Last week, the Obama Administration released its budget proposal for the 2015 Fiscal Year, which was accompanied by the Treasury Department’s General Explanation of the Administration’s Fiscal Year 2015 Revenue Proposals, commonly referred to as the “Greenbook.”[1] The two documents are an important pairing as the President’s proposal lays out his overarching objectives, which will require revenue, while the Greenbook puts forward the details of how that additional revenue will be generated. While many proposals that appear in each year’s Greenbook never make it into law, or even the following year’s Greenbook, it’s worth noting the proposals. They represent what the President would sign into law if unbridled by the legislative process and what could end up as potential trade chips in the legislative process.
In terms of the Obama Administration’s general ideas for potential revenue raisers, unsurprisingly, successful individuals remain a prime target. In the 2015 Budget, the President proposes to obtain revenue for various projects and deficit reduction “through tax reform that reduces inefficient and unfair tax breaks and ensures that everyone, from Main Street to Wall Street, is paying their fair share.”[2] This strikes a similar chord to previous proposals, such as 2014’s proposal that “the wealthiest pay their fair share” or 2013’s proposal that “everyone shoulders their fair share…”[3]
Given that the President’s overarching goal of generating additional revenue through additional taxes on wealthy individuals remains unchanged, it shouldn’t come as a surprise that many of the estate and gift tax proposals remain the same. All seven of the transfer tax proposals from last year’s Greenbook reappear almost verbatim in this year’s Greenbook. However, two new proposals have been added: The first new proposal essentially proposes the elimination of trusts that utilize Crummey powers; and the second addresses a practical issue that arises in settling a decedent’s affairs.
A Crummey Idea
The one notable addition to this year’s Greenbook has a disarming title: “Simplify Gift Tax Exclusion for Annual Gifts.” However, besides the heading, the rest of the proposal is very clear—the Obama Administration seeks to eliminate the use of Crummey powers in estate planning. As the proposal notes, a Crummey power allows a gift to a trust to qualify for the annual exclusion. The donee of such trust has the right for a limited period of time to withdraw the property contributed, which gives the donee a present interest in the property contributed allowing it to qualify for the annual exclusion.
Some planners have implemented Crummey powers by including a large number of beneficiaries, some of which may never exercise their withdrawal power or ultimately receive a distribution from the trust. With each additional donee, more property can be transferred using the annual exclusion. This planning technique can be especially effective and commonly used in irrevocable life insurance trusts that utilize annual exclusion gifts to fund large insurance premiums on the life of the grantor. These insurance trusts often provide taxpayers the best opportunity to leverage their annual exclusion and can be a key part of ensuring that there’s necessary liquidity for an estate.
The IRS has attempted to challenge the broad use of Crummey powers by arguing that each beneficiary must have a reasonable chance or expectation of receiving the property held in the Crummey trust. The Tax Court has rejected this argument, holding it’s the legal right to withdraw funds that creates the present interest that allows the annual exclusion to apply.[4] The Greenbook proposal notes the administrative costs to the taxpayers who utilize this planning technique and the costs to the IRS in enforcing the rule.
The Greenbook proposal claims to simplify annual exclusion gifts by simply abolishing the present interest requirement. While this proposal is new for the Obama Administration and comes as the surprise of this year’s transfer tax proposals, it isn’t the first time an administration has sought to eliminate Crummey trust planning. The Clinton Administration, in its last Greenbook, proposed to eliminate the use of Crummey powers.[5] The Clinton proposal eliminated the need for withdrawal rights, but would only allow the annual exclusion to apply if the trust were for the benefit of a single donee and the trust property would be includible in that donee’s estate if the donee didn’t survive the term of the trust. This is analogous to Section 2503(c) trusts.
