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AICPA Podcast on Estate Planning Impact of the President’s Budget Proposals

A 20 minute podcast on the estate planning and financial planning impact of the estate tax provisions in the recently released President’s fiscal year 2013 budget proposal covers various provisions, including those affecting intentionally defective grantor trusts, valuation discounts and grantor retained annuity trusts.  Even though these provisions may not be enacted this year, it will help you have intelligent conversations with your clients, know what the President’s legislative agenda for this year is, and be prepared for some of the estate tax provisions that may eventually be enacted.

Estate Planning Impact of the President’s Budget Proposals

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 podcast originally aired on Feb. 10, 2012.


EILEEN SHERR:  Hi, I'm Eileen Sherr, AICPA Senior Technical Manager of the AICPA Tax Division's Trust, Estate and Gift Tax Technical Resource Panel.  On behalf of the AICPA's Personal Financial Planning Section and Tax Section, this is Bob Keebler, who will provide an overview of how the newly released President's Fiscal Year 2013 Budget Proposal may impact estate and financial planning for high-net worth individuals.  Although it is unlikely that many of these proposals will go anywhere soon or at all this year, they still provide a starting point for us to know the President's legislative agenda for the year with regard to estate and income taxes for high-net worth individuals.

Of course, it will be left to Congress as to whether and when any of these proposals get enacted, so we may still be left hanging at the end of 2012, but at least we know what the President's perspective is at this point and some possible revenue raisers from which Congress may choose to pay for other provisions.  This will be helpful to you in starting to have intelligent conversations with clients and help you proactively be ready for what might be coming at the end of the year or possibly in the future.

Bob, we welcome your thoughts and insights on how the budget proposals will affect high-net worth individuals.

ROBERT KEEBLER:  Thanks, Eileen.  And, once again, it's an honor to be here with the AICPA and with our colleagues across the country that need to know what's going on in this budget bill and how it might affect their clients.

First, we'll go through the estate and trust side and then we'll follow up with some of the income tax provisions that affect high-net worth individuals.  First of all, basics.  Right now, the unified credit, if you will, is $5 million.  The exemption from estate tax, the exemption from GST and the exemption from gift tax, technically, $5,120,000.

On January 1st, 2013, that is expected to be reduced to $1 million by statute, okay?  We revert back to a million dollars.  The President's proposal would go back to 2009, where we had a $3.5 million exclusion amount and a 45% rate.  The 3.5 million would apply for GST tax and for estate tax, however the gift tax exemption would revert back to a million dollars.

So there is an unprecedented opportunity here for all of us to help clients move up to $5 million by doing gifts between now and when this bill would become enacted, this -- now, like Eileen said, the probability of this really happening is small, but I think it sets a floor.  It's gonna be very hard for the President or for the Democrats in the Senate to ask for an exemption below the $3.5 million suggested by the President's budget.

Now, the other good thing here is portability, that ability to port my exemption or exclusion to my spouse is going to be made permanent; I think that's a very good policy thing.  Okay?  That's a very good policy thing.  However, until that happens, if you have somebody that died in 2011 or 2012 and you're figuring out disclaimers, funding the bypass trusts, those things, you need to assume that portability may go away and you need to protect yourself, make sure your clients know that that could still go away, until it's made permanent.

Now, there is also a procedure in this bill which would require consistency in value for transfer tax purposes.  The proposal would impose a pure consistency requirement and reporting requirement.  The basis of property received by reason of death, under Section 10.14, the step-up in basis provisions, would equal the value of the property for estate tax purposes.  The -- people have played games here for many years; the IRS is rightfully trying to narrow this down.

Now, the basis of property received by gift and the basis of the donor would be the same and, likewise, for individuals that died in 2010, when you had that carryover basis, similar rules would exist.  And there would be some reporting requirements that would go along with this.

I truly expect that to work its way into law, because it's just a good administrative provision.

Now, modifying the rules on valuation discounts, recognize that current law -- and this goes way back, in 1986, 1990, when Congress brought in 2701 through 2704 of the Code.  And these Code Sections were designed to prevent the reduction of taxes through the use of estate freezes and other techniques that we had used for many years before that.

