This is the fourth article of a series dealing with the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Act”). For the first three articles, see:

Part 1 – Charitable IRA Rollovers
Part 2 – Estate Tax/Carryover Basis Election for 2010 Decedents
Part 3 – Temporary $5 Million Estate Tax Exemption

The Act temporarily increases the gift tax exemption to $5 million for 2011 and $5 million increased by inflation for 2012. For example, if inflation for 2011 is 2%, the gift tax exemption will be $5.1 million in 2012. The Act decreases the gift tax exemption to $1 million for gifts in 2013 or later.

In addition to increasing the gift tax exemption, the Act set the maximum gift tax rate at 35% for 2011 and 2012. The Act increases the maximum gift tax rate to 55% for 2013 and future years.

The temporary nature of the higher gift tax exemption provides an incentive to make gifts in 2011 and 2012. If you choose not to make gifts and then die in a year when the estate tax exemption is lower than $5 million, you will pay significantly more estate taxes than if you made the gift. Assume for example, that an individual who currently has $6 million of assets dies on January 1, 2013. If he makes $5 million of gifts on or before December 31, 2012, his estate will owe $550,000 of estate taxes based on current law. If he makes $1 million or less of taxable gifts, he will owe approximately $2.6 million based on current law. Thus, making gifts can reduce taxes by as much as $2,050,000. Furthermore, income and appreciation occurring after the date of the gift will be removed from your estate, which increases the reduction in estate taxes.

Some commentators believe that the IRS may attempt to “clawback” as much as $1,385,000 of these tax savings if you die in 2013 or later. The analysis is confusing because you have to make calculations by pretending that the law in prior years was different than it really was. Nevertheless, I do not think the law permits a clawback. Even if a clawback were permitted, making gifts will still yield a substantial reduction in estate taxes.

Many of our clients have already begun to take advantage of the higher gift tax exemption. Several others are evaluating different strategies for taking advantage of the additional exemption.

The simplest method is a straight gift. Due to the current economic environment, a number of our clients have made loans to their children. Some of them are forgiving the loan obligations now that this can be done without federal gift tax consequences.

While a direct gift can be very effective, we often encourage our clients to leverage their gift by transferring a “discounted” asset. Good examples are non-voting stock in a family corporation or limited partnership interests in a limited partnership, or fractional interests in real estate.

We generally recommend that gifts be made to a grantor trust. This enables the donor to continue to pay income taxes on income earned by the trust and to further decrease his or her estate.

Some of our clients want to take advantage of the gift tax exemption yet are concerned that they will run out of cash in their later years. Fortunately, there are some gifting strategies that allow the donor to maintain access to cash flow. These strategies will be discussed in a future article

I am predicting that Tennessee gift tax collections will set all-time records on April 15, 2012 and again on April 15, 2013. Tennessee allows annual exclusion gifts just like the IRS. However, Tennessee does not have any exemption from gift tax. Therefore, you will generally pay Tennessee gift taxes when you make taxable gifts to take advantage of the higher federal gift tax exemption. In a future article, we will discuss methods for making gifts that do not require you to pay Tennessee gift taxes.

In summary, the $5 million federal gift tax exemption creates a two year opportunity for decreasing the size of your taxable estate. If you choose not to take advantage of this opportunity, your children will pay more federal estate taxes unless the law is changed. Some methods of utilizing the exemption allow you to maintain access to cash flow. There are also methods for making gifts that do not require the payment of Tennessee gift taxes.
 

The attached article recognizes Tennessee as one of four Tier 2 trust states. The four Tier 1 states have only two favorable features that Tennessee does not match.

First, Tennessee imposes an income tax on dividends and interest received by a trust with Tennessee beneficiaries. This is no different than if the beneficiaries owned the assets directly. Therefore, this is not really a trust problem. Nevertheless, there are seven states in the United States that do not impose income taxes on their residents.  Tennessee does not impose income taxes on trusts held for beneficiaries who are not Tennessee residents.

