LOOKING FORWARD TO 2012
Now in the last quarter of 2011, the investment marketplace continues to be volatile, Congressional leaders are still posturing, another potential debt crisis is ahead of us, “Wall Street” is said to be “occupied,” unemployment continues to be high, and Republican Presidential candidates are debating one another three monthsbefore the first primaries. On the estate and tax planning grid, we are called upon to be vigilant and flexible. It also would not hurt to be prescient.
As we prepare to move into 2012, this report features comments on recent developments affecting estate and tax planning.
Applicable IRS Interest Rates at an Historic Low
The interest rates issued by the Internal Revenue Service for the month of November, 2011 and applicable to intra-family transactions are at an all-time low. The interest rate, for example, on a short-term loan (three years or less) made to a family member is 0.19%. Likewise, the mandatory IRS interest rate used to value gifts to split-interest trusts, such as a retained interest in a Grantor Retained Annuity Trust (GRAT), is currently 1.4%. This is the interest rate to be used when a senior family member creates a trust with a retained interest for a period of years, with the remainder passing to junior family members free of transfer tax. In a climate in which some stocks are paying dividends in excess of the 1.4% “hurdle rate,” the GRAT continues to be a very attractive wealth-transfer technique that has not been curtailed by Federal tax legislation.
This low interest climate encourages not only the creation of GRATs but also the making of intra-family loans and, for those persons with charitable objectives, the creation of charitable lead annuity trusts. Further, if the values of residential real estate holdings are depressed, many practitioners feel that, notwithstanding the low interest rate that would be used to value the Grantor’s retained interest for gift tax purposes, this is an appropriate time to create a Qualified Personal Residence Trust to hold real property that is to remain in the family, thereby removing the property and all future appreciation from the senior family member’s estate.
Same-Sex Marriage in New York has Planning Implications
Under the Marriage Equality Act, which became effective on July 24, 2011, New York became one of the seven jurisdictions to allow marriage between partners of the same sex. This Act impacts the rights of same-sex partners in a variety of contexts, including the automatic right for a surviving partner to inherit a share of a deceased partner’s estate if he or she does not leave a Will, or to elect to take a statutory share in contravention of the provisions of a deceased partner’s Will. Because the Federal estate tax rules do not recognize same-sex marriages, there is no unlimited Marital Deduction allowable at the Federal level for gift or estate tax purposes and no right to gift-split with a spouse on transfers to third parties. Additionally, same-sex couples continue to be treated as separate taxpayers for Federal income tax purposes and cannot file jointly.
The planning implications for same-sex marriage partners now necessitate the consideration of pre-nuptial or post-nuptial agreements, as well as special care in the way in which property is titled and in the use of Wills to coordinate the estate planning objectives of the couple.
Estate and Gift Tax Rules and “Portability”
Currently, the Federal estate and gift tax exemption is $5 Million. Any unused exemption at the death of the first spouse may be transferred to and used by the surviving spouse at his/her death. This “portability” concept allows taxpayers to avoid dividing assets between themselves to enable them to take full advantage of their separate exemptions when the first spouse dies. IRS guidance issued in September makes it clear that the portability election can only be made on a timely filed Federal estate tax return. It is not yet known whether portability will be available after 2012 when the current Federal rules are again scheduled to expire absent further Congressional action.
Connecticut Reduces its Estate and Gift Tax Exemption Retroactively
Connecticut had a unified estate and gift tax exemption equal to $3.5 Million until May, 2011, when Connecticut enacted legislation to reduce its estate and gift tax exemption to $2 Million, retroactive to January 1, 2011. Court challenges to the retroactive application of the legislation have been filed and are pending. Going forward, with the Connecticut exemption of $2 Million being significantly lower than the current Federal exemption of $5 Million, Connecticut residents join those in many other states where taking full advantage of the Federal exemption in the estate plan of a married couple will incur a substantial state tax at the death of the first spouse. This circumstance lends itself to consideration of a two-trust plan involving one trust for the first $2 Million (to absorb the full Connecticut exemption and first $2 Million of the Federal exemption), and a second trust holding up to an additional $3 Million to sop up the remaining Federal exemption and qualify for the Connecticut Marital Deduction. This two-trust structure reduces the taxes on the $5 Million to zero at the death of the first spouse and still protects the property in the second trust from Federal (but not state) tax at the second death.
N.B. New York has an estate tax exemption equal to $1 Million, and the New Jersey exemption is equal to $675,000.
New York Modifies its Decanting Statute
New York has had a statute since 1992 allowing a Trustee of a fully discretionary trust under certain circumstances to modify or “decant” the trust to address changes in tax rules, inadvertent drafting errors or changes in objectives. New York’s rule, which appears at EPTL 10-6.6, has recently been modified by legislation enacted in 2011 to make decanting more available to Trustees without having to commence court proceedings. The old statute required that the Trustee must have “absolute discretion” to invade the principal of the trust in order to exercise the right to “decant,” or transfer into a similar but separate trust. Under the new statute, the Trustee must have a right to invade principal for any reason, but need not have “absolute discretion.” Among other changes, the term of the “new” trust may now exceed the term of the old trust.
Federal Estate Tax Exemption is Indexed
Under the 2010 Tax Act, the $5 Million Federal estate tax exemption was indexed for inflation starting in 2012. Accordingly, the Federal estate and gift tax exemption will increase to $5.12 Million in January. There will be no change in the gift tax annual exclusion ($13,000 per donee).
We encourage clients to review their estate plans periodically and/or whenever a significant life event occurs, such as the birth of a child, death of a spouse, purchase of a new home or change of state of residence. Individuals with substantial amounts of wealth should consider using lifetime gifts to take advantage of the current $5 Million Federal gift tax exemption. We would be pleased to discuss the options and the implications of significant gift-giving.
Please contact us with any questions you might have or if you would like to discuss your estate plan.