President Obama’s proposal mirrors the Clinton proposal by eliminating the present interest requirement and allowing the current annual exclusion amount of $14,000 per donee (indexed for inflation) for transfers to individuals or trusts that are only for the benefit of the donee and would be includible in the donee’s estate.[6] However, there’s an additional taxpayer friendly modification to the Clinton proposal. In addition to being able to give a certain amount to each individual donee tax-free on an annual basis, the proposal would create a new category of donees. This new category would include trusts or transfers of other entities that, without a withdrawal right, would generally not qualify as the transfer of a “present interest.”[7] Under the proposal, each donor would be allowed a $50,000 annual exemption of gifts to trusts or of other property that wouldn’t currently qualify as a transfer of a “present interest.” While this proposal would limit the effectiveness of annual exclusion gifts in some cases, it would simplify reporting and allow the annual exclusion to apply in situations it wouldn’t have otherwise prior to this proposal.
Who’s Executor and for What?
The other new proposal in this year’s Greenbook isn’t a revenue raising proposal, but is intended to provide clarity to a term many may take for granted: “executor.” Section 2203 states:
“The term “executor” wherever it is used in this title in connection with the estate tax imposed by this chapter means the executor or administrator of the decedent, or, if there is no executor or administrator appointed, qualified, and acting within the United States, then any person in actual or constructive possession of any property of the decedent.
Notably, the definition only applies to estate taxes—not gift taxes or income taxes, which are common issues that come up in administering an estate. The proposal notes that this is increasingly becoming an issue, as estates are more frequently addressing reporting obligations related to foreign accounts and the IRS’ Offshore Voluntary Disclosure Program.
In addition, if there’s no executor or administrator acting in the United States, a variety of individuals could be deemed the executor because the term “any person in actual or constructive possession of any property” is broadly defined under the accompanying Regulation and “includes, among others, the decedent's agents and representatives; safe-deposit companies, warehouse companies, and other custodians of property in this country; brokers holding, as collateral, securities belonging to the decedent; and debtors of the decedent in this country.”[8] This could create multiple individuals meeting the definition of “executor” and taking potentially conflicting actions or filing multiple returns.
The proposal seeks to address both of these issues. First, it makes clear that the individual(s) who meets this definition has the authority to act on behalf of the decedent in all tax matters, not just estate taxes. To address the issue of knowing who’s the executor, the Greenbook proposes giving the IRS regulatory authority to set forth rules to resolve conflicts among those who would be deemed executors as a result of having actual or constructive possession of the property.
The Old Ideas
The rest of this year’s Greenbook largely restates all seven of the proposals that appeared in last year’s, which are:
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Restore 2009 rates and exemptions in 2018: To the surprise of many, as part of the fiscal cliff compromise, the American Taxpayer Relief Act of 2012 (ATRA), the unified $5 million exemption for estate, gift and generation-skipping transfer (GST) taxes was made permanent and indexed for inflation, with the tax rate set at 40 percent. Since ATRA was enacted, the Obama Administration has proposed in each of its Greenbooks to restore the exemptions and rate in effect in 2009 starting in 2018. In effect, this means that one year after President Obama leaves office, the estate and GST exemption would drop to $3.5 million, while the gift tax exemption would drop to $1 million with a top marginal tax rate of 45 percent. These exemption amounts wouldn’t be indexed for inflation. Portability would continue to exist under this new regime even though it wasn’t in effect in 2009, but in calculating future transfers by the surviving spouse using the exemption received from the decedent, there would be a differentiation between the gift tax exemption and estate tax exemption based on how much of each exemption the decedent had remaining. The proposal also confirms that there will be no “clawback” as a result of this change, meaning that no gift or estate tax liability would be created by transfers made that were covered by a higher exemption at the time of transfer.
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Consistency in value for transfer and income tax purposes: This proposal seeks to ensure that the fair market value for transfer tax purposes and the basis the transferee reports for the received property is the same, by implementing a requirement on the transferee and the transferor. There will be a consistency requirement imposed on the transferee, who can’t later report the basis in the property greater than: 1) the value of the property for estate tax purposes in the case of property received from a decedent, or 2) the donor’s basis for property received by gift. To ensure there’s compliance and consistency, the proposal seeks to impose a reporting requirement on executors with respect to bequests from estates and on donors with respect to gifts to report the basis to both the recipient and the Internal Revenue Service. This doesn’t constitute a significant departure from the framework of Internal Revenue Code (IRC) Sections 1014 and 1015 in regards to basis of received property, but instead an additional level of reporting and regulation.
