Recent developments estate planning.

AuthorRansome, Justin P.
PositionPart 1

This two-part article examines developments in estate, gift, and generation-skipping transfer (GST) tax and trust income tax between June 2012 and May 2013. It discusses legislative developments, cases, rulings, the American Taxpayer Relief Act of 2012, and inflation adjustments for 2013. Part II, in the October issue, will cover estate and GST tax issues.

Estate Tax Reform

The uncertainty about transfer-tax rates and exemption amounts that has plagued taxpayers and practitioners since 2001 was finally settled in 2013. On Jan. 2, 2013, President Barack Obama signed the American Taxpayer Relief Act of 2012 (ATRA), (1) which, for estate, gift, and generation-skipping transfer (GST) tax purposes:

* Makes permanent certain income and transfer-tax provisions in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA); (2)

* Makes permanent income tax provisions in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA); (3) and

* Makes permanent income and certain transfer-tax provisions in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Act). (4)

In most instances the effective date of the act is Jan. 1, 2013.

Gift Tax

ATRA resets the gift tax rate schedule to mirror the estate tax rate schedule with a top rate of 40%. Before EGTRRA was enacted, the exemption amount for both gift and estate tax was the same, or "unified." EGTRRA decoupled them. After EGTRRA, the estate tax exemption amount steadily increased while the gift tax exemption amount remained at $1 million. The 2010 Tax Act temporarily reunified the gift tax and the estate tax exemption amounts--ATRA makes that permanent and also makes permanent the $5 million gift tax exemption, which is indexed annually for inflation and is $5.25 million for 2013.

[ILLUSTRATION OMITTED]

Estate Tax

ATRA sets the top estate tax rate at 40% with lower rates still in effect for estates less than $1 million, but these lower rates affect the calculation of the estate tax only for an estate in excess of the estate tax exemption amount (currently $5.25 million). It also makes the portability election, which allows a surviving spouse to use the unused estate tax exemption amount of the first spouse to die, permanent.

Generation-Skipping Transfer (GST) Tax

The GST tax applies the highest estate tax rate, which is now 40%. The GST exemption amount is the same as the estate tax exemption amount (currently $5.25 million). In addition, ATRA repeals the EGTRRA sunset provisions, thereby making the following taxpayer-favorable GST tax provisions permanent:

  1. Automatic allocation of GST exemption to indirect skips;

  2. Sec. 9100 relief for missed GST allocations and elections;

  3. Substantial compliance for allocations of GST exemption;

  4. Retroactive allocations of GST exemption for unnatural orders of death; and

  5. Trust severances for GST tax purposes.

Gift Tax

Annual Exclusion Gifts

As part of its continued attacks on family limited partnerships (FLPs), the IRS has argued with some success that gifts of interests in an FLP do not qualify for the gift tax annual exclusion. Sec. 2503(b) excludes from gift tax the first $14,000 for 2013 of present-interest gifts a donor makes to any person during a calendar year. Regs. Sec. 25.2503-3(b) provides that a present interest is the unrestricted right to the immediate use, possession, or enjoyment of property or the income from property.

In Estate of Wimmer, (5) the decedent and his wife created an FLR The FLP agreement generally restricted the transfer of partnership interests and limited the instances in which a transferee could become a substitute limited partner, except for transfers to related parties. The decedent and his wife made gifts of FLP interests from 1996 through 2000 to their children, nieces, and nephews, and to a trust for the benefit of their grandchildren, grandnieces, and grandnephews. The trust beneficiaries were given the right to withdraw a specified amount of each gift; therefore, the parties stipulated that the transfers to the trust qualified as gifts of present interests if the Tax Court determined that the transfer of the FLP interests qualified as gifts of present interests.

The FLP agreement provided that all distributions of net cash flow were to be shared among the partners in proportion to their FLP interests. The FLP assets consisted of publicly traded, dividend-paying stock. During its first three years of operation, the FLP made distributions to pay the partners' federal income taxes. Beginning in 1999, the FLP continuously distributed all dividends, net of expenses, to the partners. In addition to the distribution of income, limited partners had access to capital account withdrawals and used those withdrawals to, among other things, pay their residential mortgages.

