New Hazards for Family Estate Plans

You thought your estate
plans were finally set? Not so fast. It turns out the “permanent” $5
million estate-tax exemption enacted earlier this year could change after all,
sending families back to the drawing board to sort out their strategy. A
provision in President Barack Obama’s fiscal year 2014 budget calls for
lowering in 2018 the estate-, gift- and generation-skipping-transfer-tax
exemption limits.
Those limits were just made
“permanent” in January at $5 million and indexed for inflation. (This
year’s exemption is $5.25 million.) The Obama administration proposed lowering
the exclusion to $3.5 million for estate and GST taxes, and to $1 million for
gift tax. Those amounts—a return to 2009 levels—would no longer be indexed for
inflation. All three tax rates would go up, too, with the top rate rising to
45% from the current 40%. But wasn’t the $5-million-plus exemption made
permanent just four months ago?
“Permanent doesn’t
mean Congress will never revisit it. It just means there’s no expiration date
built into it,” says Bruce Steiner, an estate-planning lawyer at Kleinberg
Kaplan Wolff & Cohen in New York. If the proposal gathers steam and is
enacted, he predicts “the same thing as last December, with another big
flood of people giving away assets because they can,” he says. If you feel
like the estate-tax exemption limit has bounced around a lot, you’re right. It
has been changing every few years since 2001. Even some lawyers who get to
charge by the hour are frustrated.
“We just need
stability,” says Christine Finn, a lawyer at Marcum LLP, a New York
accounting and advisory firm. “With the $5 million limit now [for estate
and gift taxes], it’s going to be hard to get people back to thinking about the
planning they’d need to do if the gift-tax rates go back down to $1
million.” Still, ratcheting down the three exemptions and closing other
“estate-tax loopholes” would raise $79 billion over 10 years,
according to the budget proposal. The budget includes other ways to cut the
deficit that could affect family inheritance planning as well. Here’s what to
• Discounts could
 Now, if you give a family member a minority share in your
business, an appraiser legally can discount its value. The reasoning: A
minority owner lacks control of the asset, can’t liquidate it, can’t get income
from it unless the business makes a distribution and can’t sell it easily. Mr.
Obama’s annual budget proposals have called for limiting, or getting rid of,
such discounts to family members—until now. Gordon Schaller, an estate-planning
lawyer in Irvine, Calif., contends that the provision’s absence from this
year’s proposed budget could mean that “they’re getting ready to issue
regulations to do it, so they don’t need to talk about legislation
anymore.” If that happens, families wouldn’t be able to transfer as much
wealth effectively tax-free, Mr. Schaller says. So families who have been
considering such transfers should make them now.
• GRATs could get
watered down.
 So-called grantor-retained annuity trusts, or GRATs, let
people give a portion of an asset’s future profits to heirs tax-free. The
trusts have been popular tools for passing along battered stocks, especially
because GRATs work best when interest rates are low. But GRATs also have been a
target in Mr. Obama’s budget proposals for several years. The person who sets
up the trust gets annual payments adding up to the asset’s original value, plus
a return based on a fixed interest rate set by the Internal Revenue Service.
That rate currently is only 1.4%.
When you give an asset to a
GRAT, you retain the right to regular payments for a set time period. What you
actually are giving away is any future appreciation on the asset—free of taxes.
When the GRAT’s term ends, the asset goes to the beneficiaries free of gift or
estate tax on the appreciation, even though it has been transferred. The
biggest risk is that the owner will die before the trust expires, generally
subjecting its entire value to estate tax. Because of that risk, GRATs
typically are set up with shorter terms, such as two years. But the proposed
budget would require GRATs to have a minimum term of 10 years. The change is
expected to generate $3.9 billion in 10 years. “If you’re thinking about
setting up a GRAT, do it now while you know you can, because you may not be
able to do it as favorably tomorrow,” Mr. Steiner says.
• Thousand-year
trusts could get shortened.
 In the 1980s, many states adopted a
statute that limited family trusts to a 90-year span. But since then, about
half the states have repealed that rule or lengthened the “permissible
perpetuities period,” in some cases to as long as 1,000 years, Mr. Steiner
says. Such lengthy trusts can keep large chunks of wealth out of the tax man’s
reach for decades, or maybe even forever, he adds. But Mr. Obama’s budget
proposal, echoing provisions called for in previous years, would have the
generation-skipping-transfer exemption expire after 90 years, making the assets
subject to taxes at that point. Since the proposal would apply only to new
trusts created after its enactment, you might want to set up your trust now,
Mr. Steiner says.
• Individual
retirement accounts could get emptied faster
. People who inherit IRAs and
other tax-deferred retirement accounts are allowed under current law to
“stretch” their withdrawals across their life expectancy, paying
income tax only on distributions. The budget proposal would require most heirs,
other than widows or widowers, to empty retirement accounts within five years.
The measure would raise almost $5 billion in 10 years, the budget proposal
claims. The move already has prompted some older adults whose wealth is
concentrated in IRAs to consider moving them into trusts to help their families
keep up with, and follow, the rules correctly. And people who had planned to convert
IRA holdings to Roth IRAs are starting to reconsider. IRA owners have to pay
income tax on any tax-deferred assets being converted, but future withdrawals
are income-tax-free, even for heirs, as long as they meet holding requirements.
If stretching the withdrawals past five years is no longer possible, there
could be less advantage to paying the upfront tax bill. Source: