Year-End Transfer Tax Planning

As has been widely reported, on Saturday, the Senate rejected a proposed bill that would have extended the Bush income tax cuts for taxpayers making less than $200,000 a year (and married couples making less than $250,000 a year). Less widely reported is that the bill, which was introduced by Senator Baucus last Thursday, might have a considerable impact on year-end gift tax and generation-skipping transfer (“GST”) tax planning. Although the bill did not pass, portions of the proposed bill had an effective date of December 2, which could be adopted by future legislation, adding a layer of uncertainty to year-end tax planning.

Federal gift and GST taxes

As explained in the firm’s Alert Memorandum dated January 14, 2010, this year, under the Bush tax cuts, there is no Federal GST tax and the Federal gift tax rate for gifts in excess of the $1 million gift tax exemption is only 35%. Many clients have been considering making taxable gifts this December to take advantage of the 35% gift tax rate or making transfers to grandchildren to take advantage of the temporary repeal of the GST tax.

The Baucus bill included provisions that would have imposed a 45% tax on any gift or generation-skipping transfer in excess of the applicable exemption if the gift or generation-skipping transfer was made on or after December 2, 2010. Thus, under the proposed bill, the ability to make gifts at a 35% tax rate and to make transfers to grandchildren free of GST tax would have ended last week. Although the Baucus bill was rejected, there is a risk that the bill’s December 2nd effective date could be incorporated into future legislation. If so, the cut-off date for taking advantage of the 35% gift tax rate and the temporary repeal of the GST tax may have already passed. Due to this legislative uncertainty, clients interested in making taxable gifts or generation-skipping transfers before year end should contact us.

GRATs

The Baucus bill included a proposal, also discussed in prior alert memoranda, to impose a minimum 10-year term for grantor retained annuity trusts (“GRATs”). In contrast to the proposed gift tax and GST tax legislation, however, the proposed GRAT legislation would not have taken effect until President Obama signed the bill into law. Thus, it appears that there is still time to establish short-term GRATs. (For a discussion of the benefits of short-term GRATs, see the firm’s Alert Memorandum dated June 29, 2009.)

The Obama administration and Congress are working on compromise legislation that could be enacted as early as this week. If the compromise legislation includes this GRAT proposal, the opportunity to create new short-term GRATs could end abruptly. Therefore, anyone interested in establishing a short-term GRAT should contact us as soon as possible.

Planning techniques taking advantage of low interest rates

As you know, we are in a period of historically low interest rates. The benchmark rate for valuing the annuity retained by the grantor of a GRAT is currently 1.8%, making GRATs of any term attractive.

Clients may also wish to consider other estate planning techniques that take advantage of the current low interest rate environment and that are not affected by the proposed legislation. These techniques include charitable lead annuity trusts (“CLATs”), sales to intentionally defective grantor trusts and low-interest loans to family members or trusts for family members. (For a discussion of these planning techniques, see our Alert Memorandum dated November 19, 2008.) The interest rates for intra-family loans in December are .32% (for loans not exceeding three years), 1.53% (for loans in excess of three years but not exceeding nine years) and 3.53% (for loans in excess of nine years).

Annual exclusion gifts

Finally, by way of reminder, annual exclusion gifts should be made before year end. The annual exclusion for 2010 is $13,000 per donee (or $26,000 per donee for married couples). The annual exclusion will remain at $13,000 in 2011. We recommend that gifts be made in January of each calendar year in order to shift investment returns to lower generations as early as possible.

If you would like to discuss any of the matters described in this memorandum, please contact one of the attorneys in the firm’s Private Clients and Charitable Organizations Practice Group.