Significant recent developments in estate planning: this article examines recent developments in estate and gift tax planning and compliance. It highlights legislative developments, administrative and procedural changes and significant recent cases and rulings.

• Author: Sawyers, Roby B.

This article examines recent developments in estate and gift tax planning and compliance. It highlights legislative developments over the last year, Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) changes that take place in 2005, annual inflation adjustments affecting the estate and gift tax and changes in the administrative procedure for requesting extensions for filing gift tax returns. It also covers recent cases and rulings on family limited partnerships (FLPs), general valuation, deductibility of estate administration expenses, the marital deduction, spousal disclaimers and guidance on spousal election rights and charitable remainder masts (CRTs).

Legislative Developments

The House of Representatives voted on April 13, 2005, to permanently and immediately repeal the estate tax. (1) Along with repeal, the bill would replace the current basis step-up rules with a modified carryover basis. However, the Senate has not been able to muster the votes needed for permanent repeal. Many observers expect significant estate tax legislation in the next year.

As a result of the Senate's stalemate, as of July 15, 2005, the estate and gift tax remains legislatively unchanged as the EGTRRA continues to phase in. Under current law, all of the EGTRRA tax reduction provisions will expire at the end of 2010. If the law is not changed, the applicable exclusion amount will revert to $1 million on Jan. 1, 2010, with a maximum tax rate of 55% (before the 5% surtax).

EGTRRA Changes for 2005

While the estate tax exclusion remains unchanged at $1.5 million for 2005, the top estate and gift tax rates continue to decrease. For individuals dying (or making gifts) in 2005, the top marginal tax rate is reduced to 47%.

Federal State Death Tax Credit

In 2005, the Sec. 2011 state death tax credit disappeared completely and was replaced by a deduction for death taxes paid to the states.

Decoupling from the Federal Estate Tax

States continue to decouple from the Federal estate tax. Washington state's Supreme Court invalidated the state's former estate tax in Hemphill. (2) The Washington estate tax was a "pick-up" tax that was completely phased out after 2004. The state legislature adopted a new tax independent of the Federal credit, effective May 17, 2005; it applies to estates valued in excess of $1.5 million in 2005 and $2 million in 2006 and thereafter. The tax rates range between 10% and 19%, depending on the size of the taxable estate. (3) On June 30, 2005, significant changes in Connecticut's gift and estate taxes were made, replacing the succession tax with a new transfer tax on taxable gifts and estates exceeding $2 million. (4)

Planning: Florida and California are attracting unmarried retired persons, because these states do not have an estate tax and have prohibitions against such a tax in the future.

Annual Inflation Adjustments

The Tax Reform Act of 1997 amended the Code to provide that for transfers made in any calendar year after 1998, certain provisions of the estate and gift tax law would be indexed for inflation. Rev. Proc. 2004-71 (5) contains the adjustments for 2005.

Gift Tax Annual Exclusion

The annual exclusion for gifts remains at $11,000 for 2005. The adjustment is in $1,000 increments and is likely to increase to $12,000 in 2006.

Exclusion for Transfers to Noncitizen Spouses

Noncitizen spouses are ineligible to receive unlimited property transfers under either Sec. 2523 or 2056--the gift and estate tax marital deduction provisions. However, they are eligible for an annual gift tax exclusion that differs from that for spouses who are U.S. citizens. In 2005, the annual exclusion for gifts to noncitizen spouses rose from $114,000 to $117,000.

Receipt of Large Foreign Gifts

For tax years beginning in 2005, gifts in excess of $12,375 from certain foreign persons need to be reported by the recipient under Sec. 6039F.

Special-Use Valuation

Under Sec. 2032A, an executor may elect to value qualified real property used in a farm or business on the basis of actual, rather than highest and best, use. For an estate of a decedent dying in calendar-year 2005, if the executor elects to use special-use valuation, the aggregate decrease in the value of qualified real property cannot exceed $870,000.

Tax Deferral for Closely Held Business

The Sec. 6166 amount eligible for the 2% interest rate rose from $1.14 million in 2004 to $1.17 million in 2005.

Procedure and Administration

New Form 8892--Extension of Gift Tax

The IRS has issued a new, separate form for requesting an extension to file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. The April 15th due date for gift tax returns can be extended by filing:

1. Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, which automatically extends Forms 1040 and 709...