2012 Estate Planning. Martin Inc. Shenkman
opportunities. But many taxpayers, and even many estate planners, remain obsessively focused on discounts, distracting them from more valuable planning benefits, such as the tax burn that can be achieved with grantor trust status (that is, that the trust will grow free of income tax because its income will be taxed to you, as the grantor). The obsession with large discounts can prove to be a mistake for some, especially in light of the heightened audit risk that comes with claiming aggressive discounts. This issue will be addressed in later chapters.
Grantor Trust Modifications
Grantor trusts, in very simple terms, are trusts that include certain provisions (or are administered in certain ways) to allow the income to be taxed to the grantor (typically, but not always, the person who established and funded the trust). Because of the disconnect between the gift/estate tax rules and the income tax rules, it is possible to walk the tightrope between the two tax worlds such that the grantor pays tax on the income and gains earned by a trust that is excluded from his or her estate. One advantage of grantor trust status is known as tax burn in that your estate is “burned,” or reduced, by the ongoing income tax liability caused by the attribution of the trust’s income to you as the grantor, and not to the trust or its beneficiaries, Moreover, your payment of income tax on income and gains retained inside an irrevocable trust is not deemed to be an additional gift by you to the trust. Thus, grantor trust status can shift the value of the income tax savings over many years to the irrevocable trust and provide in aggregate a significant wealth shift. President Obama’s 2012 Greenbook has proposed eliminating this benefit by ending the dichotomy between income and gift taxation of grantor trusts. It proposes to do this by making transfers to all grantor trusts incomplete gifts for gift and estate tax purposes. This would mean that all of the growth of the assets inside the trust free of income tax, as well as the trust’s underlying assets, would be includible in your estate and subject to estate tax at your death.
In spite of the incredible benefits grantor trust status affords under current law, many estate planners are using irrevocable non-grantor trusts as the receptacles for 2012 gifts. Other estate planners continue to emphasize aggressive audit-attracting valuation discounts while ignoring the benefits of tax burn. Even if you are reluctant to make any meaningful gifts in 2012, you might consider the “Standby BDIT” technique. The use and application of grantor trust status in these as well as other ways is discussed in Chapter 5.
PLANNING NOTE: In some cases, use of grantor trust status can increase income tax. First, you as the grantor might be in a higher federal income tax bracket than the trust or its beneficiaries. Second, you might be subject to a state (and perhaps local) income tax that the trust, if not a grantor trust, would not. It is appropriate to consider these factors in determining if the benefits of grantor trust status is greater than the detriments.
GST TAX CONSIDERATIONS FOR 2012
The generation-skipping transfer (GST) tax is one of the most complex of all tax laws. But in 2012 it may be one of the most important tax rules to use effectively for long-term family wealth accumulation. If you view your planning as simple 2012 gifts, you may be overlooking the incredible power that proper GST planning can provide. In short, the goal for many should be to allocate your GST exemption amount to leveraged lifetime gifts, made to long-term, multi-generational trusts such that these dynastic trusts are entirely exempt from the GST tax (as well as future gift and estate taxes) for as long as feasible. These concepts can be illustrated with the following example.
EXAMPLE: You plan to establish a “complex trust” (a trust that pays its own income tax, other than to the extent that distributions pass income to the beneficiaries). The trust is to be established in your home state for your child and grandchild. You intend to gift $2 million in cash to the trust. The trust ends when your grandchild reaches age 35 and the remaining trust assets are distributed outright to your grandchild.
This type of trust will use gift and GST exemption so it is clearly an approach that takes some advantage of the 2012 planning opportunities. However, this plan is far from optimal in terms of tax, asset protection, control, and other planning objectives. There is no leverage and only limited benefit from the allocation of GST exemption in this plan.
After consultation with your adviser, you instead consider a transfer of $2 million of discounted FLP interests to a grantor trust formed in Alaska. The trust is structured as a grantor trust to achieve the tax “burn” of reducing your estate as you pay income tax on the trust income. The trust is structured to benefit your child, grandchild, and all future descendants. The trust, unless exhausted through distributions, will thus last indefinitely. This will squeeze the maximum benefit out of the GST exemption allocated to the trust. This latter trust will thereby assure that the trust corpus (principal) can remain outside the transfer tax system forever (other than distributions that are not spent). This latter trust takes maximum advantage of leveraging gifts and GST exemption into a true multi-generational trust.
PLANNING NOTE: The key advantage of the more sophisticated multi-generational trust is that it provides far greater flexibility. If the child and grandchild need to spend trust money before the grandchild attains age 35, the more sophisticated trust might function the same as the simple one. But if circumstances are such that other assets can be used first, instead of trust assets, the sophisticated trust provides the flexibility to maximize tax, asset protection control, and other benefits of those assets. The real issue for you to weigh is whether the incremental cost of forming, funding, and maintaining the sophisticated multi-generational trust is worthwhile. What makes 2012 so unique in this decision process is that you are likely committing much more wealth to gift planning in 2012 than in prior years.
For a $200,000 gift, you would likely be unwilling to entertain the cost and complexity of the more sophisticated trust plan. However, for a $2 million gift, is it really prudent not to? For large gifts, if you opt for simplicity instead of flexibility and optimum benefit, don’t be surprised if your professional adviser documents your decision for his or her file, or perhaps even sends you a letter, confirming that you were informed of the more flexible and advantageous options and opted not to pursue them. This documentation might avert a claim by your heirs at a later date that appropriate planning was not done.
The change that has been proposed by President Obama for the GST tax is simple: Limit the number of years for which an allocation of GST exemption to trusts will be effective. All these concepts will be explained in the next section. The impact of this small change on multi-generational wealth transfers is nothing less than catastrophic. The response to this in broad and general terms is quite obvious: Structure 2012 gifts in a manner that takes maximum advantage of GST planning opportunities. That requires the relatively simple formula recommended earlier–leverage as much wealth as possible into GST-exempt trusts that last as long as possible and which have the least leakage. You should be cautious about the incremental risk that discounts might inject into a particular plan and consider steps like a “defined value clause” (limits the gift to the amount in terms of dollars that you intend to transfer) that might minimize some of that risk (see Chapter 5). But since maximizing GST planning is so incredibly important, and since too many consumers, and even some professional estate planners, fail to focus on this planning, the next sections provide an overview and background on the GST tax and help set the stage for the planning techniques and recommendations in later chapters.
The importance of GST planning, in addition