Estate Planning Developments


It is unlikely that there will be any new significant federal tax legislation (including any estate and gift tax legislation) enacted prior to 2017. The President has proposed tax legislation that will affect families’ estate planning, such as: to limit the use of annual withdrawal rights (also known as “Crummey” powers); to limit the use of GRATs and grantor trusts (also known as “defective income trusts”); to increase the estate and gift tax rates (to a top 45% rate); to reduce the estate and gift tax exclusion amount (proposed to be $3,500,000 for estate taxes and $1,000,000 for gift taxes); and to deny a step-up in income tax basis of assets at death. However, the Republican-controlled Congress and the Democrat-controlled Presidency has produced a political stalemate where there will not be any comprehensive tax legislation in 2016. It will only be after the November 2016 Presidential election and the inauguration of a new President in 2017, that there will be the possibility of significant tax legislation.

Below is a summary of developments in 2015 in estate, gift, generation-skipping taxes, and in other areas of estate planning.

1. The Estate and Gift Tax Exclusion Increases in 2016. The estate and gift tax exclusion amount (sometimes referred to as the “exemption amount”) for gifts made and decedent’s dying in 2016 increases to $5,450,000 (from the prior $5,430,000 amount in 2015). Thus, in 2016 a married couple, together, can gift or leave at death a combined amount of $10,900,000 in value free of estate and gift taxes. This exclusion amount will increase in future years based upon inflation adjustments. This higher exclusion amount allows you to make significant tax-free gifts to your children and grandchildren.

a) Plan to Increase your Properties’ Income Tax Basis. One downside to making lifetime gifts is that you could lose the potential step-up in the income tax basis of the gifted assets (which you would otherwise receive at your death or that of your spouse), and you lose control over the gifted assets. To mitigate these downside issues, you can place assets into partnerships and limited liability companies which you indirectly control. To have your assets’ income tax basis increase at your death, you can utilize a grantor trust (also known as “defective income trust”) which allows you to exchange the grantor trust’s low-income tax basis assets, for your other assets which have a high income tax basis (and your received low-income tax basis assets then receive a step-up in income tax basis at your death).

2. The Generation-Skipping Tax Exemption Increases in 2016. The generation-skipping tax exemption amount increases to $5,450,000 in 2016 (or a $10,900,000 combined amount for a married couple). Thus, you and your spouse can structure your estate plan to gift or leave at death up to $10,900,000 of assets to your grandchildren free of the generation-skipping tax for 2016.

3. Annual Gift Tax Exclusion Remains the Same Amount in 2016. The annual gift tax exclusion by a donor remains at $14,000 per donee (or $28,000 per donee each year for a married couple’s combined gift to a donee) for the 2016 calendar year. Additionally, unlimited amounts may be paid for a child’s or grandchild’s qualified medical expenses and tuition payments.

As an example, if a married couple has four (4) children and twelve (12) grandchildren (for a total of 16 potential donees), they can gift each year $448,000 to such family members free of any gift tax (this is in addition to the $10,900,000 2016 combined exclusion amount for a married couple).

4. Federal Estate and Gift Tax Rates Remain the Same in 2016. The maximum federal estate and gift tax rate in 2016 remains at 40% for the top bracket.

5. Status of Valuation Discounts. Valuation discounts among family members (such as discounts for lack of marketability and for minority interests) have been a key planning tool to reduce the value of your gifted assets and the value of assets transferred at death, thus enabling you to transfer significant amounts to your children and other family members at reduced or no gift and estate tax cost. Depending on the facts and circumstances, valuation discounts between 30% to 55% have been allowed by the courts. These valuation discounts in turn, have allowed tax-free transfers to your children and grandchildren of your businesses, real estate and liquid securities at little or no estate or gift tax costs.

In a new effort to limit valuation discounts the Treasury Department has proposed amending the Treasury Regulations under Section 2704(b) to ignore for valuation purposes certain restrictions among family members (which restrictions in turn generate these valuation discounts).

If these Regulations are promulgated by the Treasury Department it will produce a major change in the way valuation discounts are applied, potentially restricting you from utilizing valuation discounts (such as for lack of control or for lack of marketability) to reduce your estate and gift taxes.

Until the Treasury Department promulgates these proposed Regulations, valuation discounts remain an important tax planning tool to reduce your potential gift, estate, and generation-skipping taxes.

6. Use of Grantor Trusts Remains an Effective Tax Planning Tool to Transfer Large Amounts of Your Wealth Tax-Free to Your Family. A grantor trust allows you to transfer a large amount of your assets to your children and grandchildren free of estate and gift taxes, through gifting and selling those assets to a grantor trust (sometimes referred to as a “defective income trust”).

a) How a Grantor Trust Works. Commonly you, as a parent, sell to a grantor trust your business assets, corporate stock, limited partnership interests and LLC membership interests in exchange for an installment promissory note payable to yourself. In addition to selling assets to the trust, you can gift a portion of the assets to the grantor trust. In doing this sale and gift to a grantor trust, the stock, limited partnership interests and LLC membership interests are often discounted for lack of control and lack of marketability. The result of the sale and gift is that property can be transferred tax-free to the grantor trust plus there is a shift of future asset appreciation to the grantor trust beneficiaries (who are normally your children and grandchildren). Sales to a grantor trust are income tax-free since all of the grantor trust’s income is taxed to you, the parent and grantor, for federal income tax purposes. However, this grantor trust is irrevocable for federal gift and estate tax purposes, so that the trust assets are excluded from your federal taxable estate when you die. With the current low federal interest rates (the long-term AFR interest rate for December 2015 is 2.58%) required on promissory notes, the grantor trust is an effective planning technique to transfer large amounts of your wealth tax-free to your family members.

