72 J. Kan. Bar Assn. 2, 30-41 (2003). Puncturing The Paradigm - New Estate Planning and Drafting Considerations After the Economic Growth and Tax Relief Reconciliation act of 2001 (EGTRRA).

• Author: By Richard L. Zinn

Kansas Bar Journals

Volume 72.

72 J. Kan. Bar Assn. 2, 30-41 (2003).

Puncturing The Paradigm - New Estate Planning and Drafting Considerations After the Economic Growth and Tax Relief Reconciliation act of 2001 (EGTRRA)

Kansas Bar Journal72 J. Kan. Bar Assn. 2, 30-41 (2003)Puncturing The Paradigm - New Estate Planning and Drafting Considerations After the Economic Growth and Tax Relief Reconciliation act of 2001 (EGTRRA)By Richard L. ZinnI. Introduction

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)[1] represents the Congressional answer to the Bush administration's promise to reduce income taxes and end the death tax. Although the death tax, in the form of the federal estate tax, was repealed by EGTRRA, full repeal will not occur until 2010. Prior to that time, estate tax rates will be incrementally reduced, and estate tax exemptions be incrementally increased. Because of the so-called "Byrd Amendment,[2]" EGTRRA entirely disappears in 2011 and the law applicable on the date of EGTRRAs enactment returns.[3] Repeal thus has a Brigadoon existence - flourishing in 2010 and disappearing in 2011.

Illustration 1

Estate Tax

Gift Tax

Generation Skipping

Transfer Tax

Exemption

Maximum Rate

Exemption

Maximum Rate

Exemption

Maximum Rate

2002

$1,000,000

50%

$1,000,000

50%

$1,100,000

50%

2003

$1,000,000

49%

$1,000,000

49%

* $1,100,000

49%

2004

$1,500,000

48%

$1,000,000

48%

$1,500,000

48%

2005

$1,500,000

47%

$1,000,000

47%

$1,500,000

47%

2006

$2,000,000

46%

$1,000,000

46%

$2,000,000

46%

2007

$2,000,000

45%

$1,000,000

45%

$2,000,000

45%

2008

$2,000,000

45%

$1,000,000

45%

$2,000,000

45%

2009

$3,500,000

45%

$1,000,000

45%

$3,500,000

45%

2010

Repealed

$1,000,000

35%

Repealed

2011

$1,000,000

55%

$1,000,000

55%

$1,000,000

55%

* 2003 GST exemption may increase by inflation index and, in 2011, the exemption probably will be the non-EGTRRA inflation-indexed exemption for 2011.

The incrementally reduced rates and increasing exemptions, as shown on Illustration 1, combined with the prospect of repeal, create a challenge to estate planners. This challenge is more daunting than that created by most tax legislation, in that planners are confronted with three potential planning periods: 2002 through 2009, the pre-repeal period, with increased exemptions and reduced rates; 2010, the repeal period; and 2011 and beyond, the post-repeal or repeal of repeal period, during which a carry-over basis regime will exist.[4] This Article presents preliminary considerations for planning and drafting during these periods. It does not attempt to provide a detailed explanation of EGTRRA. Several excellent articles are available which provide such an explanation.[5]

2. Planning Guidelines

   The following guidelines, while not inclusive, offer a starting point for approaching the estate planning and drafting challenges presented by EGTRRA:

   A. We cannot ignore EGTRRA. We cannot assume that because EGTRRA is complex, and perhaps bad law, that it will disappear and that our comfortable planning principles and document forms will be suitable after all.

   B. We should continue using most of the effective wealth transfer techniques that were in use prior to EGTRRA.

   C. We must plan and draft for flexibility and change.

   D. We must review all of our tax-driven formula provisions and survivorship presumptions.

   E. We must review all tax-related definitions in estate planning documents.

   F. We must be alert to the new generation-skipping transfer tax automatic exemption allocation rule in any document that may potentially have a generation-skipping transfer ("GST").

   G. We must not prepare a gift tax return unless we have analyzed the gift for GST tax consequences, and determined whether we should elect out of the new automatic GST exemption allocation rules. If we are involved in the gift transaction, but we do not prepare the gift tax return, we should instruct the gift tax return preparer to undertake a similar analysis.