What the government is gonna do here is they are -- after 2701 through 2704 came into law, various states passed different statutes that would allow for valuation adjustments beyond what had been in existence in the past; in other words, Nevada passed the restricted LLC.  And the restricted LLC, basically, was designed to skirt 2704 of the Internal Revenue Code.  Congress is going to crack down on that.

I don't know how this will play out.  There's been a number of valuation proposals out there over the years.  This does not go after the minority discount as it much as it goes after very artful drafting in documents.  You -- likely, you'll see a combination of the two once everyone puts their heads together.

So the reason for this change is there's been many judicial decisions and, again, the enactment of state statutes that have made Section 2704(b) inapplicable and, basically, Congress is saying, "Wait a minute.  We're -- you know, if the states are gonna do this, we're gonna -- this is our move.  This is -- this is how we're checkmate them on this."

So the proposal would create an additional category of restrictions, which would be disregarded in valuing entities.  And we'll go into this in more detail once we actually have a bill signed by the President, but I think the moral of this part of the bill is that, if you have clients with -- you know, Mom owns 100% of this big business and she has her three children in the business, Mom is 70 years old, Mom should be gifting away pieces of that business while she can still use her $5 million exemption and while she can still assure herself of the minority discounts that are protected under Revenue Ruling 93-12.

Now, the proposal also deals with GRATs.  Basically, this probably marks the death of the GRAT in many ways, because a GRAT would have a minimum term under the proposal of ten years and they would also give a maximum term.  Now, I think the maximum term is reflecting a podcast Jonathan Blachmacher and I did in the last six months, where he talked about doing 99-year GRATs as interest rates creeped down and there's a mathematical anomaly in the regulations that gives someone an advantage.  So now the government has checkmated us on that.

And they have also said that GRATs have to go ten years.  Now, many people were doing -- including myself, we were doing two- and three-year GRATs and we really aren't going to be able to be there.  Now, today, you can still do a two- or three-year GRAT.  The rate is -- the freeze rate is 1.4%, so very important to understand how powerful this is.

Now, you also have to have a remainder greater than zero; I'm not sure what that minimum's going to be.  What's here is not legislative language; it's just an explanation.

Now, the bill would also prohibit a decrease in the GRAT annuity during the term and no -- and so now you're preventing zeroing out, you're preventing decreases.  Basically, GRATs are still gonna have applicability, but they're gonna have applicability for 40- and 50- and 60-year-olds, not for 75- and 80-year-olds, because, if you're doing a ten-year GRAT and you die in the GRAT term, almost all that property is gonna come back into your estate.

So that's a very important limitation.  If you have anyone that should be shifting wealth to a GRAT, they should do it now, not later.

Now, the bill also addresses the generation-skipping transfer tax.  And many states, as you're well aware, have repealed their rule against perpetuity.  So a trust -- literally in Wisconsin, South Dakota, Delaware, Alaska, a trust can go forever; literally, the trust can never terminate.  And what this bill would do, this proposal would provide that, on the 90th anniversary of the creation of the trust, the GST exclusion allocated to the trust would terminate.  Specifically, what would happen is you would go from an inclusion ratio of 0 to an inclusion ratio of 1 and all the distributions then would be subject to a tax.  That's very troubling and -- but, basically, it tells us that, if we have wealthy families that should be doing generation-skipping trusts, we should do them now not later, okay?

This is very powerful.  Many of you have heard me speak on this.  How a dollar goes to fifty cents, goes to a quarter, it goes to 12.5 cents, if you keep hitting it with a 50% estate tax every three genera- -- or every generation.  So what we're really up against here is we have a limited window of opportunity to put dynasty trusts into place.

Now, the last part of this provision on the estate and trust side is perhaps the biggest surprise, 'cause this provision has not been out there before.  Basically, under current law, if you have a grantor trust, the -- that income is taxed back to the grantor.  So what happened is many people, beginning in about 1985, 1990, started selling property to grantor trusts and, as you're well aware, when you sell property to grantor trusts, there's no income to report for federal income tax purposes.

Now, the transfer is a completed transfer for estate tax purposes, GST purpose and for state property law purposes.  Basically, the IRS has seen how powerful this is.  They've seen people transfer a million dollars and sell $9 million for the property.  Today, people could transfer $5 million to the property and sell $45 million for the property.  Most people believe a ratio of 1 part equity, 9 parts debt is totally acceptable.

