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Critical Issues to Consider: Estate Planning Filings

Estate planningThe final Form 706 and instructions were issued early September by the Internal Revenue Service for decedents who died in 2010. For most people who died in 2010, the form and estate tax payment were due Sept. 19. The AICPA requested a 90-day postponement of the due date, and on Sept. 12 the IRS announced filing and penalty relief for 2010 estates. In light of recent estate tax developments, listen to Bob Keebler’s thoughts on critical issues to think through for 2010 and 2011 estate planning and filings. 

Recent Estate Tax Developments

If you prefer, you can read the entire transcript after the jump or download this and other audio webcasts from the Personal Financial Planning Section on AICPA.org.

Robert S. Keebler, CPA, MST, DEP, Partner, Keebler & Associates, LLP. Bob is a 2007 recipient of the prestigious Distinguished Estate Planners award from the National Association of Estate Planning counsels. From 2003 to 2006, Bob was named by CPA Magazine as one of the top 100 most influential practitioners in the United States. He is the past Editor-in-Chief of CCH's magazine, Journal of Retirement Planning and a member of CCH's Financial and Estate Planning Advisory Board. His practice includes family wealth transfer and preservation planning, charitable giving, retirement distribution planning, and estate administration. 

This audio webcast was originally recorded Sept. 13, 2011.

Transcript: On behalf of the AICPA Personal Financial Planning Division, this is Bob Keebler to discuss Notice 2011-76 regarding 2010 deaths.  We’ll also discuss 2011 deaths and portability, and finally, most of today’s podcast will review proposals by the six Democratic members of the Supercommittee regarding the estate tax.

Moments ago before this call, the IRS released Notice 2011-76.  This notice is a very appropriate step by the Service in addressing 2010 deaths.  The problem is, these filing deadlines were coming up very quickly.  So what the IRS did in Notice 2011-76 is they provided us with an automatic extension of Form 8939 to January 17th, 2012.  No specific extension is required.  It’s just an overall extension of the filing deadline.  So this’ll make life a lot easier for many people.  It’ll give us time to understand how AMT works and the interface of AMT with Section 1022.

Also in that notice, the IRS addressed Form 706 for 2010, for individuals who want to file either Form 706 or 706-NA.  Basically, if you file an extension you’ll receive an automatic six-month extension, not only to file, but to pay.  Now, there will be no penalty if you pay late.  However, there will be interest.  There will be no penalty, but there will be interest.  So I think we have to be careful here in that we want to look at the rate we’re going to pay the government after taking into account the deductibility, if any, compared to what we’re earning in our money market-type accounts.

This notice also provided that there’s going to be a waiver of penalties for individuals and estates and trusts that already filed a 2010 income tax return or made an extension and plan to file by October 17th, 2011, if they predicated their estimates on basis they weren’t certain of because of 2010 deaths.  So if you have that situation, if you have any of these situations, I would encourage you to thoroughly read Notice 2011-76.  I’m sure we’ll write more about this, but that’s what just came out moments ago.

Now, the other thing that I wanted to discuss a little bit was 2010 deaths and portability.  So we’re shifting from 2010 to 2011.  If you represent someone that died in 2010 -- so you’re representing the executor; the decedent died in 2011, maybe January 2011 -- the person died January 1st, 2011, their estate tax return, of course, is due October 1st, 2011.  Now, we can file an extension, which is often a prudent thing to do.  Remember, though, what I want to stress, what we would like to stress is the need to file a return to obtain portability.  This is a major malpractice trap.  If you do not file the 706, you do not obtain portability.

So let’s say you represented this couple and the husband died, and they were worth $5 million exactly, and his spouse says to you, “I really don’t want to pay you to do a 706.  There will not be any estate tax when I die.”  And you try to explain, “Well, that’s current law.  We could go back to million-dollar exemption.  Your estate could grow.”  And she still doesn’t want to file that.  Recognize that she will not get any of her husband’s unified credit to carry over.  So when she dies, her exemption, even if the law stays the same, will remain at $5 million.  Now, if the law goes back to a million, odds are her exemption will be a million, and she will have none of her husband’s exemption to help shelter her estate at her death.

So this is a very difficult area, and you want to make sure that that discussion with your client is backed up by a letter.  And I think the prudent thing to do is to have -- go through all the scenarios where this could hurt the surviving spouse and have them initial each of those scenarios.  Be very careful with this.  It’s a trap for the unwary.

Also, reach out to all your lawyer friends that practice in this area and make sure everybody gets it.  So I think the American Bar Association has done a fairly good job of getting the word out on this, but you know something this difficult, such a sudden change, there’s colleagues of ours in the legal practice, there’s colleagues of ours in the CPA world that just don’t know this yet, and we have to help them.

Now, the major part of today’s podcast, we would like to spend some time talking about basically where the Democratic members of the Supercommittee are.  By now, everyone’s aware of the role of the Supercommittee.  The deadline is November 23rd.  However, about ten days ago, the Democratic members of the Supercommittee released their position on many things, including the estate tax.  And let me walk you through where we are on the estate tax and where this could be going.

