Federal Death Tax Repeal – Not So Fast

Much has been written and speculated about the fate of the Federal Gift, Estate and Generation Skipping Taxes under the current efforts of the Administration and of Republican Congressional leaders to overhaul Federal tax laws.  The common view has been that the days are numbered for these wealth transfer taxes, commonly referred to as the “Death Tax”.  However, it seems that this may not be the case.

The tax proposals of the Ways and Means Committee of the House of Representatives include provisions that would double the exemptions for each of the Federal Gift, Estate and Generation Skipping Taxes to $10,000,000 (indexed for inflation) for those who die after 2017; and, would repeal the Estate and Generation Skipping Taxes for those who die after 2023.  In addition to keeping the Federal Estate and Generation Skipping Taxes for six more years, the House proposal keeps the Federal Gift Tax indefinitely, with a lowered tax rate of 35% (as compared to the current 40%).

Note, however that, although the plan issued by the Senate Finance Committee with regard to the Federal Gift, Estate and Generation Skipping Taxes is similar, there is the significant difference that it provides for no repeal of the Estate and Gift Taxes…after 2023 or otherwise.

Tax legislation, as is the case for all Federal legislation, needs to pass both the House of Representatives and the Senate, and then be signed by the President.  Although Republicans represent a majority of both chambers, the margin in the Senate is particularly thin.  It is becoming increasingly apparent that a full repeal of the “Death Tax” may not make it through the Senate.  Of course, an increase in the exemptions to $10,000,000 (indexed for inflation) will make such Federal taxes of concern to only the most wealthy; yet, maybe surprisingly, a continuing concern.

Stay tuned…

For more information or if you have any questions about the New Jersey estate tax, please contact Judson M. Stein, Chair of the Trusts & Estates Practice Group, at 973-230-2080 or jstein@genovaburns.com or Lauren M. Ahern, Associate in the Trusts & Estates Practice Group.

IRS Recognizes Retroactive Validity of GRAT Based Upon Court Reformation

The IRS recently examined whether a Grantor Retained Annuity Trust (hereinafter “GRAT”) could be held valid despite the fact that it omitted certain key language.  In a GRAT, the Grantor transfers property into the irrevocable trust in exchange for the right to receive an annuity for a fixed period of years (“the retained interest”) based upon the IRS monthly interest rate commonly known as the Section 7520 rate. The retained interest must constitute a “qualifying interest” under the Code. When the term of the GRAT ends, the balance of trust assets are distributed to the trust remainder beneficiaries.

The value of the taxable gift, if any, is determined by reducing the fair market value of the assets transferred to the GRAT by the amount of the retained interest (i.e., the annuity). The larger the retained interest, the smaller the taxable gift.  It is noteworthy that GRATs can now be “zeroed-out” which has unlimited upside as there is no gift tax due whatsoever.  In a “zeroed-out” GRAT, the grantor takes back an annuity which soaks up all of value of the property transferred.  The grantor generally must outlive the term of the GRAT for it to be effective.  If the grantor dies before the end of the term, the portion of trust balance needed to generate the annuity payments comes back into the grantor’s estate.

The goal is for the GRAT to outperform the Section 7520 rate.  Providing the GRAT outperforms the Section 7520 rate, any excess growth flows to the remainder beneficiaries’ tax free.  Consequently, this is a great technique to remove portions of the grantor’s taxable estate in a potentially tax free manner. GRATs work best with highly appreciating assets such as securities or closely held business interests.

In this matter, the draftsman failed to include language prohibiting the trustee from issuing a note, other debt instrument, option or other similar financial arrangement in satisfaction of the annuity obligation as required by § 25.2702-3(d)(6) of the Gift Tax Regulations.  In other words, the governing language failed to make the retained interest a “qualified interest” under IRC § 2702(b)(1). After the state court issued an order reforming the trusts to include the language as required by the tax regulations, the grantor sought confirmation that their interest in each trust was a qualified one for federal gift tax purposes.

On balance, the IRS concluded that the trust instruments could be amended so as to qualify them as valid GRATs.  The IRS found that the trust agreements themselves were established with the overarching intent that the retained interest be a qualified one so as to satisfy the tax criterion.  Moreover, and pursuant to the judicial reformation of trusts to correct scrivener’s error, amendment is permitted where it was necessary to achieve the settlor’s tax objectives.  Accordingly, the IRS held that the grantor’s retained interest was a qualified one thereby validating each GRAT under the tax law, effective as of the date each was created.

For more information or if you have any questions about estate planning and taxation, please contact Judson M. Stein, Chair of the Trusts & Estates Practice Group, at 973-230-2080 or jstein@genovaburns.com or John A. Grey and Lauren M. Ahern, Associates in the Trusts & Estates Practice Group.