Transfer Taxes in Transition: Year End Pitfalls and Opportunities Co-Presenters: Thomas E. Peckham, Esquire Partner, Bingham McCutchen LLP (Boston) George L. Cushing, Esquire Partner, K&L Gates (Boston) Moderator: Michael L. Brown, J.D., CPA President, Boston Financial Management

2 Transfer Taxes in Transition What is Going On with the Federal Estate Tax Gift Tax Generation-Skipping Transfer Tax Income Tax

3 Transfer Taxes in Transition What Planning Opportunities should we consider? Taking advantage of expiring provisions in the law – repeal of estate tax, GST Possible changes in the law Low interest rates High dividend yields

4 Transfer Taxes in Transition Estate Tax – the estate tax was allowed to expire for decedents dying in 2010 Unless Congress acts, the estate tax will be reinstated for decedents dying in 2011 or later. The “exemption” will be $1,000,000; the top rate will be 55%.

5 Transfer Taxes in Transition Gift Tax -- The gift tax remains in effect for The top gift tax rate is 35%. The “exemption” is $1,000,000.

6 Transfer Taxes in Transition Interlude: Why is “exemption” in quotation marks? What we have is a credit equal to the amount of the “tentative tax” that would result from a gift of $1,000,000 under the current gift tax rates, REDUCED BY The sum of the amounts allowed as credits against the gift tax previously. (See Sections 2505(a)(1) and (2).)

7 Transfer Taxes in Transition What difference does it make? Suppose client made a taxable gift of $900,000 in Gift tax would have been $306,800 and would have been completely offset by credit. Suppose client makes an additional taxable gift of $100,000 in At a 35% top tax rate, tax would be $35,000. What credit is available?

8 Transfer Taxes in Transition Under 2010 rates, tax on gifts of $1,000,000 would be $330,800. This credit amount must be reduced by credit previously used, $306,800, leaving an available credit of $23,200. $35,000 is greater than the $23,200 credit; an out of pocket gift tax payment would result! TRAP FOR THE UNWARY!

9 Transfer Taxes in Transition GRATs – Short and Long-Term In April 2009 the Administration proposed a minimum term of 10 years The remainder could not have a zero value Annuity payments could not be front-end loaded; they could not decrease

10 Transfer Taxes in Transition Short-term GRATs Rumors that these changes would be included in tax legislation enacted over the summer of 2010 proved to be false The ten year minimum term was dropped from the Senate Bill and no vote on the revised Bill was ever taken

11 Transfer Taxes in Transition Point: Consider Funding Short-Term GRATs in 2010 to beat possible repeal Short-term GRATS are an ideal way to take advantage of low 7520 rates -- only 1.8% in December. Advantages of short-term over long-term GRATs Reduced Mortality Risk Enhanced Volatility

12 Transfer Taxes in Transition Counterpoint! Long-term GRATs aren’t always a bad thing – especially when planning with discountable interests in “pass-through” entities with good cash flow! Consider using insurance to hedge against mortality risk.

13 Transfer Taxes in Transition Consider using other techniques to take advantage of low AFRs Short-term AFR (3 years or less).32% Mid-term AFR (3 years - 9 years) 1.53% Long-term AFR (over 9 years) 3.53%

14 Transfer Taxes in Transition Techniques that take advantage of low interest rates: Intra-family loans Installment sales Refinancing existing installment obligations Note that low interest rates are bad for QPRTs in general, but enhance value of reversionary interest -- especially important with older clients

15 Transfer Taxes in Transition Techniques that take advantage of low interest rates: Consider installment sale of preferred LLC interest Yields on preferred stock are currently high Interest rates are very low Great arbitrage potential!

16 Transfer Taxes in Transition Generation-Skipping Transfer Tax – The GST has also been repealed for generation- skipping transfers in Unless Congress acts, the GST will be reinstated for generation-skipping transfers in 2011 and later years. The top tax rate will be 55%; the exemption will be $1,000,000, indexed for inflation – this is expected to be $1,360,000 for 2011.

