Waiting for estate tax repeal: what do you tell your clients in the meantime?

• Author: Gans, Richard R.
• Position: Real Property, Probate and Trust Law - Effect of repeal on estate planning attorneys - Florida

In the 1988 film "The Boost," Lenny Brown makes a handsome living selling interests in tax-shelter limited partnerships to affluent investors. He has the world by the tail until the day Congress closes the tax-shelter loophole: Almost overnight, demand for Lenny's limited partnership interests disappears. Deprived of his livelihood by the stroke of a pen, Lenny loses everything. Has Congress, by repealing the estate tax as a part of the Economic Growth and Tax Relief Act of 2001 (the "act"), consigned estate planning lawyers to a similar fate? It does not appear likely.

Repeal will not occur, if at all, until 2010. With four Congressional elections and two Presidential elections between now and then, many believe it unlikely that the law will retain its present form for long. The time for repeal could be postponed; the repeal of the tax may itself be repealed; or, perhaps, Congress will fail to reenact the repeal of the tax, and the estate tax, in its present form, will rise from the ashes in 2011. The only thing that is certain is uncertainty.

This article is not intended to be a primer on the new transfer tax laws, including the "technical" changes the act made to the generation-skipping transfer tax. (1) Instead, it discusses how the uncertain fate of the transfer taxes during the next several years may affect the advice lawyers give to their estate planning clients. In many cases, planning techniques that made sense before the act will continue to make sense for the same reasons in today's environment, and this is especially true for techniques that have primarily nontax benefits. In other cases, however, the act will force planners to rethink techniques heretofore used almost as a matter of course. The difficult task is to be able to tell the difference, and this article attempts to make that task a bit easier.

Should Your Clients Be Making Gifts Anymore? (and If So, How?)

Lifetime gifting of assets has traditionally been a tax-preferred way to transfer wealth. The act now appears to create a disincentive to make gifts. With the increasing estate tax exemption amount, it is now possible to pass more assets at death without having to pay estate taxes. For the next several years, until the slated implementation of the modified carryover basis rules, all appreciated assets in a decedent's gross estate will receive a step-up in basis as under the traditional rules. Thus, for persons whose estates will not be subject to the estate tax, holding on to assets until death will mean that post-death capital gains taxes can be greatly reduced or eliminated at no estate tax cost.

Nevertheless, for a number of reasons, the act should not cause planners to abandon the lifetime gifting as an estate planning technique. Elderly clients may not live to see repeal or the highest exemption amount. Cynical clients, on the other hand, may not believe the estate tax repeal is certain or permanent. Finally, some clients make gifts for reasons entirely separate from taxes. It could be argued that 2002 will be the best year in a long time for making lifetime gifts. The gift tax exemption will increase by $325,000 from the year 2001 level. Additionally, the value of commonly gifted assets such as publicly traded stocks is low relative to the market highs a year or so ago, so that the value of the gift for tax purposes is lower and the potential for shifting post-gift appreciation out of the donor's estate is higher.

In today's uncertain estate and gift tax environment, flexibility is the watchword. For example, an irrevocable trust set up to receive gifts from the grantor could provide that an independent trustee (by definition, someone other than the grantor) has the discretion to return the assets that the grantor transferred to the trust only if 1) the estate tax is repealed; 2) the estate tax rates drop below a certain threshold rate; or 3) there would be no estate tax imposed on the grantor's estate if he or she died owning the assets in the trust. Will the assets in this Crummey trust be included in the grantor's gross estate if he or she dies before (2) the occurrence of the triggering event?

The trust agreement cannot direct the independent trustee to return the trust assets under any of these circumstances. Section 2036(a)(1) of the Internal Revenue Code causes the inclusion of any property as to which the transferor retained at his or her death the "right ... to designate the person or persons who shall possess or enjoy the transferred property or the income therefrom." The Treasury Regulations provide that "it is immaterial ... whether the exercise of the power was subject to a contingency beyond the decedent's control which did not occur before his death." (3) However, if the event that triggers the exercise of the discretion to return the property to the grantor is beyond the grantor's control, the grantor should not be considered to have retained any power or right that would cause the trust assets to be taxed in his or her estate. It is the retention, and not the existence, of the power that causes the application of Code [section] 2036.

The triggering event of "no estate tax due on the grantor's estate if grantor owned the trust assets" may be risky because the occurrence of that triggering event is within the grantor's control. The grantor could give away assets to drive the value of his or her estate below the estate tax threshold amount, or the grantor's testamentary documents could dispose of all of his or her assets to a spouse or to charity, thereby zeroing out the taxable estate with deductions. If the grantor could be thought thereby to have retained a power to affect the enjoyment of the transferred property to a degree sufficient to cause the application of Code [section] 2036(a) or 2038(a), all or a portion of the trust assets would be included in the grantor's gross estate at his or her death. Such a result would frustrate the goal of gifting the assets out of the grantor's estate.

Conversely, the first two contingencies are entirely outside of the control of the grantor. The contingency that triggers the discretion is in the hands of Congress and the President. The gift would be complete for federal gift tax purposes because "the donor has so parted with dominion and control as to leave him no power to change its disposition...." (4) In a Revenue Ruling, the Internal Revenue Service reasoned that the transfer to the irrevocable trust at issue in the ruling was an incomplete gift because, under applicable state law, the trust assets were subject to the claims of the grantor's creditors. (5) Thus, if under Florida law the grantor's creditors could reach the assets in the irrevocable gift trust by virtue of the trustee's discretion to return the trust assets to the grantor...