fair market value of most property you donate to a qualified organization. Special rules apply to several types of donated property, including clothing or household items, cars and boats.

4. If your contribution entitles you to receive merchandise, goods, or services in return – such as admission to a charity banquet or sporting event – you can deduct only the amount that exceeds the fair market value of the benefit received.

5. Be sure to keep good records of any contribution you make, regardless of the amount. For any contribution made in cash, you must maintain a record of the contribution such as a bank record – including a cancelled check or a bank or credit card statement – a written record from the charity containing the date and amount of the contribution and the name of the organization, or a payroll deduction record.

6. Only contributions actually made during the tax year are deductible. For example, if you pledged $500 in September but paid the charity only $200 by Dec. 31, your deduction would be $200.

7. Include credit card charges and payments by check in the year they are given to the charity, even though you may not pay the credit card bill or have your bank account debited until the next year.

8. For any contribution of $250 or more, you must have written acknowledgment from the organization to substantiate your donation. This written proof must include the amount of cash and a description and good faith estimate of value of any property you contributed, and whether the organization provided any goods or services in exchange for the gift.

9. To deduct charitable contributions of items valued at $500 or more you must complete a Form 8283, Noncash Charitable Contributions, and attached the form to your return.

10. An appraisal generally must be obtained if you claim a deduction for a contribution of noncash property worth more than $5,000. In that case, you must also fill out Section B of Form 8283 and attach the form to your return.

For more information see IRS Publication 526, Charitable Contributions, and for information on determining value, refer to Publication 561, Determining the Value of Donated Property. These publications are available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

Publication 78, Cumulative List of Organizations

Publication 526, Charitable Contributions ( PDF)

Publication 561, Determining the Value of Donated Property ( PDF)

What to do with Inherited Property in 2010?

With the repeal of the Estate Tax and Generation Skipping Transfer Tax in 2010, those who inherit assets from someone who dies in 2010 may be forced to deal with some very difficult income tax basis rule changes. If someone dies and their entire estate is less than $1.3M the inherited assets will receive a "step-up" in basis to the fair market value of the asset as of the decedent's date of death. But, if the person who dies in 2010 owned more than $1.3M in assets, then a tax return must be filed with the decedent's final income tax return which would be due April 15, 2011 or such later date as the IRS might prescribe by regulation not yet issued [see IRC Section 6075(a)].

If an heir sells property in 2010 where the asset is included in an estate of a deceased person with more than $1.3 M in property, that individual will need to wait until he or she receives the information required by Internal Revenue Code Section 6018. So far, the IRS has not even published the necessary tax forms to file this report.

Heirs who inherit property from someone who dies in 2010 in excess of $1.3M would do best to NOT sell that asset in 2010. There is an argument that with the sunset of the current tax laws at the end of this year (Section 901 of the EGTRRA) that the basis of assets sold after 2010 from decedents dying in 2010 will be entitled to a step-up in basis under the resurrected Section 1014 of the Internal Revenue Code. No one can say for sure what Congress might do before the end of the year? Stay tuned.

Generation Skipping Issues in 2010

Like the federal Estate tax, the federal Generation-Skipping Transfer ("GST") tax is currently repealed for 2010. If Congress continues on its "do nothing" approach to tax reform, the GST tax will reappear on January 1, 2011 at a top rate of 55%.

Unlike the estate tax where one has to die in 2010 to benefit from the repeal, there are some options this year for those who are planning on living until 2011. By way of background, the GST tax was implemented by Congress in 1976 as a way to stop rich people from passing wealth down to future generations tax free. It was designed to tax distributions that did not get passed down from one generation to the next (i.e. parent to child) by taxing distributions that "skipped" a generation. Thus, in addition to income tax, estate tax, and gift taxes Congress leveled a new tax (the GST tax) for transfers that are classified as "generation skipping transfers" to or for the benefit of a "skip person". This system was so complicated that Congress decided in 1976 to give every taxpayer a $1M dollar exemption from GST taxes. In 1976 $1M was a lot of money. From 1976 to 2001 the GST exemption was increased to $1, 060,000. Suddenly, people who had never heard of the GST tax [Chapter 13 of the Internal Revenue Code] were paying more in taxes. Congress ratcheted the exemption up to $3,500,000 by 2009. We are now poised for the return of the GST tax on January 1, 2011 at the base rate of $1M with perhaps some minor inflation adjusted amount.