Now, we haven’t heard from the Republican side of the aisle yet, so it’s very important to understand, there will be a Republican response, and I’m sure it’s not going to look like the Democratic response, and that’s the nature of politics, is there will have to be a compromise in this.

Now, just for the record, President Obama’s jobs bill that was posted yesterday does not address the estate tax in any way, shape or form.  So this is not coming from the Administration.  It’s coming from the Democratic members of the Supercommittee.

First thing that would happen is under their proposal the exemption would be reduced from 5 million to 3.5 million.  The rate would go from 35% to 45%, but all this would happen on January 1st, 2012 -- 1/1/2012.  Now, let’s think about what that means.  That means you represent a lady who is 75 years old, her husband passed away, she’s worth $6 million, but she’s able to live off her pension.  And she says, “You know, I have my pension.  That, that -- Between my pension and Social Security, I have more than enough money, and I really don’t need the rest of this property.”  If that’s really where she is financially, it might be prudent for her to gift away the $5 million exemption, gift tax exemption she has and not look back, because if the law changes, she’ll lose that.

Now, what everyone’s thinking is that under this Democratic proposal, the gift tax exemption would in all likelihood revert back to a million dollars, and the estate tax exemption would revert back to $3.5 million.  Again, none of this is exactly clear.  There’s no legislative language out here yet.  But on the other hand, this is where they’re going.

What this means to your very wealthy clients is that they should probably be gifting away as much of that $5 million exemption as they can, the gift tax exemption.  But remember, that gift tax exemption has a mirror image of itself in the GST, and today husband and wife can transfer up to $10 million to a GST-exempt dynasty trust for the benefit of grandchildren, great-grandchildren and down many generations.

We represent a client who, on January 1st, 2007, received several hundred million dollars from a long-term trust created by his fourth great-grandfather.  Our client, who’s a chemical engineer by training, he figured out that if his great -- fourth great-grandfather hadn’t been so wise to do this, he would have received about 6% of that amount just based on the intervening estate taxes.  And that shows you how important these dynasty trusts are.  So remember that exemption, that $5 million, doesn’t just apply for estate and gift tax purposes, but it also applies for GST purposes, which I’ll talk about in a moment.

Now, the other changes.  One of the other proposals by the Democratic members of the Supercommittee would be to change the nature of the GRAT.  Today you can do very short-term two-year GRATs and you can zero out a GRAT.  Now, you literally can zero out a GRAT.  Typically, we never zero out a GRAT.  We always have a small gift for -- to run the statute of limitations for gift tax purposes.  But you can bring that gift down very low.  So if a client transferred $5 million worth of McDonald’s stock into a GRAT, the gift that you would report on their gift tax return might only be $100.  And the goal, of course, is the McDonald’s stock outperforms the 7520 rate, which is roughly 2% right now.

Now, what the proposal regarding GRATs would do would to be to mandate a ten-year term and possibly a percentage remainder.  So today on a $5 million transfer, my remainder might only be $100, where maybe under this proposal the remainder might be 5 or 10%.

Short-term GRATs have been very, very beneficial.  I’ve done a lot of work with my friend, Steve Oshins, from Las Vegas, Nevada, and he has a lot of clients that do short-term GRATs.  And the reason the short-term GRATs work so well in today’s volatile stock market is because if you do a short-term GRAT with, say, Procter & Gamble or Coca-Cola and the stock goes up during that two-year period of time, only to fall during the next three -- you know, during the third year, if you had a longer-term GRAT, you wouldn’t catch up at the pinnacle of value.  Okay?  You’d catch it maybe in a trough.  By doing a two-year GRAT, you can catch it when it’s at its high.

The other thing that would happen is we’d go to a 10% remainder interest in the GRAT.  A $5 million gift would burn up 500,000 unified credit.  It’s going to make the GRAT much more difficult.  Today, GRATs are virtually a risk-free transaction.  That will change under these proposals.  The moral of the story here is if you have clients that should be doing short-term GRATs or very large GRATs, they should be done immediately between now and November 23rd.

On the dynasty trust, one of the other proposals by the Democratic members of the Supercommittee is to reduce the length of trust for federal purposes.  Now, the federal government cannot interfere with state property law rights, but what they can do is put a term on how long your GST-exempt trust will last.  In other words, create an automatic termination of the GST trust.  And the language that’s out there right now would basically create a federal rule against perpetuities, which, of course, you’ll remember is life in being plus 21 years, generally.

So basically, a trust, we couldn’t be doing long-term, ten-generation dynasty trusts anymore.  Trusts would probably last roughly 90 to 110 years, depending on how they were designed and who were the measuring lives.  That changes a lot, okay?  And between the GST exemption potentially falling from 5 million down to 3.5 million, and between the fact that we might lose our dynasty trust, we should probably be looking at what transfers can we make in the very near term?

