by Joseph K. Hollak - Financial Consultant - Salomon Smith Barney

No doubt, the Economic Growth and Tax Relief Reconciliation Act of 2001 has you wondering about its impact on your estate plan. But, before you make any changes to your current plan, or establish a new one, explore the details of the legislation, and then consider some of its potential opportunities. 

The New Estate Tax Law in Brief

The Act raises the estate tax exemption to $1 million for 2002 and 2003, $1.5 million for 2004 and 2005, $2 million for 2006, 2007 and 2008 and $3.5 million for 2009. Please note that in 2010 there is a total repeal of the estate tax, for that year only. Under the existing provisions of the Act, the estate tax laws go back to 2001 rules unless extended. The exemption returns to $1 million in 2011 under the current law. That being said, what options should you consider? 

Gifting Away Assets During Your Lifetime

If you wish to set aside assets for lifetime gifting, be aware that under the new tax law, a gift tax remains. Starting in 2002, as the estate and generation-skipping transfer (GST) taxes are gradually phased out, the top estate, gift and GST tax rates are reduced from 50% to 45%.  In 2010, the top gift tax rate will equal the top individual income tax rate (estimated to be 35%). Any used gift tax exemptions reduce your estate tax exemption by that amount. Consequently, if you want to engage in lifetime gifting above the annual gift tax exclusion amounts ($10,000 per year per person) and the lifetime gift tax exclusion amount ($1 million)*, you will need to use some creative options that may allow you to increase the size of your gifts while minimizing any gift tax. Here are some examples:

The Grantor Retained Annuity Trust (GRAT)

A GRAT allows you to pass along assets you believe will appreciate in value to family members at discounted levels. You contribute assets to the trust and receive a fixed annuity stream for a specified period of years. At the end of the trust term, the assets and their appreciation are distributed to your beneficiaries. Since the initial value of the gift is reduced by the present value of the annuity payments, you could structure a payment schedule and amount that could result in a “zero” gift tax value. If you die before the end of the specified term, the trust property would be included in your estate and subject to estate taxes.  Of course, if the estate tax were not reinstated, this would not be a problem.

The Charitable Remainder Trust (CRT)

The CRT could allow you to leverage your gift tax exemption. What’s more, if properly established, a CRT could help you diversify your highly appreciated assets while avoiding or postponing any capital gains tax on the sale of those assets, increase your annual income, reduce potential estate tax liabilities and contribute to your favorite charity.

To establish a CRT, you transfer assets into the trust, name a person or persons (including yourself) as beneficiary for a specified term and a charity or charities as remainder beneficiary. Once the assets are in the trust, the trustee may sell the appreciated assets and reinvest the proceeds in a blended portfolio for both income and growth. No immediate capital gains are due upon the sale. In addition to receiving a lifetime payment stream from the trust assets, you may also receive a charitable income tax deduction. You could also use a wealth-replacement option, gifting a portion of the trust payment to another “family” trust. If structured properly, this trust may invest these gifts or use them to purchase an insurance policy and have the proceeds go to the family, estate tax-free.

Wealth Transfer Options

You could use life insurance to help reduce your estate and gift tax liabilities. Life insurance is a leveraging and discounting option that often provides a substantial benefit for relatively small premium dollars.  It may be used by itself to maximize the size of your estate for transfer tax purposes, creating an “instant” estate. Or, it may be used for liquidity and paying estate taxes cost-effectively (based on the inherent discounting). And, the proceeds of life insurance are typically income tax-free to the beneficiary. With careful planning, these proceeds may also be estate tax-free.

If You’re a Business Owner

A Limited Liability Company (LLC) or Family Limited Partnership (FLP) might be a useful leveraging technique. An LLC or FLP may help protect your family wealth, provide a tool for reducing the size of your estate for transfer-tax purposes and let you retain control and management of your assets. The LLC or FLP is made up of managing or voting interests and nonvoting interests. You, as business owner, could retain the voting and managing interests (thereby keeping control and management of the assets) and gift the nonvoting interests to your children and grandchildren. Since the non-voting interest gifts to your children and grandchildren lack voting rights and are not readily marketable, they will be discounted for gift tax purposes.

The Dynasty Trust

The Dynasty Trust could allow you to maximize the use of your GST tax exemption. Here’s how it works: Generally, you would fund the trust, with an amount up to yours and your spouses GST tax exemptions (if funded during your lifetime you may be responsible for a gift tax).  The amount that grows over time will remain free from federal transfer tax—assuming the contributed amount remains in the trust.  In certain states, such as South Dakota, which have eliminated the common law rule against perpetuities, the trust may theoretically last forever. 

Income or principal from the trust may be distributed to your children, grandchildren and great grandchildren as specified in the trust document. The provisions could tie those distributions to incentives, such as maintaining gainful employment, and permit distributions for funding businesses or purchasing homes for the use of beneficiaries or other activities. There may also be provisions in the trust document to gift a percentage of the assets directly to a charity or family foundation. Assets remaining in the trust are protected from creditors and divorce judgments.

Discuss your estate planning objectives and concerns with your Financial Consultant and your tax and legal advisors. Together you can develop an estate plan that addresses your unique financial situation so that you can effectively transfer wealth to your beneficiaries before, during and after possible estate tax repeal.
 

*The lifetime gift tax exclusion will remain at $1 million.

Joseph K. Hollak - Financial Consultant
Salomon Smith Barney
121 SW Morrison Street
16th Floor 
Portland, OR 97204
503-221-6680

Source (data tables and report text): The Economic Growth and Tax Relief Act of 2001, prepared by the Joint Committee on Taxation, U.S. House of Representatives.