With only two months left in 2010, the uncertainty surrounding the estate tax still hangs over our heads. There have been a variety of bills proposed over the past two years, yet we do not have an answer as to what 2011 will bring, and if we look in the rear-view mirror, there are still many unresolved questions surrounding 2010. The possibility of a return of the federal estate tax in 2011 with a $1 million exemption and a 55 percent maximum tax rate increases as every day passes. As we noted in our April 2010 Estate Planning Update, "So ... Now What?", although we are in a difficult environment to plan, depressed asset values combined with historically low interest rates provide many opportunities to transfer wealth efficiently. As the economy picks up, businesses begin to grow and profit again, and as new legislation looms on the horizon, now is a perfect time to consider transferring the potential growth in asset values on to future generations.
Income Tax Set to Increase in 2011
Along with the possibility of the return of the federal estate tax at the highest level since 2001, income tax rates are set to increase unless Congress intervenes. The brackets of 10 percent, 15 percent, 25 percent, 33 percent, and 35 percent that we have grown accustomed to will be replaced by brackets of 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent. In addition, the capital gains tax rates will be changing, with the top rate rising from 15 percent to 20 percent (although it is still 18 percent for capital assets held more than five years). Moreover, the tax on dividend income will no longer be at capital gains tax rates, but will be taxed as ordinary income under the higher graduated rates.
These rate changes may provide some planning opportunities before the end of 2010. First, if you are in a position to accelerate income from 2011 to 2010, you may want to consider doing so to protect yourself against the possibility of higher rates. In addition, if you can declare a dividend in a corporation, do so before the end of 2010 to take advantage of the 15 percent rate. Second, if you anticipate selling investments in 2011, you may want to consider moving the sale into 2010 to take advantage of the lower capital gains rates. There is a budget proposal that would limit charitable deductions in 2011 to 28 percent if you have adjusted gross income in excess of $250,000. If you are considering making charitable donations in the near future, have adjusted gross income in excess of $250,000, and would not be subject to the alternative minimum tax, you may want to consider making those gifts in 2010 to lock in potentially greater tax savings. However, if the budget proposal is not adopted, the potential tax savings from making a charitable contribution in 2011 would be greater, due to the rise in income tax rates.
End of the Year Gifts
As the end of the year approaches so does the deadline for taking advantage of the annual exclusion for 2010 gifts. The annual exclusion for federal gift tax purposes remains $13,000 per donee ($26,000 for gifts by married couples). In addition, each individual can make lifetime taxable gifts in excess of the annual exclusion in the amount of $1 million (subject to the exception noted below). This year, any gift above these amounts is subject to a 35 percent gift tax rate. As of January 1, 2011, this rate will jump to 55 percent unless Congress intervenes. You may have an opportunity to save gift tax if you accelerate a transfer that you are planning to make next year into this year. To be certain your gifts are treated as 2010 gifts, you should not wait until the last minute to make your gifts, since the transfer of the cash or asset must occur before December 31, 2010.
A technicality in the way the gift tax is calculated actually causes the gift tax exemption to be lower in 2010 than it was in 2009. A donor who made more than $500,000 in taxable gifts prior to 2010 will not have the ability to make another $500,000 in taxable gifts in 2010. A donor who made $961,538 in taxable gifts prior to 2010 will have no gift tax exemption left in 2010, although, under current law, the lost amount will be restored in 2011.
Generation-Skipping Transfers—A Possible Planning Opportunity
The generation-skipping transfer (GST) tax was also suspended as of January 1, 2010. Normally, one would think this provides a golden planning opportunity for existing trusts that are subject to the GST tax (sometimes referred to as nonexempt GST trusts) to make distributions to skip persons (persons that are two generations or more below the generation of the grantor) and for grandparents thinking about making gifts of greater than $13,000 to their grandchildren without incurring GST tax. (Prior to this year and starting again in 2011, a direct skip to grandchildren was or will be subject to GST tax.) However, before making such a distribution or gift, there are a variety of factors to be considered. For example, there is uncertainty whether Congress will reinstate the GST tax retroactive to January 1, 2010. If so, it is possible you could end up paying GST tax on the distribution or gift. Moreover, if you are a trustee of a nonexempt GST trust, you must consider the purposes of the trust and the needs and protection of the beneficiaries to determine if a distribution is permitted. These factors, along with others, must be balanced against the possibility of avoiding GST tax. We urge you to contact us if you are considering making a direct gift to a grandchild or if you are a trustee or beneficiary of a trust that is not exempt from GST tax.
There is also uncertainty concerning 2010 gifts to trusts that are intended to be exempt from GST tax. It is unclear how distributions from these trusts in future years will be treated because no portion of your GST exemption can be allocated to the trust in 2010 when there is no GST tax.