The other slight advantage for some states is the rule against perpetuities. Tennessee trusts must terminate after 360 years due to our state consitution. A few states allow trusts to last into perpetuity. The benefit of perpetual trusts is overrated. I have never had a client complain to me that 360 years is too short.  More than one-half of the other states require trusts to end after approximately 90 years.  The difference between 90 years and 360 years is material to a lot of my clients. 

Our legislature has made a concerted effort to keep our trust laws at the forefront. In addition to our comprehensive Tennessee Uniform Trust Code, our laws permit asset protection trusts, decanting, community property trusts, unitrust conversions, directed trusts, equitable adjustments, and a long perpetuities period.

This is the third article of a series dealing with the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Act”). For the first two articles, see:

Part 1 – Charitable IRA Rollovers
Part 2 – Estate Tax/Carryover Basis Election for 2010 Decedents

The Act temporarily increases the estate tax exemption to $5 million for 2011 and $5 million increased by inflation for 2012. For example, if inflation for 2011 is 2%, the estate tax exemption will be $5.1 million in 2012. The Act decreases the exemption to $1 million for people dying in 2013 or later.

The Act set the maximum federal estate tax rate at 35% for 2011 and 2012, but increases the maximum rate to 55% for 2013 and future years.

The Act is great news for individuals who die in 2011 or 2012. Very few will owe federal estate taxes. However, the huge increase in estate taxes for people dying in 2013 makes estate planning tricky. Earlier this week, I met with a couple whose estate tax liability will increase from $2.9 million under 2011 law to $9 million if the survivor dies in 2013 or later. A large portion of their net worth involves a family business. They have sufficient liquid assets to pay for the 2011 taxes, but not the 2013 taxes. Should they make gifts to try to reduce estate taxes? Should they buy life insurance to provide liquidity to pay the taxes? It is possible that the $5 million exemption and 35% rate will be extended by future legislation. However, it is dangerous to make plans based on hoped for tax decreases to be enacted in the future.

Tennessee has not changed its exemption from inheritance tax. Tennessee’s exemption is still $1 million. Having different exemption amounts for Tennessee inheritance taxes and federal estate taxes is a matter that we have grown accustomed to since 2001. Most married couples deal with the disparate exemptions by transferring $1 million to a traditional credit shelter trust and transferring the difference between the federal exemption and the Tennessee exemption ($4 million under current law) to a Tennessee QTIP Trust. The Executor will make a Tennessee QTIP election for the Tennessee QTIP Trust, but will not make a federal QTIP election. This will ensure that no Tennessee taxes will have to be paid at the first death. Taxes will be payable with respect to the Tennessee QTIP Trust upon the surviving spouse’s death. However, there will not be any federal estate taxes imposed upon the Tennessee QTIP Trust upon the surviving spouse’s death.

Fortunately, most of the revocable trusts and wills that we have prepared for our clients have formulas that adjusted to the new estate tax exemption so that no changes are necessary. There is a very subtle change that we will recommend for people who otherwise need to amend their documents.. Even though it may not be necessary to amend their documents, married couples may need to rearrange ownership of certain assets. Each spouse should have $5 million of assets titled in their name so that the couple will be able to take full advantage of the higher estate tax exemption regardless of which spouse dies first.  A Tennessee Community Property Trust is a good method for dividing assets between the spouses.

The Act has a portability option which allows the surviving spouse to take advantage of any unused estate tax exemption of the first spouse to die. In theory, the portability option makes it unnecessary to rearrange ownership of assets and to fully fund the estate tax exemption of the first spouse to die in a credit shelter trust and/or Tennessee QTIP trust. As drafted, the portability option is a Trojan horse. We will explain in a future article why we do not recommend planning to take advantage of portability.

In summary, the higher estate tax exemption and lower estate tax rates will significantly reduce estate taxes for individuals dying in 2011 and 2012. There is some rearranging that may need to occur in order to take full advantage of the additional exemption.
 

In his State of the Union address on January 25th, 2011, the President made the following statement: “Those with accountants or lawyers to work the system can end up paying no taxes at all. But all the rest are hit with one of the highest corporate tax rates in the world. It makes no sense, and it has to change."

