Significant recent developments in estate planning.

• Author: Whitlock, Brian T.

EXECUTIVE SUMMARY

* The current phase-in and indexing of prior EGTRRA provisions will continue to affect estate planning.

* The IRS won significant court victories in the FLP area last year.

* Taxpayers continued to challenge various examples on GRATs in the Sec. 2702 regulations.

This article examines recent developments in estate, trust and gift tax planning. It highlights the current year phase-in and indexing of the Economic Growth and Tax Relief Reconciliation Act of 2001, recent cases and rulings an grantor retained annuity trusts, family limited partnerships and the marital deduction, and other miscellaneous developments.

This article examines recent developments in estate, trust, gift and generation skipping transfer (GST) taxes. It focuses e the current indexing and phase-in prior-year legislative changes, court battles and rulings in significant areas (such as grantor retained annuity trusts (GRATs) self-cancelling installment notes (SCINs) family limited partnerships (FLPs) and the marital deduction) and other miscellaneous IRS guidance.

Legislative Developments

The estate and gift tax remains legislatively unchanged since the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). All of the EGTRRA tax reduction provisions w expire at the end of 2010, because the Senate was unable get the 60% vote needed to approve a permanent repeal Although the House has raised the issue again, Senate action remains doubtful. Nonetheless, the last 12 months have generated Federal and state legislation that will have a significant effect on income tax and business-succession strategies.

JGTRRA

President Bush was able to get the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) enacted before Congress adjourned for the summer Although the JGTRRA accelerates real of the EGTRRA income tax provisions and lowers the tax rates on dividends an capital gains, it does not make any changes in the estate and gift tax.

Planning: Planners focusing on business succession will surely find the new 15% tax rates for dividends and long-term capital gains to be useful. (1) These change may affect a taxpayer's choice of entity.

HSA

Clients regularly ask about the deductibility of contributions to memorial or educational funds established at a local bank for the family of a relative or neighbor. Normally, charitable deductions are not available for contributions to individuals or their families to defray medical educational or funeral expenses.

President Bush signed the Homeland Security Act (HSA) on Nov. 25, 2002.The HSA created a new form of charitable trust that may prove useful in estate planning. The Johnny Michael Spann Patriot Trust (Patriot Trust) (named after the CIA agent killed in Afghanistan) allows taxpayers to make charitable contributions to a trust for the benefit of the survivors of (1) members of the U.S. Armed Forces, (2) CIA personnel and (3) employees of the FBI and other Federal agencies charged with the domestic protection of the U.S. it killed in the line of duty as a result of terrorist acts, intelligence operations, military operations, accidents associated with post-Sept. 11,2001 activities and efforts to curb international terrorism.

Planning: Additional guidance from Treasury is needed on Patriot Trusts Funds contributed to a Patriot Trust for a family must be spent within 36 months. Query whether that would allow transferring funds to Sec. 529 accounts.

Gift, Estate and GST Tax Exclusion Indexing

Aside from new legislation, the phase-in provisions of the EGTRRA will continue to affect estate tax planning. In addition, the Taxpayer Relief Act of 1997 required inflation indexing for a number of existing exclusion items, after 1999. The indexing will continue even after the EGTRRA. The EGTRRA phase-in and the indexing changes, which were released earlier this year, (2) are as follows.

Gift and Estate Tax Rates

The top estate tax bracket for 2003 is 49%. In 2004, it will be reduced to 48%.

Credit Equivalent Amounts

The unified credit for both gift and estate tax is currently $1 million. In 2004, the estate and gift tax credits be decoupled and no longer be "unified." The estate tax credit equivalent will increase to $1.5 million effective Jan. 1, 2004; the gift tax credit equivalent will remain at $1 million.

State Death Tax Credit

This credit continues its phaseout, reduced from 50% to 25%, effective Jan. 1,2004. Beginning in 2005, the credit is scheduled to change into a Federal deduction.

Planning: As of May 9, 2003, 17 jurisdictions had decoupled their "pickup" tax from the Federal state death tax credit. (3) The proliferation of separate state taxes will complicate planning for multijurisdictional taxpayers. Today's wealthy individuals have numerous multistate real estate holding: homes, vacation properties, residential and commercial rental properties, etc. The proliferation of the number of state estate and inheritance tax statutes that divorce from the Federal credit will add complexity to the estate planning process.

Gift Tax Annual Exclusion

The Sec. 2503(b) gift tax annual exclusion remains at $11,000 per person per year for 2003. The adjustment is in $1,000 increments as needed to reflect inflation.

Noncitizen spouses are not eligible to receive unlimited property transfers under either Sec. 2523 or 2056, the gift and estate tax marital deduction provisions. Noncitizen spouses are eligible for an annual gift exclusion historically limited to $100,000, under Sec. 2523(i). Effective Jan. 1, 2003, the Sec. 2523 exclusion for noncitizen spouses increased to $112,000.

GST Exemption

This exemption increased to $1.12 million for calendar-year 2003. Indexing continues under the EGTRRA; however, in 2004, the phased-in increase of the GST exemption to $1.5 million will likely surpass and replace the indexed amount.

Special-Use Valuation

Under Sec. 2032A, an executor may elect to value real property used in a farm or business on the basis of actual, rather than highest and best, use. The maximum allowable deduction was set at $750,000; indexing for 2003 increases it to $840,000.

Tax Deferral for Closely Held Business

The Sec. 6166 2% interest rate for the applicable portion of the estate tax payable in installments increased to $1.12 million.

QFOBIs

The deduction for qualified flintily owned business interests (QFOBIs) under Sec. 2057 will be repealed effective Jan. l, 2004.

Receipt of Large Foreign Gifts

For tax years beginning in 2003, recipients of gifts from certain foreign persons may have to report them under Sec. 6039F if the aggregate value of the gifts received in a tax...