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Obama’s 2014 Tax Plan Could Change the Estate Tax — But Probably Not Dramatically

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Posted on May 15, 2013 | Share this post: Like Us on Facebook Join Us on Google Follow Us on Twitter

You may have seen a headline or two recently proclaiming that President Obama aims to expand the estate tax, that he wants to take levels back to 2009, that he made the “permanent” estate tax levels Congress passed in January temporary again, that the “death tax” is getting “more deadly.”

These stories, based on the Obama Administration’s budget proposals for fiscal year 2014, may have been true in the sense that among the almost 50 proposals in the publication (known as the Greenbook) was an estate tax of 45% and an exemption of $3.5 million (2009 levels).  But no one – no doubt including the president – expects any of that to actually happen.

In fact, President Obama has proposed these same limits every year of his presidency, and we’ve seen how much traction they’ve gotten. (Uh, virtually none.) With Republicans in charge of the House, and effectively the Senate with the filibuster, that’s not likely to change.  Even if the sweeping estate tax changes don’t stand a chance, experts believe some of the narrower proposals could find some support.

Two of these would affect rather esoteric estate planning techniques: installment sales to grantor trusts and grantor annuity trusts (or GRATs).

The administration has had its eye on grantor trusts for a while now. In a grantor trust, the creator of the trust (the grantor) transfers property irrevocably into trust for beneficiaries (say, children), but retains certain rights to the property to be considered the owner for income tax purposes.  This allows the grantor to not only gift an asset out of his or her estate to shift any gain or appreciation to the next generation, but by requiring the grantor to pay the income taxes, it shifts even more wealth to the kids.

Unlike a non-grantor irrevocable trust, the trust and the grantor are not considered separate entities, so the grantor also can sell appreciated property to the grantor trust without triggering capital gain or other income taxes.  In such a sale, the grantor sells assets to the trust in exchange for a loan. The assets, now owned by the trust and out of the grantor’s estate, grow in value. The grantor gets the benefit of the loan payment, but any appreciation belongs to the trust and is not added to the grantor’s estate.

It’s these “installment sales” that Obama’s 2014 plan aims to reel in. Although it is not entirely clear how any legislation or regulations would evolve, at least some of these sold assets would be treated as owned by the grantor.  This means the appreciation would no longer escape estate tax – eliminating the main purpose. The future of the idea is unclear, but it’s possible this technique will not last forever, so if it is on your to-do list, it might be wise not to let it linger for much longer.

Another estate tax-related proposal that could be implemented is limiting the terms of GRATs to ten years.  A GRAT (grantor retained annuity trust) is a trust that acts like an annuity or an installment sale.  A grantor transfers property to an irrevocable trust for beneficiaries, but retains the rights to annual payments for a stated term. The IRS has a calculation as to how the gift is valued.  If the grantor dies during the term, the property is included in the grantor’s estate, but if the grantor survives the term, the remaining property passes to the named beneficiaries.  There is no additional gift tax at that transfer, so if the property in the trust has appreciated more than the IRS guessed it would, there is estate tax savings.

Practically speaking, practitioners could set up many short-term GRATs, and for any assets that grew more than expected, there would be estate tax savings.  For assets that didn’t grow as expected, the money all comes back to the grantor through the annuity payments, and there is no loss.  Clients would typically set up multiple two-year GRATs with different investments, and the results were “heads you win,” “tails you don’t lose.”

Obama’s 2014 proposal would require a minimum 10-year term.  A longer period would reduce the ability to “gamble” as effectively with multiple GRATs, because the long-term growth would be required to be spread out.  While the technique could still be effective, the ability to leverage significant amounts out of an estate is reduced.  Again, if you are interested in a GRAT, better to act relatively soon, just in case.

There also has been discussion about some scary income tax proposals in the Greenbook, though there would likely be a big, drawn out fight over tax reform to get them through Congress, and there’s a much bigger constituency to fight back. Among those discussed:

>Inherited IRAs would no longer be able to stretch out payments over the beneficiary’s lifetime; except for those inherited by a surviving spouse, they would have to be paid out in five years.

>Limits would be put on how much you could accumulate in tax-free retirement accounts. (The Wall Street Journal comments)

>New limits on exclusions and deductions.

>A “Buffett Rule” would create a new minimum tax (a “Fair Share Tax”) for adjusted gross incomes of $1 million to $2 million; 30% tax, but a 28% credit for charitable contributions.

For more information, check out: The Greenbook