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"Last Chance" Estate Planning May End Soon

"Last Chance" Estate Planning May End Soon
This article was first published in the Orange County Business Journal, February 13, 2012

Much has been written about the perfect storm of estate planning: the coincidence of low values, low interest rates, valuation discounts and the $5 million ($10 million for a married couple) gift and estate tax exemption. Unfortunately, the $5 million gift and estate tax exemption ends (reverting to $1 million) after December 31, 2012. Values of certain assets are increasing. However, most importantly, valuation discounts may be severely restricted at any time by IRS regulations. Thus, the best opportunities may close well before December 31, 2012. Don’t wait for this "last chance" at once-in-a-generation estate planning.

Over the last three years of economic crisis and unfunded legislative spending, extraordinary deficits have been created and will continue for years to come. Congress and the Administration continue to examine all available means for raising new tax revenue, including additional gift and estate tax revenue. The Administration’s revenue raising proposals for the last three budgets, include: (1) disregarding valuation discounts applicable to certain restrictions on transfer of interests in family-controlled entities; and (2) limiting grantor retained annuity trusts to a minimum 10-year term. In addition, the IRS has for several years maintained that it has the authority to restrict or eliminate valuation discounts by regulation. Several political and legal factors suggest that such regulations could be issued at any time, effective on the date of publication, without an opportunity for notice and comment. President Obama has promulgated the "We Can’t Wait" doctrine to justify extensive regulatory actions and bypass Congress. If there is political concern regarding the potential outcome of the 2012 elections, there is strong incentive to implement more "can’t wait" regulations, including eliminating family valuation discounts.

Many traditional planning techniques employ valuation discounts to enhance the transfer of wealth to heirs with little or no gift or estate tax consequences. For example, a Grantor Retained Annuity Trust ("GRAT") allows a person to transfer assets to a trust in exchange for payment from the trust of a yearly amount that includes an interest factor set by the IRS, which is 1.4% for February 2012. Valuation discounts effectively lower the required annual payment, thus increasing the amount that passes to the beneficiaries when the GRAT ends. This has been a favorite wealth transfer
technique of the rich and famous, including the Gates, Buffet and Walton families, and numerous Google millionaires.

Elimination of family valuation discounts would impact many other conventional planning techniques. One is a sale to an intentionally defective grantor trust ("sale to a DGT"). A sale to a DGT has several advantages over a GRAT. Another technique that would be impacted is a transfer to a charitable lead annuity trust ("CLAT"). The CLAT is a Trust to which the grantor transfers assets and the Trust pays a yearly amount to a charity for a period of years, after which any remaining trust assets pass to the grantor’s children or other beneficiaries. The annuity payment is a fixed percentage of the initial value of the assets transferred to the CLAT, including valuation discounts. The value of the gift to the remainder beneficiaries is measured by the initial discounted value of assets, value of the annuity payments, and term. There are many nuances applicable in considering these and other planning techniques that should be reviewed with a qualified estate planning professional.

Finally, the grand revenue raiser – rates and exemptions. No one would have predicted that 2010 would be the year with no estate tax or that the gift and estate tax exemptions would increase to $5 million with a maximum estate and gift tax rate of 35% in 2011 and 2012. Now, the specter of huge 2013 estate and gift tax increases looms. This window of opportunity, combined with the possible loss of valuation discounts, should create some urgency for those desiring to transfer wealth to children and grandchildren. Advisors and clients should act now.