Predicting changes in tax legislation is risky business, but failing to consider how the transfer tax rules might change in the near term is also not prudent. So, where are we now and where might President-elect Obama and the next Congress take us in areas that affect estate planning decisions?
Based upon current law, we know that the credit against estate and generationskipping transfer (GST) taxes will adjust in January 2009 to a level that will fully shelter transfers of up to $3,500,000. Some have estimated that this change in the shelter level will eliminate estate tax filing requirements and tax exposure for 99.7 percent of all decedents’ estates.
To discourage taxpayers from using large lifetime gifts to shift future taxable income to individuals in lower income tax brackets, however, the gift tax rules will remain unchanged in 2009. The lifetime shelter against taxable gifts (that is, gifts in excess of what will be the $13,000 annual exclusion) will continue to be $1,000,000. As has been the rule all along, if you use any portion of your lifetime shelter against gift taxes, the amount so used will offset the maximum shelter available at death against estate, and possibly GST, tax.
The new year will also see no change in the maximum estate, gift and GST tax rates, which will remain at 45 percent.
The 2009 shelter amounts and tax rates are currently scheduled to change dramatically in the future. The estate and GST taxes are repealed for individuals dying in 2010. However, they are due to return in 2011 with only a $1,000,000 shelter amount for estate tax purposes and at least $1,300,000 for GST tax purposes (due to automatic inflation adjustments since 1997), with a maximum tax rate of 55 percent.
Looking beyond what we know will transpire and moving into the area of speculation on future changes in the law, we know that President-elect Obama has supported freezing the estate and GST tax shelter amounts at the 2009 levels of $3,500,000 and maintaining a maximum tax rate of 45 percent. He has made no proposals to change the gift tax.
Also, many family investment partnerships invest one third or more of the entity’s assets in marketable securities. In the past, the IRS has attempted to get Congress to enact legislation that would reverse decades of Tax Court decisions defining and shaping how the fair market value of property, including interests in family partnerships, would be determined for estate, gift and GST tax purposes. Most notably, the IRS has attempted to eliminate the use of discounts for lack of control and lack of marketability when valuing transfers of interests in family-owned businesses, including investment partnerships.
The most recent of these attempts was evidenced by the 2005 Joint Committee on Taxation (JCT) proposals. Had the proposals been adopted, they would have imposed a series of complex rules that would have severely limited the use of valuation discounts for transfers of interests in a family-controlled business among family members, even if the interest transferred represented only a minority interest. Furthermore, the 2005 proposals contained “look-through rules” for valuing interests in a business entity that held marketable securities amounting to more than one third of the underlying assets of the business. Under these rules, the portion of the transferred interest attributable to the company’s marketable securities would have been valued separately, as if those securities were directly owned by the transferor, while any applicable valuation discount applied only to the remaining portion of the transferred interest.
Again, no one knows what Congress will actually do with future tax legislation. But it is clear that the IRS has long wanted to see legislation enacted that would overrule the use of discounts in valuing transfers of interests in family-controlled businesses. It is also apparent that the more conservative members of Congress prevented these measures from becoming law in 2005. Now that the mix in both houses of Congress has changed and budget pressures are increasing, one can assume that the IRS has not forgotten what was on their legislative wish list in 2005. Therefore, the prospect of an additional attempt to secure legislative changes in valuation rules should not be minimized.
For anyone who has been delaying his or her estate planning because of an expectation that the estate tax will be repealed, or who has been considering a future gift of interests in a family-controlled business, it might be a good idea to accelerate your thinking into action soon.