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Lisa Featherngill
Lisa Featherngill
Estate Planning Before January 1, 2011

With all of the uncertainty swirling around estate planning, your clients will benefit by focusing on things that ARE certain.

October 21, 2010
by Lisa Featherngill, CPA, PFS

We all know that the estate, generation-skipping and gift tax rules revert to the 2001 law at the stroke of midnight New Year’s Eve unless law is enacted. Most estate planners are reluctant to predict the probability of legislation passing prior to year end, especially after 2009. So, what can we suggest to clients in light of the current uncertainty?

First, let’s focus on what we know for certain. The Applicable Federal Rates (AFRs) are currently at lows that we haven’t seen (except in February of 2009) for at least 20 years. Many asset values are depressed, particularly real estate. There is currently no estate or generation-skipping transfer (GST) tax and the tax rate on gifts above the $1 million exemption is 35 percent. We have planned under worse conditions! As a CPA with the Personal Financial Planning (PFS) credential practicing in this area, here are a few ideas for 2010 estate planning, based on what I have learned this year. Caveat: the law may change at any time so act quickly and carefully.

2010 Gifts and the GST Tax

This is an area that requires tremendous caution. If there is no GST tax in 2010, there will not be any GST exemption to apply against gifts to grandchildren. This is not a problem if the gift is outright to the grandchild, but if the gift is into a trust in which the grandchild (or more remote individual) is a potential beneficiary, the problems could occur in the future. If GST exemption is not applied to the 2010 gift to the trust, a portion of future-trust distributions to grandchildren would be subject to the GST tax. Note that a gift to a custodial account for a minor grandchild (e.g., Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA)) will be treated like a gift to a GST trust.

The annual exclusion is available for 2010 gifts and the $1 million exemption can offset gifts in excess of this amount. However, remember that annual exclusion gifts do not always qualify for the GST annual exclusion. Typically, only gifts given directly to grandchildren or to a trust for the benefit of a grandchild with a general power of appointment will qualify for the annual exclusion. So what about the annual gift to fund the premium on the policy in the life-insurance trust for the benefit of the client’s descendants? Since grandchildren (or more remote descendants) are potential beneficiaries, normally GST exemption would be applied to the gift.

A couple of options are available. First, determine if the premium can be delayed until January 1, 2011. If not, consider a loan to the trust to fund the premium payment. If your client does not want to be bothered, the gift can be made this year, but most likely you will need to make a late allocation of the GST exemption in January. This will require additional work and fees, but GST tax can be avoided on future distributions. These options (delay, loan or late allocation) are available to gifts to any trust that potentially benefits generations beyond the client’s children.

Taxable Gifts in 2010

A lot has been written about making taxable gifts in 2010. It is often difficult to convince a client to pay taxes. However, if the transfer would otherwise be subject to a 55-percent tax at death, payment of a 35-percent gift tax may make sense in 2010. Again be careful of gifts that would be subject to GST tax as described above. Second, delay taxable gifts until late in December to minimize the risk that the client makes a taxable gift and then dies while the estate tax is not in effect.

Minimizing Taxable Gifts

The recently enacted Small Business Jobs Act (SBJA) contained a provision in the House version of the legislation that would have required a 10-year minimum term on Grantor Retained Annuity Trust (GRAT). The Senate dropped the provision and we narrowly escaped that bullet once again. The October 7520 rate is two percent, which combined with depressed asset values, make GRATs very attractive. If the asset return exceeds the 7,520 rate, the client “wins” with a GRAT. As such, the hurdle rate is low right now.

The short-term AFR (less than three years) is 0.41 percent, the mid-term AFR (three years to nine years) is 1.73 percent and the long-term rate is 3.32 percent in October. This provides an opportunity for clients to make inexpensive loans, either directly to family or trusts for the benefit of family members. This wealth transfer strategy is very attractive if the client does not have gift tax exemption available and does not want to make a taxable gift. In addition, as mentioned above, the loan is a means of financing gifts to GST trusts in 2010.

Roth Conversions

Roth conversions are really prepayment of income taxes without any gift or estate tax implications. If you have a client who does not need an individual retirement account (IRA) and can afford to pay the income tax from non-IRA assets, a conversion may be a great idea. The benefit of a Roth conversion is profound when distributions are delayed until after the death of the IRA owner and then are made over the lifetime of the children who are named beneficiaries. Often the benefit is equal to the value of the IRA. In addition, the IRA owner can elect to pay the income tax in 2010. If rates increase in 2011, our analysis has always shown that the payment in 2010 produces a greater value to the ultimate heirs.

Distributions From Non-Exempt GST Trusts

The lack of GST tax in 2010 provides an opportunity to “clean up” trusts that are not entirely GST exempt. Consider either a taxable distribution or a taxable termination of the trust this year. The trust agreement must contain language that would allow the distribution to a skip person in 2010 and the trustee must be agreeable to making the distribution. However, if the distribution is made this year, there will be no GST tax paid by the trust. This could be a significant savings.

Recognizing Gains on Defective Grantor Trust Assets

If the estate tax rules revert to the 2001 law, the basis of assets that pass through an estate will “step up” to the estate value. However, consider assets that do not pass through the estate such as assets in trusts. These assets will not receive an increased basis at death. If the trust is a defective grantor trust for income tax purposes (e.g., the income is taxable to the grantor although the assets are not included in the grantor’s estate), consider recognizing gains in 2010 while the capital gain rate is 15 percent. There has been discussion In the Administration about extending the reduced capital gain rate in 2011. Therefore, the client may wish to wait and see what happens with income tax legislation. If the client has a capital loss carryover, however, this may be the perfect time to “refresh” the basis of the assets in the trust.

Dotting the I-s and crossing the T-s

A beautiful estate plan can become worthless if the estate assets have the wrong beneficiary or the titling of the assets is inconsistent with the plan. This is an area where CPAs excel because of their understanding of the client’s balance sheet. In addition, make sure the client’s living will and healthcare powers of attorney are up to date. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) changes of the last few years require a review of these documents.

Finally, encourage your client to share the estate plan with his or her heirs. Often we focus on the plan, but fail to prepare the heirs who will inherit the wealth. Clients are afraid to discuss their wealth because they want their children to be productive. However, several studies have shown that most estate plans “fail” due to a lack of communication and trust that is often caused by this secrecy.

Conclusion

Although we are in a period of uncertainty, there are opportunities to help clients with wealth transfer this year. Holding the PFS credential has helped open discussions that require caution and different thinking, but then as CPAs we are accustomed to these requirements.

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Lisa Featherngill, CPA, PFS is the director of Wealth Planning at Wells Fargo Family Wealth in Winston-Salem, NC. She chairs the PFS Credential Committee of the AICPA.

The PFS credential is exclusively available for CPAs. Prepare for the November/December 2010 PFS Exam with a 32.5 hour CPE self-study course covering estate, retirement, tax, investment, and insurance planning. Discounts are available. Order at CPA2Biz website. More in-depth education on the same topics is available as well. For more information, go to aicpa.org/pfp/pfs.

All members of the AICPA are eligible to join the PFP section. For CPAs who want to demonstrate their expertise in this subject matter apply to become a PFS Credential holder.