Now, what Congress is going to do here is Congress is going to coordinate the income tax and the transfer tax rules.  And, basically, the proposal is -- to the extent that the income tax rules treat a trust as a grantor trust, the proposal would (1) include the assets of that trust in my gross estate.  I do a grantor trust sale after this is enacted.  I transfer a million; I sell nine million.  When I die, those assets would be included in my gross estate for estate tax purposes, so the trust has no -- the beauty of the trust just disappeared.

Now, further, it would -- you would incur a gift tax on any distribution from the trust to my beneficiary.  So, if my children and grandchildren were the beneficiaries to this trust, any distribution from the trust would incur a gift tax.

And, finally, there would be a gift tax on the remaining trust assets at the time in the grantor's life that the trust ceased to be a grantor trust.  So, right before I die, you very cleverly flip it from a grantor trust to a non-grantor trust; at that point in time, there would be a gift tax.

So, this is a very, very, powerful proposal.  Now, will this become law?  We don't know.  It depends on how the Republican leadership views this.  But what we have to do is we have to be ready for this.

So, to the extent you represent people that should be doing defective trust sales, they need to do those trust sales -- they need to structure those trusts and do those sales before this is enacted.

Further, if you represent people that already have grantor trusts in place and they should be transferring more property into those grantor trusts, they want to do that before this is enacted.

Now, the proposal would be effective with regard to trusts created on or after the enactment and with regard to any portion of a pre-enactment trust attributable to a contribution made on or after the date of enactment.  And the government's going to have broad regulatory authority here.

This -- we are about to lose, potentially, our grantor trust sales and the efficacy of GRATs will be severely damaged.  So it's time for us to really look at these issues and talk to our clients.

Now I know, when you're reading this, it's tax season, but, as you see people during tax season, plant these seeds, start to motivate these people and then, in late April, in May, we need to move forward and get these transactions going.

Now -- now, let's do a quick review of the income tax provisions that will affect your high-net worth clients.  First of all, one of the provisions in here will eliminate the capital gains tax on small business stock.  This was in place from September 27th, 2010, to January 1st, 2012; technically, December 31st.  This would extend tax-free treatment to small business stock held for five years.

Take a look at this provision.  If we have a client that is trading in new business -- say, he already has, you know, five -- he already owns 25 McDonald's franchises and he's gonna create another one.  We're gonna probably drop it into a C-corp and try to qualify as small business stock, okay?  So because when we -- when he sells it, that will be tax-free, provided he's held it for five years.

Now, the second thing.  Carried interest would be taxed as ordinary income.  Carried interest.  Wall Street.  People receive interests in the partnerships they manage.  This is how Governor Romney, a lot of the income on his return was taxed as carried interest, the way I understand it.

What this means, this is a provision -- my guess is, if the Republicans support this, they would take that arrow out of President Obama's quiver in the debates.  So, certainly, that's something -- I'm expecting the Republicans, although they're gonna despise it, they are gonna support changing the carried interest.

So just to be clear, carried interest would be taxed at the normal income tax rate, not capital gains rate.

Now, the next thing we're gonna have is there is going to be a sunset of the Bush tax cuts for taxpayers with income in excess of $250,000 for married couples.  That would be basically changing the top rates to 36 and 39.6%, but, remember, on January 1st, 2013, we also have to work with the 3.8% Medicare surtax.  So, for your wealthiest clients, their rate is potentially gonna go from 35% to 43.4%.

I think what we need to focus on, in the next ten months, is how do we bring income in to 2012.  If all this happens, we are going to want to be accelerating income into 2012.  We'll talk about this more later.  The major techniques, I think, we're well aware of; some of the more subtle techniques -- maybe selling bond portfolios in late December and re-buying them, but bringing that interest income into 2012.  There will be a dozen or two-dozen ideas that come out like that and we will, as soon as we see where the ball is going, we will get those ideas to you.

But the key is for all of us to be talking to our clients about they're going to have to shift income.

