There is no area of the Internal Revenue Code that yo-yo’s up and down like the rules pertaining to the estate tax and its companion, gift taxes. What is particularly frustrating is that estate planning can be extremely complex and requires a long-term horizon.
One of the misimpressions the general public has about the applicability of the estate tax is that it affects only affluent Americans. But the path to affluence for some wealthy Americans includes starting a company. Businesses are often closely held corporations, and typically, a significant component of a person’s estate is the value of his stock.
Unless a person takes the time and expense to formulate a plan, his death could trigger a forced sale of the business. Many times, a competitor purchases the business to eliminate competition, which can result in employees being laid off.
Against this backdrop, the American Taxpayers Relief Act passed early in 2013 set an exemption at $5 million per person (indexed for inflation), which included the gift tax and tax on estates above that amount set at 35%. It was referred to as making the exemption “permanent.”
This should have settled the estate tax for the foreseeable future, and lawyers, accountants and insurance agents could craft an estate plan that would be reliable, unless the client’s circumstances changed.
But this notion was upset by President Obama’s proposed 2014 budget, which, in 2018, calls for lowering the exclusion to $3.5 million for estate and generation-skipping taxes and dramatically lowering the gift tax exclusion to $1 million. In addition, the amount would not be indexed for inflation. The proposed budget would also increase the tax rate from 40% to 45%.
These proposed changes are dismal news for estate planners, but what has not received as much attention is the President’s proposed changes to two popular estate planning provisions:
The President’s proposed budget limits or eliminates the use of the so-called “minority discount” in valuing minority ownership of closely-held businesses. This is a popular technique to gift a substantial portion of a business to family members for valuation purposes. Estate planners will be watching carefully to see if the forthcoming budget regulations address this avenue.
Another common estate planning technique involves granter-retained annuity trusts, which allow business owners to give away a portion of the business’s future profits to their heirs on a tax-free basis. Using this technique, the grantor transfers specific assets into the name of the GRAT and retains the right to receive an annual annuity payment for a certain number of years.
When the term of the GRAT ends, the remaining amount of it is distributed to the trust beneficiaries, such as children or the grantor's other beneficiaries. The amount of the annuity payment that is required to be paid to the grantor during the term of the GRAT is calculated by using an interest rate that is determined monthly by the IRS.
Currently, the rate is only 1.4%. The proposed budget would also require GRATs to be for a term not less than 10 years. The current minimum can be as short as two years.
Independent agents should monitor the outcome of the proposal to assess the effect estate planning objectives for them and their clients. No doubt, this will not be the last change.
Dave Evans is a certified financial planner and an IA l-h contributing editor.