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Minimum terms for GRATS: All of President Obama’s Greenbook proposals have targeted the use of short-term grantor-retained annuity trusts (GRATs). The concern is that this planning technique permitted by statute has very little “downside risk.” Of specific concern are short-term zeroed out GRATs, in which the donor retains an annuity sufficient to have the gift valued at zero and with a relatively short term to minimize the chance of the donor dying during the GRAT term and having the assets includible in his estate as a result. To create the downside risk, Obama’s proposal would have GRATs with a minimum term of 10 years. The theory is that by having the GRAT remain in existence for a decade, there’s a greater chance of the donor dying. Also, as in previous proposals, the remainder interest would have to be greater than zero, though no specific amount is given, which permits near-zeroed out GRATs, but would ensure there was a gift tax reporting obligation.
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Attack on dynasty trusts: This proposal intends to eliminate what the Greenbook calls a “transfer tax shield.” Various trust jurisdictions allow for perpetual trusts, commonly referred to as “dynasty trusts,” which have allowed planners to utilize a donor’s GST exemption to provide substantial long-term transfer tax savings. If a trust not subject to the rule against perpetuities is structured and maintained properly, it’s possible for assets to continue to grow free of transfer taxes indefinitely. The Greenbook proposal provides that while a trust need not ever terminate, it effectively will lose its transfer tax exemption on the 90th anniversary of the trust’s creation.
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Prevent leveraging techniques with IDGTs: For the third time, the Obama Administration is taking aim at intentionally defective grantor trusts (IDGTs) in its Greenbook proposals. The administration notes that significant transfers of wealth can occur by planning that focuses on the discrepancies between the grantor trust rules and the estate tax inclusion rules. With IDGT planning, it’s possible to have the donor be the owner of trust assets for income tax purposes, which causes transactions with the trust to be disregarded for income tax purposes, but with the trust outside the donor’s estate. The Greenbook proposal seeks to “coordinate” the income and transfer tax rules by treating assets that are sold or otherwise exchanged with a trust that the donor is deemed the owner of for income tax purposes as includible in the grantor’s estate upon the grantor’s death, or as a taxable gift upon the termination of grantor trust status or upon the distribution of assets from the trust during the grantor’s life. Any transfer tax liability would need to be paid from the trust. This proposal wouldn’t apply to trusts already includible in the grantor’s estate, such as GRATs, qualified personal residence trusts and revocable trusts. In addition, this wouldn’t apply to life insurance trusts.[9]
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Extend estate tax lien with IRC Section 6166 election estates: This proposal seeks to close a disparity between the deferral allowed under Section 6166 for the payment of estate taxes owed by estates that own closely held businesses and the general estate tax lien imposed under IRC Section 6324(a)(1). Under current law, an estate that qualifies for a Section 6166 election can defer estate taxes up to approximately 15 years. However, the general estate tax lien under Section 6324(a)(1) expires after only 10 years. During this potential five year gap period, the IRS has experienced issues collecting estate taxes due to the business failing. While the IRS currently has discretion to require a security interest in the estate’s property for the gap period, it has proven unworkable from the standpoint of both the IRS and debtor estates. The proposal would extend the general estate tax lien through the entire period of the Section 6166 election deferral period.
