Changes to Estate/Gift Tax Laws

The Congressional Research Service (CRS) has issued a report in which it notes predictions of the effects of changes made to the estate, gift and generation skipping transfer (GST) taxes by the American Taxpayer Relief Act of 2012 (ATRA) and discusses recent proposals by Congress and the Administration to change those taxes.

Background-the estate and gift taxes from 2001 until the present. Under the Economic Growth and Tax Relief Act of 2001, the estate tax exemption rose from $675,000 in 2001 to $3.5 million in 2009, and the top tax rate fell from 55% to 45%. The gift tax exemption was, however, restricted to $1 million.

For 2010, EGTRRA scheduled the elimination of the estate tax, although it retained the gift tax and its $1 million exemption. EGTRRA also provided for a carryover of basis for assets inherited at death. However, that provision had a $1.3 million exemption for gain (plus $3 million for a spouse).

As with other provisions of EGTRRA, the above tax revisions were to expire in 2011, returning the tax provisions to their pre-EGTRRA levels. The exemption would have reverted to $1 million (a value that had already been scheduled for pre-EGTRRA law) and the rate to 55% (with some graduated rates). The carryover basis provision effective in 2010 would be eliminated.

During debate on the estate tax that took place before the EGTRRA provisions were scheduled to expire, President Obama proposed a permanent extension of the 2009 rules (a $3.5 million exemption and a 45% tax rate). Senate Minority Leader McConnell proposed an alternative of a 35% tax rate and a $5 million exemption. A similar proposal for a $5 million exemption and a 35% rate, which also included the ability of the surviving spouse to inherit any unused exemption of the decedent, was made in the Senate. At the end of 2010, a temporary 2-year extension, with a $5 million exemption, a 35% rate, and inheritance of unused spousal exemptions was enacted in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. These provisions provided for estate tax rules through 2012, and absent legislation, the provisions would have reverted to the pre-EGTRRA rules ($1 million exemption, 55% top rate).

ATRA established a permanent exemption  and portability of unused spousal exemption.

CRS cites predictions of effects of ATRA. Citing a 2010 report by the Tax Policy Center, CRS said that, compared with pre-existing law (a $1 million exemption and a 55% rate), the ATRA revision was projected to lose $369 billion in revenue from fiscal year (FY) 2013 to FY 2022. This change reduced total projected revenue from the estate tax by about two-thirds. CRS also noted the following predictions:

  • The estate tax would affect less than 0.2% of decedents over the first post-ATRA decade.
  • The estate tax would be concentrated among high income taxpayers: 96% would be paid by the top quintile, 93% by the top 5%, 72% by the top 1%, and 42% by the top 0.1%.
  • About 0.2% of estates with half or more of their assets in businesses would be subject to the estate tax.
  • About 65 farm estates per year are projected to be subject to the estate tax, and constitute 1.8% of taxable estates. Less than a fourth of those 65 are projected to have inadequate liquidity to pay estate taxes. 0.8% of farm operator estates are projected to pay the tax.
  • About 94 estates per year, that have at least half their assets in small business and who expect their heirs to continue in the business, are projected to be subject to the estate tax; they constitute 2.5% of total estates. Less than half of the 94 are projected to have inadequate liquidity to pay estate taxes.

CRS discusses some proposals to change the estate and gift taxes. Congressional Republicans and a few Congressional Democrats have favored repeal of the estate tax, while other proposals, principally put forth by the Obama Administration, seek to increase the tax and/or close loopholes in the tax.

Repeal of estate tax. which was passed by the House on April 16, 2015, would repeal the estate tax for estates of individuals dying on or after the date of enactment. The bill would also repeal the GST tax for such transfers made on or after the date of enactment. In addition, H.R. 1105 would lower the top marginal gift tax rate from 40% to 35%. The bill is estimated to cost $269 billion for the 10-year period from FY 2015 – FY 2025. S. 860 has similar provisions.

Return to 2009 rates and exemptions. The Administration’s FY 2016 budget proposes to restore the 2009 higher rates and lower exemptions.

Grantor retained annuity trusts. A grantor retained annuity trust (GRAT) is a trust that allows the grantor to receive an annuity, with any remaining assets transferred to the trust recipient. The value of the gift is reduced by the value of the assets used to fund the annuity. If the assets in the trust appreciate substantially, then virtually all of the gift can be reduced by the value of the annuity, while still providing a substantial ultimate gift to the recipient.

The GRAT proposal in the President’s budget proposal, much of which was also in his past budget proposals, would impose a minimum annuity term of 10 years, disallow any decline in the annuity, and require the remainder interest in the GRAT to have a value greater than zero at the time the interest is created. It would impose a maximum term of the annuitant’s life plus 10 years.

Minority discounts. There are existing restrictions to keep estates from engaging in artificial actions designed to reduce the value of estates (such as freezes on assets). However, courts sometimes allow estates to reduce the fair market value when assets are left in family partnerships in which no one has majority control. These discounts have even been allowed when assets are in cash and readily marketable securities, and the setting up of these family partnerships has become an estate tax avoidance tool. A provision to limit the use of minority discounts is not in the current budget proposal, but it has been proposed in the past.

Limit length of generation-skipping trusts. When generation-skipping transfers are made to a trust, the estate tax exemption applicable to them also exempts the associated earnings during the trust’s lifetime. In the past, a trust life has been limited because most states had a Rule Against Perpetuities that generally limited trusts to a 21-year life. Most of these laws have been eliminated. The Administration would limit the life of a GST trust to 90 years.

Estate tax liens. Currently, IRS has a lien on estate tax deferrals for closely held business, but these liens are for 10 years, shorter than the deferral period. A proposal would extend the liens through the deferral period.

Gift and GST exclusion for medical care and education. Currently, payments for medical care or education made directly to the provider for another are exempt from the generation-skipping tax and the gift tax.  Taxpayers have been using trusts to eventually pay for these expenses and avoid tax on the accumulations. The Administration indicates that the original purpose of this provision was to exempt payments between living persons and would disallow exemptions for payments to trusts.

Limit the use of Crummey trusts. A “Crummey” trust typically gives the beneficiary of the trust (or a guardian if the beneficiary is a minor) the right to demand distribution of any additional property transferred to the trust by the donor during the year, up to a specified amount. The power of withdrawal is noncumulative and must be exercised within a specified period. If the power to withdraw is not exercised, it lapses as to additions made during that year. This type of trust is designed to get the gift tax annual exclusion for present interests while limiting the beneficiary’s right to use the property.

A proposal would disallow the unlimited use of Crummey trusts by imposing an additional overall limit of $50,000 on gifts made via trusts.

Coordinate grantor trust income and transfer tax rules. In a grantor trust, an individual is treated as owner for income tax purposes. However, the trust and the individual are treated as separate persons for purposes of the estate and gift tax.

A previous year proposal from the Administration would include the assets of the trust in the grantor’s estate and subject distributions to the gift tax if the grantor is the owner for income tax purposes. If the grantor ceases to be the owner, the assets would be subject to a gift tax.