Each year, the U.S. Department of the Treasury issues a report setting forth the revenue proposals of the current presidential administration. This report, known as the "Greenbook," often proposes sweeping changes to the Internal Revenue Code. Although the Greenbook provides a valuable insight into the intentions and positions of the administration, many of its proposals are aspirational and have little chance of passage.
The Greenbook for the 2013 fiscal year, released in February, contains several proposals relating to gift and estate taxation, most notably its recommendations as to how these taxes should work in 2013. In 2012, each individual is entitled to a unified gift and estate tax exemption of $5,120,000, meaning that he or she may give, in the aggregate, assets up to that amount free of transfer taxes, whether during life (as gifts) or at death (as bequests). Any transfers in excess of that amount will be subject to gift or estate tax at a 35% rate.
Absent Congressional action, the current gift and estate tax regime will "sunset" at the end of 2012 and revert to the exemption and rates in effect in 2001, namely a $1 million estate and gift tax exclusion, with transfers above that amount taxed at a maximum rate of 55%.
The Greenbook proposes to take a middle ground between the 2001 and 2012 rates by making permanent the tax regime in effect in 2009, when the gift tax exemption was $1 million, the estate tax exemption was $3.5 million and the maximum gift and estate tax rate was 45%. These new rates would apply only for transfers made after December 31, 2012. In addition, the Greenbook would make permanent a taxpayer’s ability (also scheduled to otherwise sunset at the end of 2012) to utilize any estate tax exemption left unused by a deceased spouse (known as "portability").
The Greenbook also seeks to place restrictions on the use of certain estate planning techniques commonly used by wealthy individuals to transfer assets to their descendants during their lifetimes. For instance, GRATs would be subject to a minimum term of ten years and would be required to have a remainder interest greater than zero. The imposition of a ten-year minimum term may increase the chances that a given GRAT will be unsuccessful, since a GRAT fails entirely if the Settlor dies during the GRAT term (the likelihood of which increases along with the GRAT term). In addition, a GRAT with a longer term may be less successful than a succession of short-term rolling GRATs in taking maximum advantage of market fluctuations. For instance, if trust assets appreciate wildly for five years and then suffer an equivalent decrease in value in the next five years, two successive five-year GRATs will collectively outperform a single ten-year GRAT.
The Greenbook also proposes to include in the gross estate of a grantor any trust he or she is considered to be the owner of for income tax purposes (i.e., any "grantor trusts"). At present, by proving a grantor certain retained powers in a trust agreement, estate planners can structure a trust such that (1) all trust income is payable by the grantor but (2) trust assets are not included in the grantor's estate at death. This disparate treatment (and the fact that sales, loans and other transactions between a grantor and a grantor trust do not constitute recognition events for income tax purposes) gives rise to several sophisticated estate planning techniques that allow a grantor to leverage his or her gifts to pass more assets to his or her descendants free of gift tax, such as by selling assets to an intentionally defective grantor trust in exchange for a promissory note.
Although the proposed inclusion of grantor trust assets in the grantor's estate will not apply to certain widely used trusts (such as GRATs and qualified personal residence trusts), the scope of the proposed change is still breathtaking. Numerous trusts that estate planners create on a daily basis, and that do not appear to be the intended targets of the proposal, would be negatively impacted, including insurance trusts and inter vivos marital trusts. Given the dramatic nature and breadth of this proposal, it is unlikely that it will be put into effect.
In 2012, each individual has a lifetime generation-skipping transfer tax (the "GST" tax) exemption of $5,120,000, meaning that a married couple could together create a $10,240,000 trust for descendants that will never be subject to future transfer taxation. If the trust is created in a jurisdiction with no rule against perpetuities, the trust can, theoretically, continue indefinitely and provide transfer tax-free distributions to successive generations of descendants. The Greenbook proposes to curtail the effectiveness of such trusts by requiring that no trust shall be allowed to have its assets exempt from GST tax for longer than ninety years.
Finally, the Greenbook proposes to limit the use of discounts when valuing transfers of interests in family-controlled entities between family members. For these transfers, certain restrictions imposed on the transferred interest, which otherwise might give rise to a valuation discount (such as for lack of control or lack of marketability), will be disregarded if, after the transfer, the restriction will lapse or can be removed by the transferor or his or her family. This proposal (which was also included in the Greenbook for the 2012 fiscal year) is intended to minimize the use of family limited partnership and other entities to obtain valuation discounts that decrease the amount of gift or estate tax the government collects.