Now, by the same token, what's going to happen is there will be a limitation on itemized deductions for high-income taxpayers.  We're gonna go back to the 3% haircut and remember how that was limited?  You could only lose 20% of your itemized deductions.

Now, there is also going to be a phase-out of personal exemptions; again, for high-income taxpayers.  And perhaps the major change here is there would be no qualified dividend treatment for high-income taxpayers.  This would change the tax rate on dividends from 15% to 43.4%.

I don't know what's going to happen here.  I mean, we all understand the double taxation of C-corporations, we all covered that in school.  But, at the end of the day, that may be unfair, but the way that the Administration is portraying this, when you look at tax returns like Mr. Buffett or Governor Romney, it jumps out to the average American that it seems unfair.

And you as a CPA may understand the analytics and why it's there, but it seems -- still seems unfair, it's becoming an election-year issue.  We don't know how this so-called "Buffett rule" may play out.

Now, capital gains.  Capital gains for high-income taxpayers would increase from 15 to 20%.  That would occur for sales after December 31st, 2012.  Interestingly enough, for the first time in our lives, we are probably -- or one of the few times in our lives, we are probably gonna be telling our clients to harvest gains, not to harvest losses.

So what that means is, if you have somebody that needs to live off their portfolio and they need to harvest cash out of their portfolio for the next three or four years' living expenses, we will have to run the math.

Now, let's say I was determining whether I should sell in December 2012 at 15% or January 2013 at 20% and I asked you, "What is the ROI on that?"  What you'd probably say is, "Well, Bob, you know, you're saving a nickel, 5%, by selling in 2012."  And if I just take and look at that, it looks like we're getting a 33% return -- 5% divided by 15% -- on your money for selling early, I think that's the math.  And I think, if you went two years, three years, we could all do the math.

And it does -- just because you sell doesn't mean you have to be out of the stock.  There is no wash gain rule.  And I think, if you cross trades, the government may challenge you under economic substance, but, if you -- you know, if you sell Pepsi on December 1st and you buy Coke or you -- that same day or you buy -- you re-buy the Pepsi two days later, I think you're still gonna have your upside in the market, but you will have harvested that gain and created a basis boost, which is gonna save you tax when you later sell at the 20% rate.

Couple other provisions we should be aware of.  One, I think, is a very good policy proposal and that's that RMDs would be eliminated on plan balances of $75,000 or less.  This is a very, very good idea.  It will cover something like well over half of retired taxpayers.  I know just -- sometimes, when I've done some things for people -- how confusing these RMD rules are to someone who hasn't had a lot of financial issues during their lifetime.  So this is -- this is a good rule.

Plus, what it's going to do is, as people live longer, it will give a little bit more retirement secretary.

Finally -- and this is a provision you should read on your own; I don't know if I can give it justice.  There is a proposal in here which is gonna limit tax expenditures; let me translate that for you.  That's Washington talk for limiting the value of tax deductions.

So itemized deductions for upper-income taxpayers would be limited to 28%; they would be limited to 28%.  This same proposal would change the taxation of tax-exempt interest, making some of that taxable; that's what I'm seeing.  And I'm not sure about the constitutionality of that; that's something that -- we will see how that plays out.

But you also have -- they're also gonna change the tax benefits -- this proposal would change the tax benefits of above-the-line deductions.  For example, I'll give you a quick list: Employer-sponsored health insurance; health insurance for the self-employed; defined contribution plans, the employee contribution side of that.  Would all only receive a tax benefit at 28%.

IRA contributions.  If you were an upper-income taxpayer and somehow you could make a deductible IRA contribution, that would only provide a tax benefit of 28%.  Domestic production activities would be limited to 28% tax benefit, along with moving expenses, HSAs and MSAs, interest on student loans, educational expenses.

Now, for most Americans, this would not affect anything, because they would not be in those upper brackets, but, for your clients in those upper brackets, they will lose some of the value of these deductions.

I do not have any idea how this is going to play out.  I think this is a proposal that is probably never gonna get through a Republican House of Representatives, but we just don't know and that's why we have to kinda ready for this.  And, to the extent we can work with our clients to get ahead of this, I think it's very, very wise.

On behalf of the AICPA, this has been Bob Keebler with Eileen Sherr, bringing you the President's budget proposal.


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