A skip person is generally a person more than one generation removed (think grandchild and beyond) from the transferor. A skip person can also include a trust for the benefit of beneficiary or beneficiaries of a skip person(s). A generation skipping transfer can be either:

1. a "Direct Skip" which is an outright transfer to a skip person or a trust for a skip person;
2. a "Taxable Distribution" from a trust to a skip person; or
3. a "Taxable Termination" of a trust or non-skip person's interest in a trust that vests property in a skip person, which could include the termination of all non-skip persons' interests in the trust, leaving only skip persons as beneficiaries.

Certain trusts may be "GST Exempt" trusts because they were set up before the date of the enactment of the GST tax (i.e. they are "grandfathered") or the maker of the trust allocated his or her GST exemption on a validly filed GST tax return to allow the GST Exempt trust to have an inclusion ratio of "0".

Several planning opportunities present themselves in 2010. For example, a donor can make direct gifts to grandchildren without any GST tax in 2010. However, the federal Gift tax still remains in effect. The highest federal Gift Tax rate for 2010 is 35%. Gifts that are less than $13,000 per donee per calendar year are exempt from gift tax. In addition, a person may allocate any part of their $1M dollar lifetime gift tax exemption to such gifts. Note that the gift tax rate is down 10% from last year (45%) and will be 20% less than the projected current gift tax rate of 55% for next year.

If a grandparent who has exhausted all of one's annual exclusions and gift tax exemption were to gift $1,000,000 to a grandchild this year, the transfer tax would be $350,000. That same gift if made in 2011 would incur a combined gift tax and GST tax liability of $1,100,000! That is a tax rate of 110%! If a grandparent were to make gifts to great-grandchildren, such gifts would skip two generational levels.

Many grandparents have established gift trusts for grandchildren. Each calender year the grandparent would gift $13,000 into such a trust for the benefit of the grandchild. Normally Section 2611 (b)(2) of the Code would protect future distributions from such trusts from GST tax in the future since the original transfer to the trust was subject to GST. A transfer to such a trust in 2010,however, would NOT be subject to GST. There fore, the protection of Section 2611 (b)(2) may not apply. Accordingly, grandparents should not make annual exclusion gifts to gift trusts in 2010. Instead, one may wish to consider either direct transfers to skip persons or to a Uniform Transfer to Minors Account for such a grandchild in 2010. Consideration needs to be given to the appropriateness of such gifts to a grandchild outright.

Grantor Retained Annuity Trust ("GRAT")

The Grantor Retained Annuity Trust (often referred to as a "GRAT") is a long favored technique for those with substantial estates who find themselves staring at a 55% estate tax rate starting January 1, 2011. By setting up a GRAT one can legally pass wealth down to the next generation on a tax favored basis. In essence, a donor sets up an Irrevocable Trust and retains the right to receive an annuity paid to the donor over a specified term of years. At the end of the annuity term, if there is anything left over for the beneficiaries, known as "remaindermen", the amount of increase in the trust's investments that exceeds a specified rate set by the IRS, passes tax free to the remaindermen.

The IRS hates this technique even though it is sanctioned by the current tax Code. Clients often set up revolving GRATS that rollover at the end of the term as a way to leverage their transfers to younger beneficiaries. Typically, we use GRATS that have a term of two, three or sometimes five years.

On July 1, 2010 the House of Representatives voted 215 to 210 to pass an amendment to H.R. 4899 ( a supplemental spending bill) that would now require all GRATS to have a minimum ten year term. If the donor who sets up a GRAT dies during the term, the bulk of the GRAT is includable in the estate of the donor for Federal Estate Tax purposes. Thus, for older donors this may well be the death knell of the use of the GRATS. The Senate is expected to take the measure up in the next few days.

For anyone interested in setting up GRATS, now is the time to do so! The effective date of the legislation will be the date the Act is enacted. Due to the very low interest rates now in play, if anyone has ever considered this technique, they should rush to get this accomplished post haste to avoid the application of the ten year minimum term rule. It looks like the clock will be ticking down soon.