3. We Cannot Ignore EGTRRA

   EGTRRA is law. Even though significant parts of EGTRRA may change before 2010, planning cannot be premised on the inevitability of such change. To the contrary, our planning should recognize that the law, as currently in effect, requires conscious planning and drafting through the 2002, 2009, 2010, and 2011 planning periods. If, following an explanation of the planning alternatives, clients consciously decline to incur the cost and complexity of EGTRRA planning, that choice should be documented in correspondence to the client. Certainly, as estate-planning documents are reviewed in the normal course of reviewing and updating those documents, EGTRRA issues should be addressed.

4. Continue Wealth Transfer Planning

   This Article is not intended to describe wealth-transfer techniques. EGTRRA should not, however, preclude the use of effective wealth-transfer techniques, but should probably accelerate the use of such techniques, particularly for larger estates. For estates that likely will be insulated from estate tax exposure because of increasing exemptions, at least through 2006, the use of wealth transfer techniques must be tempered by the non-tax consequences of their use. For example, an irrevocable life insurance trust for a couple whose combined assets, including the face value of life insurance, total $2million should probably not be used unless there are non-tax benefits to be derived from such trusts. In larger estates, however, wealth transfer techniques, including the following, should be considered: annual exclusion gifts using the current $11,000 annual gift tax exclusion; §2503(e) tuition and medical expense gifts; irrevocable life insurance trusts, particularly flexible life insurance trusts with provisions that would permit access to cash values; Grantor Retained Annuity Trusts, particularly the so-called "zeroed out GRAT" following the Walton case;[6] sales to Intentionally Defective Grantor Trusts;[7] creation and fragmentation of family limited partnerships and limited liability companies;[8] and gifts using the full $1,000,000 exemption equivalent, as discussed more fully in Section XI of this Article. The use of many of these techniques will continue to require an analysis of basis issues, including the tension between estate tax reduction and the loss of basis step-up, and the possibility of a carry-over basis regime beginning in 2010.

5. Planning and Drafting for Flexibility and Change

   Standard drafting techniques such as marital or bypass trusts determined by formula must carefully be examined in each planning situation. Consideration must be given to the incrementally increasing credit shelter amount and the prospect of repeal. Formulae should also be reviewed to be certain that tax-driven provisions do not alter the client's desired economic distribution of assets. The possibility of a grantor's incapacity or unwillingness to incur the cost of several revisions may require drafting in the alternative for pre-repeal death, post-repeal death, and death following repeal of repeal.

   Consider, for example, the consequences of a typical drafting arrangement using a pre-residuary marital deduction trust and a residuary credit shelter trust determined by formula: The wife's assets are $3 million and the husband's assets are zero. In 2001, prior to EGTRRA, if the wife predeceased the husband, the marital trust would be in the amount of $2,325,000, and the credit shelter or by-pass would be in the amount of $675,000. In 2002, the marital trust would be $2 million and the credit shelter trust $1 million. In 2004, the marital trust would be $1.5 million and the credit shelter trust $1.5 million. In 2006, the marital trust would be $1million and the credit shelter trust $2million, and in 2009 the marital trust would be zero and the credit shelter trust $3 million, or the wife's entire estate. The consequences of the decreasing marital trust and the increasing credit shelter trust may differ significantly depending on whether the husband was the beneficiary of the credit shelter trust or whether the children or grandchildren were the beneficiaries. The consequences may also differ depending on how individual clients perceive and how attorneys explain the advantages and disadvantages of credit shelter trusts. A flexibly drafted credit shelter trust, in which the surviving spouse is the beneficiary with as much control as possible without creating a general power of appointment over the trust, will be perceived differently from a credit shelter trust in which the surviving spouse is subject to the whims of an independent and perhaps hostile trustee.

   Ameliorating this potential mischief will require matching the clients' family and asset mix to one of several planning alternatives. Although other alternatives are available,[9] the following approaches should be considered as we offer planning recommendations to our clients:

   A. Use of Disclaimers. Qualified Disclaimers under IRC § 2518[10] and K.S.A. 59-2291 to 2294 are friends of post-mortem planning. Their use may be involved in preventing over qualifying or under qualifying marital deduction assets. Over-qualifying marital deduction assets may be prevented by having the surviving spouse disclaim some of those assets into a credit shelter trust or to the children. Under qualifying assets may require that the children disclaim in favor of the surviving spouse, thus qualifying the disclaimed assets for the marital deduction and avoiding unnecessary estate tax at the time of the first spouse's...