I agree with the President that we have an unfair tax system. It is exceedingly complex and has numerous laws that are nonsensical. For example, a law was passed in 2001 that encouraged wealthy people to die in 2010. Numerous attempts to remove this perverse incentive were rejected by Congress. On December 17, 2010, the 2001 law was reaffirmed in a deal brokered by the President. The new law also created a new incentive for wealthy people to die in 2011 and 2012. I have decided that I will not encourage my clients to take advantage of this tax savings “opportunity.” I hope the President will approve of my decision.

I must take exception with the President’s criticism of my profession. I have an ethical duty to do the best job that I can of counseling my clients on how to arrange their affairs to lawfully minimize their tax obligations based upon the laws that Congress and the President have enacted. Indeed, I should be disbarred if I concealed from my clients the laws that Congress has passed that would allow them to reduce their tax obligations.

President Obama is an attorney himself. He knows our ethical obligations. I have some advice for the President: Don’t blame others for following the laws that he is at least partially responsible for passing. Enact fair and simple tax laws and you will have a system that is fair and simple.
 

Jeff Mobley prepared the attached summary of estate, inheritance and gift tax facts. The chart provides various exemptions and rates under federal law and Tennessee law for 2011 and future years.

As you will see from the chart, Tennessee law is very stable. Federal law has another significant change occurring in less than 24 months.

I would like to vote for politicians who will pass stable, predictable, tax laws. When I voted last November, I was unable to find any federal politicians in this category.  

Last week, the attorneys in our firm gave a presentation to the Nashville Society of Financial Service Professionals titled "The New Estate & Gift Tax Laws – The 2-Year Window of Opportunity.” The presentation was a joint effort by Bryan Howard, Jeff Mobley, Stephanie Edwards, and our two newest members, Paul Hayes and Paul Gontarek, who joined us at the beginning of the year.

Paul Hayes is an experienced estate planner like the rest of us, and is also a CPA and a Certified Financial Planner.

Paul Gontarek specializes in trust and estate litigation, which seems to be a growth industry due to  increased life expectancies and other societal changes.
 

This is the second article of a series dealing with the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Act”). For the first article, see: Part 1 – Charitable IRA Rollovers

The Act retroactively reinstated estate taxes to apply to decedents who died in 2010. However, the Act provided two relief provisions. First, the federal estate tax exemption for 2010 decedents was $5 million. Second, the Act allows executors to elect the carryover basis regime for 2010 decedents if that regime is preferable to the estate tax regime.

We represent several estates that plan to elect the carryover basis regime. The carryover basis regime may result in future income taxes; however income taxes are less than estate taxes. Most estates of $10 million or more will elect the carryover basis regime. This is because the estate tax regime would result in estate taxes, either now or upon the death of the surviving spouse. Estates of unmarried decedents with more than $5 million will generally elect the carryover basis regime.

Estates worth $5 million or less will stay with the estate tax regime. They will not owe any federal estate taxes and all assets owned by the estate will receive a stepped-up basis.

The Executors for married decedents whose estates were between $5 and $10 million will have to analyze the two regimes. When the available basis step-up of $4.3 million is enough to increase the basis of all assets to date of death value, the estate should elect the carryover basis regime. When the basis step-up is not enough to eliminate all pre-death gains, the executor will need to analyze whether future income taxes to be incurred on pre-mortem appreciation will be more than future estate taxes to be incurred upon the death of the surviving spouse.

The analysis of future income taxes and future estate taxes requires a crystal ball. Income taxes might be avoided if the surviving spouse gives appreciated assets to charity or holds them until death. Estate taxes might be avoided if the surviving spouse makes sufficient gifts or if the $5 million federal estate tax exemption is extended until the year of the spouse’s death.

The Act did not specify how or when to make the election to be subject to the carryover basis regime. The Act specified that the Form 706 for decedents subject to the estate tax regime does not need to be filed until September 17, 2011. I expect guidance from the IRS clarifying that the carryover basis election can also be made as late as September 17, 2011.

On December 17, 2010, the President signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Act”). In addition to extending the so-called “Bush” income tax cuts for two years, the Act made several significant changes to estate, gift and generation-skipping transfer taxes. This article is the first of a series summarizing various provisions of the Act.

