2012 Estate Planning. Martin Inc. Shenkman

      THROW MOMMA FROM THE TRAIN BEFORE NEW YEAR’S

      If the $5.12 million exemption really declines to $1 million, the more macabre impact of the possible change in the tax laws might entice would-be heirs of aging wealthy benefactors to take them on extreme adventure vacations such as mountain climbing, skydiving, or parasailing between Christmas and New Year’s. Okay, that is probably too cynical, but if Momma has under a $5.12 million estate, there will be no federal estate tax in 2012 (although beware of state death taxes). If the exemption drops to $1 million in 2013 and the rate increases to 55 percent, as the law presently provides, pushing Momma from the train in 2012 instead of 2013 could lead to some multi-million dollar savings. Then again, there’s probably not much you’ll be able to spend that inheritance on while you’re living in the Spartan government quarters you are likely to be residing in. The point is that the differing impact of current 2012 law, and what is scheduled to take effect in 2013 is dramatic.

      ESTATE TAX PROPOSALS MAY CHANGE THE PLANNING LANDSCAPE

      A host of proposed law changes are floating around Washington. Given the current political climate, it would be impossible to guesstimate the likelihood of any particular proposal being enacted. Thus, the real benefit of reviewing the proposals is to assess what tax benefits might be lost. This will help determine what planning steps to take in the remaining months of 2012. If you’re waiting for certainty before planning, you will likely miss the boat. Some of these proposed changes are discussed next.

      Grantor Retained Annuity Trusts (GRATs)

      GRATs in simple terms are irrevocable trusts to which you as the donor (the one making a gift to the trust) and grantor (this has important income tax implications discussed later) makes a gratuitous transfer of appreciating or high yielding assets. In exchange for this gift, you will be paid an annuity amount each year for a fixed number of years (the GRAT term). The annuity amount is typically based on a percentage of the initial value of the assets you gifted to the GRAT. The amount is typically set at a level that for gift tax purposes reduces the value of the remainder interest (what is left when your annuity ends) in the GRAT to zero or near zero. The result is that any appreciation of the assets inside the GRAT that exceed the mandated federal interest rate used in the calculation will go to the remainder beneficiaries, typically your children, or a trust for their benefit, with no transfer tax cost. Basically, these so-called “zeroed-out” GRATs are a win-win for the taxpayer since, if the GRAT property appreciates at a rate in excess of the IRS hurdle rate, you will have achieved a tax-free transfer of wealth to your children and, if the property fails to achieve that level of appreciation, you are no worse off than had you never created the GRAT in the first place (i.e., because you made no or a minimal taxable gift when creating the GRAT). Over time, the GRAT technique was engineered into a series of rolling or cascading short-term (e.g., two-year) trusts that could capture upside market volatility with no meaningful tax downside. Realizing that a properly designed GRAT is a “win-win” for taxpayers, restrictions have been proposed to limit the usefulness of GRATs. These proposed restrictions include:

      •GRATs must have a minimum 10-year term.

      •The annuity payment may not be reduced from one year to the next during the first 10 years of the GRAT term.

      •The GRAT remainder interest at the time of the transfer must have a value greater than zero.

      In 2012, GRATs remain alive and well, and interest rates that determine the size of the annuity that must be paid to the grantor to “zero out” the GRAT (and hence the amount of leakage back into your estate) are at historic lows. As a result, many tax experts are hawking 2012 as the last great GRAT opportunity. While that may be true, as discussed in Chapter 5 and later chapters, for many taxpayers 2012 GRATs may not be the optimal strategy. Like every great tool, GRATs need to be used in the right circumstances only.

      Valuation Discounts

      Remember your first grade math? 1+1 equals 2. Well with valuation discounts, taxpayers have long been able to prove that the sum of the parts is less than the value of the whole, at least for gift and estate tax purposes. When a taxpayer gifts 30 percent of an interest in a limited liability company (LLC) owning a $1 million rental property, the value of that LLC interest is not $300,000 (30% x $1 million), but something less to reflect that a 30 percent minority owner generally cannot influence important business decisions, including cash distributions, and so on. While there is clearly merit to this concept when unrelated parties do business together, the economic reality becomes less certain when mommy, daddy, and a trust for Junior are the partners. As a result of the perceived abuses associated with intra-family transfers of hard-to-value assets, and the costs to the court system of litigating discounts, many proposals have been floated to restrict or eliminate certain valuation discounts. There is a good chance that discounts as they presently exist will have a short half-life.

      The use of entities like family limited partnerships (FLPs) as a wealth-shifting tool may be curtailed. For example, the tax laws provide that, for valuation purposes, certain contractual restrictions (e.g., in a partnership agreement) that are more restrictive than applicable state law should be ignored when determining values. Certain states (e.g., Nevada) have laws that incorporate significant transfer restrictions, thus undermining the effectiveness of this federal provision. New legislation might mandate that even certain state law restrictions be ignored when valuing family business interests for federal gift and estate tax purposes. This could include certain categories of restrictions, such as the lack of an indefinite term in an agreement, the creation by transfer of a limited assignee interest, or an inability to withdraw capital (called a “lock-in feature”). For example, a lock-in provision might prevent any member of a limited liability company (LLC) from exiting the entity as an equity holder for a specified minimum period of time without some adverse consequence. This would significantly increase the valuation discount for lack of marketability since it would prevent realization of the value of the LLC interests for the lock-in period. Transfers of small FLP interests to non-family members (so that family members cannot unilaterally remove the restrictions used to justify discounts) might also be legislatively addressed. So if you want to take advantage of these favorable valuation discounts, act quickly. Whatever changes may occur in the discount arena, FLPs and LLCs will likely remain important planning tools because of the many non-estate tax benefits they provide, such as asset protection, centralized management, and income shifting.

      For 2012 the “Discount Game” is alive and well. When combined with the generous $5.12 million gift tax exemption (or $10.24 million for a married couple), it creates