Now, valuation adjustments, again, the other thing that’s in the proposal would be to trim back on valuation adjustments.  A little bit of background.  The federal gift and estate tax law measures value based upon a hypothetical called willing buyer, willing seller.  Okay?  So we have this hypothetical willing buyer, willing seller.  And what’s going to transpire here is under the law they would change that to where family transfers no longer were at a willing buyer, willing seller methodology, but they ignored some of the minority interest discounts when you’re transferring property between family members.

Now, this could be a very big change.  Basically, we’ve been using Revenue Ruling 93-12 for almost 18 years here, and that ruling says that if I own 100% of a company and I die with 100%, I have to include 100% of my estate with no minority interest discounts.  But if I gave away one-third to each of my children, then each of my children would receive a minority interest discount on that gift, and that’s what’s so important here.  We do not want to lose those minority interest discounts when we’re making transfers between family members.  So I think this is very, very important for you to look at in a grace, and if you have clients with closely held businesses, family limited partnerships, large farms or ranches, talk to them immediately.  Talk to them about what could happen.

Now, finally, we have to address -- The other part of this proposal is their -- Congress would like to see consistency in basis between decedents and between their heirs.  This is an area that Congress has been concerned with for many years.  It’s a very reasonable proposal, in my opinion, where if the estate took the position that an asset was worth $100, the heirs would be mandated to take that position.  The law now does not allow such a strict adherence to the basis that an estate took.

Now, when we step back and look at all this, I think it’s very, very critical to deal with possibilities, not probabilities, okay?  You might look at this and you might say most of this is improbable.  But it is possible.  And let’s just say that these things happened.  Let’s say the exemption for gift tax went from 5 million to 1 million.  Let’s say that along with that the rate goes from 35% to 45%.  So as we’re going down that path, we’re also going to see -- maybe we’re going to see GRATs change, where we can no longer do short-term GRATs.  We may also see dynasty trusts change.  If the dynasty trusts change, we might not be able to do long-term trusts anymore.

I think the dynasty trust and the unified credit exemption are very important to use quickly.  We represent some clients who are actually going to incur gift tax, and they’re willing to step up to the plate and pay a gift tax at 35%.  This is very important, because the gift tax rate is really not 35%, but if a person lives three years, the effective rate for gift tax purposes becomes about 26%.

Now, if we were to go back -- remember, on January 1st, 2013, if we do nothing, we go back to a 55% rate, and if this proposal were to become law, we go back to a 45% rate.  It is impossible to know exactly where Congress will compromise.  It’s absolutely impossible to know.  So again, when you’re talking to your clients, tell them it’s important that we deal with possibilities, not probabilities, and we have to deal with what could become law, even if it’s just a 5% chance.  If you represent somebody that’s going to gift away their unified credit either this year or next year, gift it away sooner than later.  Try to do these gifts before November 23rd.  If you represent somebody that should be doing a large GRAT, look at doing that sooner than later.  Same thing with the dynasty trust.

Now, one of the things that’s out there, gifts can be made pretty quickly.  Dynasty trusts generally take time.  Even the most skilled lawyers are going to take some time to put together a dynasty trust, because it’s a document that could live for 200 years.  You can’t put it together in an afternoon.  So clients are going to need time to meet with you and their lawyers.  Clients are going to need time to give legal counsel a chance to put together a draft of the document for everyone to review.

Finally, the appraisal side of things.  We want to keep our eye on these valuation adjustments.  We do not want to lose that privilege that could be taken away from us if some of these minority interest discounts are disallowed.  So those are all things that we can be focused on.

So again, just to summarize, we covered three different things in today’s talk.  First we talked about Notice 2011-76, which was issued literally within a half hour of when I taped this podcast for you.  So go back and read that notice.  But I think the essence of that notice is Form 8939 is now due January 17th, 2012.  And if we extend the federal estate tax returns for 2010, there will be no penalties if we owe late taxes, but there will be interest on that.  So that’s very important to look at.

And finally, we talked about 2010 deaths and portability.  Remember, you need to file a return to obtain portability.  We believe this is a major malpractice trap if you miss that.  So get out in front of that and encourage your clients where, if they lost someone in 2011 -- husband died, surviving spouse is working with you; wife died, husband’s working with you -- talk to them about portability and the need to file a return.  If you’re not sure what you’re going to do, at least extend the return right now and buy yourself some time to sort through that.  But absent a return, you’re not going to be able to use portability, and the surviving spouse is not going to be able to take the deceased spouse’s unified credit and use it against their own taxes later.

In closing, I encourage members of the PFP division to keep connected with the latest news and resources on this and other topics via the weekly AICPA PFP News, and by visiting the website at aicpa.org/PFP.  For those of you who are grappling with 2010 decedent issues, make sure to tune in to next week’s AICPA seminar “Analyzing the Carryover Basis Election for 2010.”  If you’re unable to join this, you’ll be able to get the recording materials within a week of the seminar at aicpa.org/PFP/webseminars.

This has been Bob Keebler.  On behalf of the AICPA, I thank you for joining us today.


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