The Act extended for 2010 and 2011 the ability of taxpayers who are at least 70½ years of age to transfer $100,000 per year from their IRA to charity. If you missed this opportunity in 2010 and may want to give more than $100,000 during 2011, you can do so if you act by January 31, 2011. There is a special provision that allows you to use the amount you didn’t use in 2010 during January 31 of 2011. Assume, for example, that you made a Charitable IRA Rollover of $20,000 on December 28, 2010. You can give as much as $180,000 in 2011. However, at least $80,000 of the 2011 Rollover must occur on or before January 31, 2011. You would then be able to give the other $100,000 any time during the year.

If the most that you would give in 2011 is $100,000, then you do not need to worry about the January 31 deadline. If you might give more than $100,000 this year, then you should roll over part of the gift before the end of January. For example, if you might give $150,000 this year, you should give at least $50,000 by January 31.

Before making a Charitable IRA Rollover, you should investigate making a Synthetic Charitable IRA Gift. The Synthetic Gift technique also helps those who do not qualify for a Charitable IRA Rollover or do not like some of the restrictions imposed with respect to Charitable IRA Rollovers.

Late last night, the House of Representatives approved the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The Senate has already approved the Act and the President is expected to sign the Bill into law.

The Bill is almost all good news for taxpayers. The only bad news is that the tax reductions will only last through the end of 2012.

After 9½ years of waiting for changes to the estate and gift tax laws, we start a new two year waiting period. I wonder if there will ever again be a Bill which “permanently” reduces taxes without a sunset after some period of years.

There are several year-end planning opportunities that you can now take advantage of without worrying about whether this Bill will be enacted. Hats off to Congress for giving us two full weeks to plan during the holiday season.

If you have been waiting on selling depreciated stocks to harvest losses in 2010, you might as well pull the trigger because the losses will not be more valuable in 2011 than they are in 2010. Your broker will thank you for acting before Christmas rather than after Christmas.
 

On December 15, 2010, the Senate passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 by a vote of 81-19. The Bill’s fate now rests in the hands of the House of Representatives. If the Bill is enacted as drafted, there are a few transactions that will be treated more favorably if they are completed during 2010.

1. Gifts to grandchildren are treated more favorably in 2010 because you do not have to allocate Generation Skipping Transfer Tax exemption to the gift. However, if you are making a taxable gift and you have already used your $1 million federal gift tax exemption, you should wait until next year when the gift tax exemption increases to $5 million.

2. Transfers to grandchildren from non-exempt trusts are not subject to GST tax in 2010. In general, this is advisable when the trust will be subject to GST tax upon the child’s death and the child has other resources.

3. Gifts to children should be postponed until next year in order to benefit from the increased gift tax exemption (from $1 million to $5 million).

4. Due to income tax rates staying the same in 2011 and 2012, you should evaluate making a Roth IRA conversion in December of 2010 as compared to January of 2011. If you make the conversion this year, you will be able to pay the income taxes from the conversion as follows: 62.5% on April 15, 2012, 12.5% on June 15, 2012, 12.5% on September 15, 2012, and 12.5% on January 15, 2013. You will have the ability to recharacterize the conversion until October 15, 2011. Alternatively, if you make the conversion in January, 2011, you must pay 100% of the tax on April 15, 2012. However, you will have the ability to recharacterize the Roth IRA to a regular IRA until October 15, 2012. As a general rule, the ability to recharacterize the conversion for the longer time period is more valuable than the ability to postpone 37.5% of the tax for a few extra months. Therefore, I am advising my clients to wait until January unless they expect material appreciation of their IRA between now and January.

5. Those of you who are at least 70½ years of age will be able to distribute up to $100,000 of the required minimum distribution from your IRA to charity. You should compare this option with the Synthetic Charitable IRA Gift technique which can be used even if the Bill does not pass or if you are younger than 70½.

The recommendations herein are dependent upon the Bill getting passed substantially in the form approved by the Senate. If the Bill does not get passed in its current form, these planning recommendations will need to be revisited. Stay tuned, and try to keep your options open for last minute planning.