Troutman Sanders LLP: The Administration’s FY 2013 Estate and Gift Tax Proposals

By Carol F. Burger, David F. Golden, Molly F. James and Michael D. Erickson

Last week, the President released his proposed budget for the upcoming fiscal year. On the same day, the Treasury released its explanation of the President's budget, which contains specific information and more detailed elaboration on several important proposals (together, the Administration's Proposal). In addition to substantial changes to income tax laws, the Administration's Proposal would make substantial changes to estate and gift taxation. While some of these changes have been proposed before, others, including far-reaching changes to "grantor trusts," are quite surprising.

We now have estate, gift and generation skipping transfer (GST) tax exemptions of $5.12 million, a maximum tax rate is 35%, and "portability" of any unused estate tax or gift tax exemption of a predeceased spouse to the surviving spouse. However, without further congressional action, these exemption levels will revert to $1 million in 2012 (except for the GST exemption, which will be $1.39 million), the maximum tax rate will be 55%, and portability will no longer apply. 

The Administration's Proposal would return these exemptions and rates to their 2009 levels, meaning a $3.5 million estate tax exemption and GST tax exemption, but only a $1 million gift tax exemption, and a 45% tax rate. Several other key features of the Administration's Proposal are not really new, having been discussed previously in other contexts, and include the following:

• Making "portability" of any unused estate tax or gift tax exemption of a predeceased spouse to the surviving spouse permanent.
• Curbing the use of valuation discounts (e.g., for transfers of minority or nonmarketable interests in business entities) when the restrictions involve family members or certain charities. This change is proposed to be retroactive, and could affect transfers in prior years if the statute of limitations has not already closed.
• Requiring a minimum GRAT term of 10 years.
• Imposing a maximum period of 90 years on the GST exemption, thereby restricting "dynasty trusts," especially in states that have eliminated or extended the rule against perpetuities.  

The most surprising aspect of the Administration's Proposal is one which would have far-reaching effect. Grantor trusts have long been used for estate planning purposes. A grantor trust is a trust where the person who created the trust is treated as the owner for income tax purposes (e.g., the trust property is taxed to the donor, regardless of who the trust actually benefits, and transactions between the creator and the trust are ignored). The Administration's Proposal would cause all trusts that are grantor trusts for income tax purposes to be included in the grantor's estate for estate tax purposes. This would impact the use of life insurance trusts, sales of assets to family trusts and gifts to any trust where the grantor's spouse is a beneficiary. The Administration's Proposal would also subject to gift tax any distribution from a grantor trust to other persons during the grantor's life, and subject all remaining assets to gift tax if the trust ceases to be a grantor trust. These provisions could also apply to persons who are not the donor, but who are treated as the owner for income tax purposes, in certain contexts, but would not apply to grantor trusts that are already includable in a grantor's estate for estate tax purposes under existing provisions (e.g., GRATs, QPRTs). These changes would apply to trusts created on or after the date of enactment, and to existing trusts if additions are made after the date of enactment. 

The Administration's Proposal is still just a proposal, and most commentators believe it unlikely to be acted upon prior to the presidential election, and unlikely to be enacted without substantial changes in any case. Still, a possible reduction of exemptions, increase of rates, tightening of GRAT and family entity rules, and the possibility of sweeping changes to grantor trust rules makes planning in 2012 that much more advisable. Clients who defer their planning to 2013 and thereafter may lose out on a number of planning opportunities.

© TROUTMAN SANDERS LLP. ADVERTISING MATERIAL. These materials are to inform you of developments that may affect your business and are not to be considered legal advice, nor do they create a lawyer-client relationship. Information on previous case results does not guarantee a similar future result. Follow Troutman Sanders on Twitter.

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