- GST tax to apply to HEETs: The Greenbook expresses concerns that some taxpayers are implementing planning techniques that are contrary to the intent of the GST provisions. A health and education exclusion trust (HEET) is a trust established to pay for the education and medical expenses of future generations. Some planners have taken the position such trusts are exempt from GST taxes based on IRC Section 2611(b)(1), which excludes payments permitted under IRC Section 2503(e) from GST tax. The Greenbook takes the position that IRC Section 2611(b)(1) wasn’t intended to allow for tax free growth inside trusts but to allow for a grandparent to pay directly the educational or medical costs of a grandchild without incurring GST. The proposal would allow Section 2611(b)(1) GST exclusion only in cases in which the donor pays the costs directly to the education or medical provider and not to the trust. The inclusion of this proposal is interesting in that the Administration’s own budgets estimates show that this is the only one of the nine transfer tax proposals that will actually fail to raise revenue and increase the size of the deficit over the coming years.[10]
What To Make of this Year’s Greenbook
The provisions of this year’s Greenbook, both new and the old, aren’t surprising given the President’s desire to raise revenue through transfer taxes on wealthy individuals and decreasing the potential planning techniques that taxpayers can implement. The question is: What will this mean for planners going forward? As Yogi Berra said, “It is tough to make predictions, especially about the future.” These Greenbook proposals represent what the President wants to be law. What actually becomes law depends on what happens in Washington during a mid-term election year, which is anyone’s guess.
Endnotes
[1] Office of Management and Budget, Executive Office of the President, Budget of the United States Government, Fiscal Year 2015 (2014); Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2015 Revenue Proposals (March 2014).
[2] Budget of the United States Government, Fiscal Year 2015, supra note 1, at 5.
[3] Office of Management and Budget, Executive Office of the President, Budget of the United States Government, Fiscal Year 2014, 5 (2013); Office of Management and Budget, Executive Office of the President, Budget of the United States Government, Fiscal Year 2013, 2 (2012).
[4] Estate of Cristofani v. Comm’r, 97 T.C. 74 (1991); Kohlsaat v. Comm’r, TCM 1997-212.
[5] Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2001 Revenue Proposals, 186-187 (February 2000).
[6] The Greenbook proposal achieves this result through reference to IRC Section 2642(c).
[7] In Hackl v. Comm’r, 118 T.C. 279 (202), aff’d 335 F.3d 664 (7th Cir. 2003)
and its prodigy, the IRS has successfully argued that gifts of interests in entities that have restrictions that prevent the donee from being able to “any substantial economic or financial benefit that might be represented by the interests” didn’t constitute a gift of present interest.
[8] Treasury Regulations Section 20.2203-1.
[9] The text in the Greenbook related to insurance trusts has evolved since the proposal related to coordinating income and transfer tax rules in regard to grantor trusts. In the Greenbook proposal for the 2013 Fiscal Year, irrevocable insurance trusts (ILITs) weren’t excluded from the scope of the proposal as the only excluded trusts were ones that would be includible in the grantor’s estate. In the Greenbook for the 2014 Fiscal Year, “any trust that is grantor solely by reason of section 677(a)(3)” was excluded, which would exclude ILITs from the scope of the proposal. In this year’s Greenbook, the proposal “would not apply to any irrevocable trust whose only assets typically consist of one or more life insurance policies on the life of the grantor and/or the grantor's spouse.” The variation between the Greenbook’s for the 2014 and 2015 Fiscal Years reflects a bit of ambiguity in the Internal Revenue Code, one in which the 2014 Greenbook had inadvertently taken a position contrary to that of the Internal Revenue Service. IRC Section 677(a)(3), read literally, would result in the mere power to use income of a trust to pay insurance premiums on the life of the grantor or grantor's spouse would trigger grantor trust status, which means intentionally defective grantor trusts (IDGTs) that didn’t prohibit the purchase of life insurance policies would in theory be excluded from the proposal. However, court cases on Section 677's predecessor, Revenue Ruling 66-313, and some private letter rulings from the 1980s indicate that there must be an actual payment of insurance premiums as the mere power isn’t enough. However, there are other conflicting PLRs from the 1980s that hold the opposite and reflect a literal reading of the IRC. The fact that the Treasury deviated from their near verbatim recitation of last year’s proposal shows both the ambiguity related to this IRC section as well as the fact that IDGTs are the clear aim of this proposal.
[10] Budget of the United States Government, Fiscal Year 2015, supra note 1, 190, Table S-9.
