Obama Budget Proposal Estate Impact

Obama Tax Proposals

By: Martin M. Shenkman, CPA, MBA, PFS,
JD

Introduction

President Obama released a 2011 fiscal year budget which
includes some nasty stuff affecting folks with money trying to do estate
planning. Here are a few:

Tax basis consistency.

Tax “basis” is generally the price you paid for property,
plus the cost of improvements, less depreciation if applicable. Tax basis is
used to determine gain or loss when property is sold. If you received property
by gift, tax basis is generally the same as the person who gave it to you
(called “carryover basis”). IRC Sec. 1015. If you inherit property the basis is
generally the fair value of the property at death as reported for estate tax
purposes. IRC Sec. 1014.

There have been abuses. For example, if someone gave you a
gift that was worth less than the annual gift exclusion ($13,000 in 2010) no
gift tax return would report the information to the IRS. Similarly, if someone
bequeathed you property and their estate was less than the estate tax filing
threshold ($3.5 million in 2010 assuming the estate tax is reinstated which is
likely), no estate tax return has to be filed. If property was owned by you and
the decedent jointly it passes to you by operation of law with no documentation
necessarily required. How does the IRS know that you’re fessing up to the real
value? This Obama proposal would require that the basis of the property in the
hands of the recipient be no greater than the value of that property as
determined for estate or gift tax purposes (subject to subsequent adjustments).
And to make sure this happens reporting requirements will be added. Executors
(for estates) and donors (for lifetime gifts) will be required to provide the
necessary information to both the recipient and the IRS. The Treasury
Department will be given authority to issue tax regulations, so in the words of
Captain Jean-Luc Picard to Commander Will Riker “Make It So, number 1,” they’ll
make sure to cover the tax collector’s back with guidelines as to the
implementation and administration of these requirements.

Valuation Discounts

Gift, estate and GST tax rates are applied to the value of
assets transferred above certain threshold amounts.

• While taxpayers can’t change the rates they pay, they can reduce tax if
  values are made lower. So contractual and other restrictions were created
  that reduced the value of assets. So it goes…
• Congress enacted a number of provisions including Code Section 2704(b)
  that provides that certain restrictions be ignored in determining value
  (i.e., those restrictions not be considered so that the discounts in value
  they would otherwise support won’t affect the value of the interests
  transferred by gift). The restrictions that were to be ignored included
  contractual restrictions that were more stringent than comparable
  restrictions under state law. Example: Billy Pilgrim set up a corporation
  and the shareholders’ agreement provided that no shareholder could sell
  their shares for ten years the value of the shares would be reduced
  dramatically. But if state law provided that a dissenting shareholder had
  be paid fair value in six months the ten year restriction was ignored. So
  it goes…
• Well, taxpayers couldn’t change the federal tax laws, but gee, want not
  get states to enact restrictions that would support tax discounts. So it
  goes…
• Gee, so the Obama proposal will provide that a new category of
  restrictions, called “disregarded restrictions” will be, well,
  “disregarded.” Treasury will issue regulations identifying which
  restrictions will be ignored in valuing interests in family controlled
  entities if the ownership interests involved are transferred by bequest or
  gift to family. These will include interests that can be removed by family
  members and even charity. So it goes…

The reduction in discounts, long talked about, will impact
a myriad of planning techniques and take the juice out of many deals that would
have been quite effective prior to discounts. Alas, using grantor trust status
to leverage gifts and other joyful tax techniques will likely become even more
popular if the discount toy is taken off the game board.

These new rules will apply to transfers after the date of
enactment if the restrictions were created after October 8, 1990, the date 2704
was first enacted.

GRATs

Grantor retained annuity trusts have been a favored tool
of the Rich and Famous. Just ask Robin Leach. Assets are given to a trust for a
short say two year period. A very high annuity payment is paid back to the
person setting up the trust (“grantor”) that effectively makes the value of the
GRAT zero for gift tax purposes. If the assets given beat a specified market
interest rate, all that extra growth is out of the estate. No downside risk.
The Obama proposal seeks to assure that taxpayers have a bit of skin in the
game. So GRATs have to last a minimum of 10 years (increasing the mortality
risk of the technique). GRATs might have to have something more than a zero
gift tax value and the annuity payments may not be permitted to be decreased
during the GRAT term.

GRATs will remain viable, but perhaps not for older
taxpayers, and they just won’t be as effective of as much fun.

These restrictions are to be effective from the date of
enactment.

Conclusion

Better get it while you can. There’s tougher times brewing
for those seeking to reduce estate taxes (assuming reinstatement). The window
on some techniques is closing fast. But unfortunatley, given the present state
of the law — estate and GST taxes have been repealed and replaced by a carry
over basis regime, none of which any expects to remain law, planning during the
remaining days of this “window” are not simple, certain or easy.