Watch Out for Additions to Existing Irrevocable Insurance Trusts in Early 2011
Under the law from 2002 to 2009, there was an increasing exemption from GST tax that peaked at $3.5 million for gifts in 2009. In 2011, the GST tax exemption drops back to $1,360,000. Many trusts that own life insurance have limited rights of withdrawal designed so that additions to the trust needed to pay premiums qualify for the gift tax annual exclusion (often called a "Crummey power"). The "Crummey power" does not qualify for an exclusion from GST tax, so in many of those trusts the one time GST exemption has been allocated, either directly or automatically. It is possible that the total GST exemption allocated by the end of 2009 was in excess of the $1,360,000 available 2011 exemption, but still well under the 2009 limit of $3.5 million. In those trusts, you should be careful not to make further additions in 2011 until either the tax laws are clarified or until you have done a careful review of how much GST exemption may remain.
Pa. Governor Signs Act 85
On October 27, Pennsylvania Gov. Rendell signed into law Act No. 85, formerly Senate Bill 53. This Act makes a number of changes to the Pennsylvania Probate, Estates, and Fiduciaries Code, which is the statutory law in Pennsylvania concerning trusts, estates, powers of attorney, and other fiduciary relationships. Most of these changes, while important, are fairly technical. The Act places significant restrictions on the ability of an agent under a power of attorney to make changes to the beneficiary designation of life insurance and retirement plans. It also shortens the time limit (to 2.5 years) for beneficiaries of trusts to object to transactions after receiving regular periodic reports with regard to transactions in the trust. Note that triggering this time limit requires that the trust statements received by the beneficiary include a "conspicuous written statement" describing the time limit involved in making an objection. With regard to the use of the marital deduction/credit shelter/generation-skipping exemption formulas described in more detail in our December 2009 Estate Planning Update, the Act adds a new Chapter 28 giving specific guidance as to the interpretation of these clauses for someone dying in 2010 and, more importantly, provides clear access to a judicial proceeding if there is doubt or disagreement as to the proper interpretation of such a clause.
The End of Grantor Retained Annuity Trusts and Valuation Discounts for ‘Non-Business’ Assets and Minority Interests?
As we discussed in our April 2009 Estate Planning Update, "Congress Considers Multiple Proposals for Changing the Estate Tax" and April 2010 Estate Planning Update "So... Now What?", various bills that have been presented will have a negative impact on future estate planning. One bill, H.R. 4849, which was passed by the House of Representatives and is now in the Senate, requires a grantor retained annuity trust (GRAT) to have a minimum annuity period of 10 years. Essentially, a GRAT pays the donor an annuity based upon an interest rate set by the IRS and in return, the appreciation of the assets of the GRAT above such rate passes to the beneficiary without estate or gift tax. However, this only works if the grantor survives the annuity period. If he or she does not, the value of the property is included in the grantor’s estate. Mandating that a GRAT have a minimum annuity period of 10 years reduces the probability that the grantor will survive the term of the GRAT and thus reduces the probability of a successful GRAT.
There also is legislation pending that, if enacted, would eliminate valuation discounts for minority interests and "non-business assets" (defined as an asset not used in the active conduct of a trade or business).
Consequently, you should consider acting now to create a short-term GRAT or to transfer some of your business interests or other assets to family. Congress will return after the November election, and it is likely that any new legislation will be effective for transactions entered into after the effective date of any new law.
Do Not Fear—FDIC Insurance Limitations Made Permanent
The Federal Deposit Insurance Corporation (FDIC) provides insurance coverage to protect depositors in insured banks located in the United States against the loss of their deposits if an insured bank fails. For almost 30 years, the FDIC insurance limit on insurable bank accounts was $100,000. This all changed with the failure of more than 25 banks in 2008 (more than 240 banks have since failed in 2009 and 2010). In 2008, in an attempt to allay fears among depositors that they may lose their money if a bank fails, the FDIC temporarily raised the insurance coverage amount to $250,000.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. The primary purpose of this Act was financial reform. However, the Act also contained a provision making the $250,000 coverage limit permanent. The limit applies per depositor, per insured depository institution for each account ownership category. Therefore, all of your single accounts at the same insured bank are added together and the total is insured up to $250,000. You may qualify for more than $250,000 of coverage at one insured bank if you own deposit accounts that are in different ownership categories. Ownership categories include, among others, single accounts, joint accounts, revocable trust accounts, and certain retirement accounts. The limits are retroactive to January 1, 2008. With respect to revocable trust accounts, the coverage is based upon the number of beneficiaries specifically named on the account, subject to certain limitations.