b) Income Tax Basis of Assets and Grantor Trusts. A tax issue with a grantor trust is that when you die, will that grantor trust’s assets receive an increase in their income tax basis to those assets’ date-of-death fair market value under Section 1014, even though those trust assets are not included in your estate for federal estate tax purposes? Such an income tax basis increase could effectively eliminate the income tax on the grantor trust’s assets’ appreciation. The IRS recently informally announced that the IRS intends to issue guidance on income basis adjustments of grantor trust assets.1 Even with this income tax basis question unresolved, grantor trusts still allow you to transfer large amounts of your wealth tax-free to your children and grandchildren.

7. Tax Court Refuses to Increase a Property’s Value by Combining that Property with Other Property Owned by the Children. In the Tax Court case of Estate of John A. Pulling, Sr.,2 the Tax Court refused to “assemble” the property of the deceased parent with the children’s property for valuation purposes. In the Pulling case the children and parent owned adjacent properties and the IRS asserted that the deceased parent’s property should be assembled with the children’s property for valuation purposes in order to produce a higher value. The Tax Court, however, rejected this IRS position and refused to assemble the deceased parent’s property with the property of the children for valuation purposes. Thus, the Tax Court once again refused to apply an ownership attribution rule to parents and children. This Court’s refusal to apply family attribution rule to valuing property will assist you in lowering the estate and gift tax value of your property.

8. Where Stock is Transferred Among Family Members to Settle a Bona Fide Dispute, there is No Taxable Gift on the Transfer of Such Stock. It is common for families owning corporate, partnership and business interests to have disputes between each other. In order to settle those disputes, stock (or partnership or other business interests) may be transferred from parents to children or grandchildren. The Tax Court recently held that the transfer of stock of a family corporation to a trust benefiting the children was not a taxable gift, because such transfer was made in the settlement of a bona fide dispute between the family members. See Estate of Redstone.3 The Redstone case reaffirms the tax principal that settlements of bona fide disputes among family members where stock and partnership interests are transferred to younger generations, will not be treated as a taxable gift.

9. Structuring Your Estate Plan to Provide for Income Tax Basis Increases at Death. Income taxes are a critical planning consideration for you with the higher federal and California income tax rates and the 3.8% Medicare Tax on net investment income over a base amount. The general income tax rule that an asset’s income tax basis is adjusted to its fair market value at your death (and for the entire community property at the death of your spouse or yourself) can produce significant income tax savings. With the increase in the federal estate and gift tax exclusion amount (increased to $5,450,000 in 2016), the Bypass Trust (also known as the “Decedent’s Trust”) can be funded with large amounts of assets. If those Bypass Trust assets increase in value between the date of the first-to-die spouse’s death and the date of the surviving spouse’s death, then those trust assets will be denied an increase in your income tax basis when the surviving spouse dies. You need to think about building flexibility whereby some or all of the Bypass Trust’s assets are brought back into the second-to-die spouse’s estate in order to receive an increase in income tax basis (for those assets’ appreciation in value after the death of the first-to-die spouse).

10. A New Statutory Provision Prevents Your Heirs from Claiming a Higher Income Tax Basis for Inherited Assets than was Claimed on the Federal Estate Tax Return at Your Death. A new statutory provision contained at Section 1014(f) requires that an asset’s income tax basis be made consistent with the federal estate tax return value of that asset. Thus, for inherited property that property’s income tax basis cannot exceed the estate tax value of that property as finally determined for federal estate tax purposes. This tax basis consistency requirement only applies to property which inclusion in the decedent’s estate increased the estate’s liability for federal estate taxes. If the alternate valuation date is selected on the estate tax return for the decedent’s estate then the property’s income tax basis will be the fair market value as of the alternate valuation date.

Under this new statutory requirement, when an estate is required to file an estate tax return executors must furnish to the IRS and to each person acquiring an interest in the estate’s property an information statement identifying the value of each interest in such property as reported on the federal estate tax return along with other information.4

11. U.S. Supreme Court Holds that States Cannot Ban Same-Sex Marriages. The U.S. Supreme Court in June 2015 held that state bans on same-sex marriages are unconstitutional.5 Thus, same-sex couples can now legally marry in all states. The tax results of this Supreme Court decision is that same-sex married couples can utilize the unlimited federal estate tax marital deduction, make tax-free gifts to their spouses, and file joint income tax returns as married couples.

© 2015, Law Offices of Robert A. Briskin, a Prof. Corp. All rights reserved.

Nothing in this Newsletter shall be deemed legal or tax advice as to any person or transaction. Please feel free to contact Robert A. Briskin if you have any questions as to items in this Newsletter.

1 The IRS in Rev. Proc. 2015-37 stated that the IRS would not issue private letter rulings as to whether a grantor trust’s assets’ tax basis receive an adjustment to fair market value at the parent’s death.

2 See T.C. Memo 2015-34.

3 See 145 T.C. No. 11 (decided October 26, 2015).

4 The IRS has issued Notice 2015-57 delaying the due date for such information statements. The IRS is expected to issue forms in January 2016.

5 See Obergefell v. Hodges 115 AFTR2d 2015-2309 (decided June 26, 2015).