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,

* FLPs continue to be a hotbed of controversy--tax advisers need to assist clients in FLP management.

* The marital deduction may be protected by clearly stating the intent to qualify for it and including a savings clause in the trust document.

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This article examines recent developments in estate, trust and gift tax planning. It highlights recent cases and rulings on valuation, family limited partnerships, deductibility of administration expenses and qualified marital deduction trusts.

This article examines recent developments in estate, trust, gift and generation-skipping transfer taxes. It focuses on the current indexing and phase-in of prior-year legislative changes, court battles and rulings in significant areas (e.g., valuation, family limited partnerships (FLPs) and the marital deduction) and on other IRS guidance.

Legislative Developments

The estate and gift tax remains legislatively unchanged as the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) continues to phase in. All of the EGTRRA tax reduction provisions will expire at the end of 2010, because the Senate has been unable get the 60% vote needed to approve a permanent repeal. Little is likely to be done in this current election year, as the parties campaign. Most likely, the first year of the new presidential term will bring broad legislative changes.

EGTRRA Changes Taking Effect in 2004

QFOBI Deduction Disappears

The deduction for qualified family owned business interests (QFOBI) under Sec. 2057 was prospectively repealed, effective Jan 1. 2004.

Estate Tax Credit Decouples from Gift Tax

The estate tax credit equivalent increased to $1.5 million. However, the gift tax credit equivalent remains at $1 million. Although the tax tables are unified, the credits are not.

Estate and Gift Tax Rates

The estate and gift tax rates continue to "flatten out." The top marginal tax rate for both of these taxes was reduced for individuals dying in 2003 to 48%. Effectively, there are four brackets for the gift tax and two brackets for the estate tax:

Threshold amount Rate $1,000,000 41% $1,250,000 43% $1,500,000 45% $2,000,000 or more 48% Federal SDTC

The Federal state death tax credit (SDTC) was reduced from 50% to 25%. In 2005, it will disappear completely, and a deduction for death taxes paid to the state will replace it.

States Decouple from the Estate Tax

Prior to the EGTRRA, over 40 states based their death tax on the Federal SDTC. As the Federal phase-out of the SDTC leaves these states without a death tax, 19 jurisdictions had, by October 2003, either decoupled their "pick-up" tax from the SDTC or fixed their estate tax at a level to avoid the phase--out. The jurisdictions include: Illinois, Kansas, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Jersey, New York, North Carolina, Oregon, Pennsylvania, Rhode Island, Vermont, Virginia, Washington, West Virginia, Wisconsin and the District of Columbia. (1)

Today's wealthy individuals have numerous multistate real estate holdings (e.g., homes, vacation properties, residential and commercial rental properties, etc). The proliferation of separate state taxes will add complexity to the estate planning process.

Annual Inflation Adjustments

Each year since 1997, the IRS has been required to adjust various income, gift and estate tax exclusions and brackets for inflation. Rev. Proc. 2003-85 (2) contains the adjustments for 2004. Among the items of interest to advisers focusing on estate and gift taxes are the following.

Gift Tax Annual Exclusion

The Sec. 2503(b) gift tax annual exclusion remains at $11,000 per person per year for 2004. The adjustment is in $1,000 increments as needed to reflect inflation.

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. They are eligible for an annual gift exclusion historically limited to $100,000, under Sec. 2523 (i). Effective Jan. 1, 2004, that exclusion increased to $114,000.

GST Exemption

The GST exemption increased to $1.5 million in 2004, surpassing and replacing 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 2004 increased it to $850,000. (3)

Tax Deferral for Closely Held Business

The applicable portion of the estate tax payable in installments and subject to the Sec. 6601(j) 2% interest rate increased to $1.140 million.

Receipt of Large Foreign Gifts

For tax years beginning in 2004, recipients of gifts from certain foreign persons may have to report them under Sec. 6039F if the aggregate value of the gifts received...