In Hackl, (6) the Tax Court established the test to determine whether the transfer of property is a gift of a present interest--the gift must confer on the donee a substantial present economic benefit by reason of use, possession, or enjoyment of either (1) the property or (2) the income from the property. To satisfy the first requirement, the taxpayer must prove that the facts and circumstances establish that possessing the interest renders an economic benefit available to the donee (via sale, acquisition, or otherwise). To satisfy the second requirement, the taxpayer must prove (1) that income will, in fact, be produced; (2) that some portion of that income will flow steadily to the beneficiary; and (3) that the portion of income flowing out to the beneficiary can be ascertained.

In Glimmer, the FLP agreement generally restricted the transfer of partnership interests and limited the instances in which a transferee could become a substitute limited partner. Thus, the Tax Court had little trouble concluding the donees did not receive unrestricted and noncontingent rights to the immediate use, possession, or enjoyment of the FLP interests.

The Tax Court next turned to the question whether the donees received rights in the FLP's income. The court found that the estate met the first prong of the income test (proving that the FLP expected to generate income) because the FLP had, since its inception, owned publicly traded, dividend-paying stock.

For the second prong (whether some portion of that income will flow steadily to the donees), the Tax Court examined the fiduciary relationship between the general partners and the trustee (a bank). The only asset in the trust was the FLP interest, so the trust had no source of funds to pay the federal income tax on its distributive share of the FLP income unless the FLP made distributions to it. The court determined that the necessity of an FLP distribution in these circumstances comes within the purview of the general partners' fiduciary duties and, therefore, the general partners were obligated to distribute a portion of partnership income each year to the trustee. Because distributions were required to be made pro rata under the FLP agreement, any distribution to the trustee triggered proportionate distributions to the other partners. As a result, the estate proved that some portion of FLP income was expected to flow steadily to the limited partners.

For the third prong (whether the portion of income flowing to donees can be ascertained), the court determined that because the FLP owned publicly traded, dividend-paying stock, each donee could estimate its share of the dividends based on the stock's dividend history and its percentage of ownership in the FLP. Finding that the facts established that the donees of the FLP interests had the immediate use, possession, or enjoyment of the income from property, the court concluded that the donees received a substantial present economic benefit sufficient to render the gifts of the FLP interests as gifts of present interests that qualified for the gift tax annual exclusion.

This is the first litigated case in which taxpayers have been successful in establishing that gifts of FLP interests qualified for the gift tax annual exclusion. In Hackl, the FLP owned timberland that had little or no existing salable timber when the gifts were made, so the taxpayers did not pass the income test. Because the Wimmer FLP held publicly traded, dividend-paying stock, the Tax Court was satisfied that there would be income. And because the FLP had to make distributions sufficient for the donees to satisfy their income tax obligations from their share of the FLP, the mandatory distribution was sufficient to convince the court that a portion of the FLP income would flow steadily to the donees. While the duty to make distributions to satisfy the partners' income tax liability was based on the general partners" fiduciary duties under state law, it could easily be a requirement of the FLP agreement. Even if, for estate planning purposes, the FLP does not want to distribute all its income currently, FLPs as a matter of course usually distribute enough for the partners to cover their income tax liability.

The Wimmer case also highlights the importance of reporting annual exclusion gifts on a gift tax return to begin running the statute of limitation on the gifts and the annual exclusions. Because these gifts had not been reported on a gift tax return, Sec. 6501(c)(9) (which prohibits the statute of limitation from running on gifts that are not disclosed) applied and the statute of limitation never began to run. If these gifts had been adequately disclosed on gift tax returns, only the gifts made in 1996 (before the effective date of Sec. 6501(c)(9)) would have been subject to adjustment when the decedent died in 2004.

Disclaimer by a Nonresident Alien

Under Sec. 25 18, if a person makes a "qualified disclaimer" of an interest in property, the disclaimed interest is treated for transfer-tax purposes as if the interest had never been transferred to that person. The person making a qualified disclaimer will...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT