The consensus at 48th Annual Heckerling Institute on Estate Planning was that because 2014 is an election year, there’s unlikely to be any major tax reform this year. The year 2015, however, could be a different story.
What looms on the horizon for 2015 and beyond? Although the tea leaves can be difficult to read, the 2014 Green Book (officially called General Explanations of the Administrations’ Fiscal Year 2014 Revenue Proposals) proposals that pertain to estate planning, which were released in April 2013, provide a broad outline of what could potentially happen down the road, subject of course to the inevitable horse-trading that marks the legislative process.
Here’s a summary of several of the key provisions of the Green Book proposals. Conspicuously absent from the Green Book is the Obama Administration’s long-time stalwart proposal to eliminate marketability discounts for interests in family-owned entities that hold passive assets, such as marketable securities.
1. The estate, gift and generation-skipping transfer (GST) tax exclusions and rates would revert back to 2009 rules.
The Obama Administration proposes to restore the 2009 estate, gift and GST transfer tax exclusions and rates beginning in 2018. Under this proposal, the estate and GST tax exemption amounts would be reduced to $3.5 million, while the gift tax exemption would be reduced to $1 million. There would no longer be any indexing of these exemption amounts for inflation. The top tax rate would be increased to 45 percent from the current top rate of 40 percent. Portability would, however, continue in effect.
The Administration’s proposal clarifies that there would be no clawback for prior transfers by reason of the reduction in the estate, gift and GST tax exemption amounts. Accordingly, if this proposal were enacted into law, it would most likely prompt another rush of gifting for wealthy individuals in late 2017 similar to the recent gifting rush at the end of 2012.
2. Sales, exchanges and “comparable transactions” with grantor trusts.
The Obama Administration would attempt to address the disconnect between the income tax rules and the estate tax rules that apply to intentionally defective grantor trusts (IDGTs). However, in stark contrast to the previous year’s vastly overbroad Green Book proposal concerning grantor trusts–which would have generally sought to include most grantor trusts in the decedent’s gross estate for estate tax purposes–the 2014 proposal is much more narrowly drawn and would only be triggered in the case of certain transactions with grantor trusts that constitute a “sale, exchange or comparable transaction that is disregarded for income tax purposes by reason of the person’s treatment as a deemed owner of the trust.” In those transactions, the portion of the trust attributable to the property received by the trust (including all retained income therefrom, appreciation thereon and reinvestments of such property), net of the amount of the consideration received by the person in that transaction would be: (1) subject to estate tax as part of the gross estate of the deemed owner, (2) subject to gift tax when grantor trust status ceases as to the deemed owner during such person’s lifetime, and (3) treated as a gift by the deemed owner to the extent any distribution is made to another person (except in discharge of the deemed owner’s obligation to such other person) during the life of the deemed owner. The transfer tax imposed by this proposal would be payable from the trust.
Thus, the current proposal would allow IDGTs to be created, but wouldn’t allow taxpayers to sell or exchange assets to an IDGT (or engage in a comparable transaction) without potential adverse tax consequences. An “exchange” presumably could include a grantor’s exercise of a power to substitute assets of equivalent value in a non-fiduciary capacity, which is a commonly used trigger for grantor trust status under Internal Revenue Code Section 675(4)(C). It’s unclear what this proposal means through its reference to “comparable transactions” and whether that would embrace, for example, making loans to the trust or leasing back real property (such as a vacation home) from the trust.
Significantly, the Green Book proposal specifically excludes from its ambit trusts that are grantor trusts solely by reason of IRC Section 677(a)(3), which pertains to the application of income to pay life insurance premiums. Thus, such narrowly drawn irrevocable life insurance trusts wouldn’t be subject to estate tax inclusion merely because they’re grantor trusts, perhaps even if the specified transactions described above were engaged in. In addition, the proposal wouldn’t alter the treatment of any trust that’s already includable in the grantor’s gross estate under existing provisions of the IRC (such as grantor retained annuity trusts and qualified personal residence trusts).
This proposal would apply to transactions entered into on or after the date of enactment.
3. Additional restrictions on grantor retained annuity trusts.
The Obama Administration would significantly reduce the attractiveness of grantor retained annuity trusts (GRATs) by, among other things, requiring a minimum term of 10 years (thereby eliminating short-term rolling GRATs), preventing the ability to front-load the GRAT annuity and imposing a minimum taxable gift requirement. In addition, to combat the perceived abuse of “99-year GRATs,” the Obama Administration would limit the maximum term of a GRAT to the annuitant’s life expectancy plus 10 years.
4. Additional Green Book proposals that pertain to estate planning.
The Green Book contains the following additional proposals that pertain to estate planning:
- A change to existing law under IRC Section 101 by subjecting “buyers of policies” to the “transfer-for-value” exception to the exclusion of life insurance proceeds for income tax purposes. The phrase “buyers of policies” presumably is broad enough to encompass grantor trusts. If enacted, such “buyers of policies” would be taxed on death benefit proceeds in excess of the amount of consideration furnished.
- A limit on the scope of the current law exclusion under IRC Section 2611(b)(1) for GST tax purposes for direct payments of tuition and medical care so that this exclusion would only apply to payments made by a living donor directly to the provider of medical care or to the school for tuition. As a result of these restrictions, trust distributions for these same purposes—including so-called “Health and Education Exclusion Trusts” (HEET Trusts)—wouldn’t qualify for this exclusion.
- Imposition of a consistency requirement for basis purposes between what’s reported as fair market value on the decedent’s Form 706 Federal Estate and Generation-Skipping Transfer Tax Return (presumably, as finally determined for federal estate tax purposes) and what the beneficiary later reports as his stepped-up basis on the decedent’s death for income tax purposes.
- A limit on the availability of the GST exemption to 90 years.
- An extension of the 10-year estate tax lien under IRC Section 6324(a)(1) to cover the entire 14 year and nine month term subsequent to the decedent’s death that’s subject to the deferral of estate tax under IRC Section 6166.
- A restriction on deductions and harmonization of the rules for contributions of conservation easements for historic preservation.
5. Related proposals pertaining to qualified plans and individual retirement accounts. In addition, the Green Book includes the following proposals that pertain to qualified plans and IRAs:
- A limit on the total accrual of retirement benefits by prohibiting additional contributions or the receipt of additional accruals if the taxpayer has accumulated retirement benefits in excess of the amount necessary to provide the maximum annuity permitted under a defined benefit plan (currently $205,000 per year payable as a joint and 100 percent survivor annuity beginning at age 62). This amount is currently approximately $3.4 million at age 62.
- A general requirement that non-spouse beneficiaries of qualified retirement plans or IRAs must take distributions over no more than five years. Exceptions would apply for beneficiaries who are disabled, chronically ill, up to 10 years younger than the participant or IRA owner or a minor child (the minor child’s 5-year distribution period would commence upon attaining the age of majority).
- An extension to non-spouse beneficiaries of the ability to make 60-day rollovers of distributions from qualified plans or IRAs to non-spousal inherited IRAs. This proposal would afford non-spouse beneficiaries the same treatment for 60-day rollover purposes that surviving spouses currently enjoy.
- An exemption for participants and IRA owners with aggregate benefits under $75,000 from having to take required minimum distributions.