17 Transfer Taxes in Transition How are transfer taxes likely to change? Who knows? “Bush tax cuts” could be allowed to expire 2009 transfer tax laws could apply temporarily starting in transfer tax laws could apply retroactively to 2010 as well as to later years

18 Transfer Taxes in Transition The estate tax could be repealed -- temporarily or permanently

19 Income Taxes in Transition Modified Carryover Basis Beneficiaries inherit assets at the decedent’s cost basis; Executor may allocate up to $1,300,000 of “Basis Increase” to decedent’s assets, up to FMV of each at date of death.

20 Income Taxes in Transition Adjustment to be made by Executor on Form Form not yet been released. Form theoretically due with decedent’s final income tax return (i.e., April 15, 2011 unless extended). Amount may be increased by decedent’s unrealized losses and loss carryovers.

21 Income Taxes in Transition Additional adjustment permitted for assets passing to a surviving spouse of up to $3,000,000 in “Qualified Spousal Property.” Qualified Spousal Property is either property transferred to spouse outright or QTIP-able property. “Basis increase” for NRAs limited to $60,000.

22 Income Taxes in Transition Property Eligible for Basis Increase In order to be eligible for “Basis Increase,” property must be: Owned outright by decedent (solely, jointly or as community property); or Owned through a revocable trust that would qualify for an IRC § 645 election Not eligible for basis increase: Property held in a QTIP Trust for decedent Property over which decedent holds power of appointment

23 Income Taxes in Transition MA basis issues: No “step-up” under current law in spite of estate tax on decedent’s assets. Unclear whether MA will respect federal basis of assets to which “Basis Increase” has been allocated. MA legislative proposal pending.

24 Transfer Taxes in Transition Planning Opportunities – Make taxable gifts in % gift tax rate is likely to be less than future gift tax and estate tax rates. Massachusetts does not impose a gift tax; Massachusetts taxable estate would be reduced by amount of gift. If donor lives 3 years after the gift, any money used to pay gift tax will escape estate tax.

25 Transfer Taxes in Transition Risk of Donor’s Death in 2010 after Making Taxable Gifts Gift tax would have been needlessly incurred. This risk can be lessened by making transfer to a revocable trust which, by its terms, becomes irrevocable on the first to occur of the donor’s death or 11:59 p.m. on December 31, No section 2035 issue if power to revoke trust terminates by its terms. Do not release power!

26 Transfer Taxes in Transition Other things that could go wrong: Estate tax could be repealed Estate tax rate could be reduced to less than 35% Exemption could be increased so much that decedent’s assets would not have been taxable Assets given away could decrease in value

27 Transfer Taxes in Transition Possible Pitfall: MA Estate Tax Where decedent has made taxable gifts prior to death that have consumed entire unified credit, no longer have a $1M MA estate tax “exemption” $1M is amount of state death tax eliminated by federal unified credit on first $1M of estate assets, based on 2000 estate tax law If unified credit has been consumed, actual exemption available is only $60,000 If you have estate involving decedent who has made large taxable gifts (perhaps in order to reduce taxable estate below $1M), be aware that estate may nevertheless be taxable - particularly if you intend to seek an extension of time to file (must pay 80% of tax due or extension will be “void”)

28 Transfer Taxes in Transition Planning Opportunities – GST Outright direct skip gift in Again, must deal with risk of death before end of year. Make outright distributions to skip persons from non-exempt generation-skipping trusts before end of year.

29 Transfer Taxes in Transition Planning Opportunities – GST – How to deal with risk of retroactive legislation? Disclaimer planning.

30 Transfer Taxes in Transition Problem with “sunset legislation” -- several helpful EGTRRA provisions, such as qualified severances and certain GST exemption allocations will not apply in 2011 or later unless Congress acts.

31 Transfer Taxes in Transition If a decedent dies in 2010, when there is no estate tax, and leaves assets to what would otherwise be a generation-skipping trust, would the GST apply to distributions to skip- persons in later years?

32 Transfer Taxes in Transition For a great discussion of the application of the sunset provisions to the Generation Skipping Transfer Tax, see McCaffrey and Schneider, “Time Traveling and Generation- Skipping in 2010 and Beyond,” appearing in the July 26, 1010 issue of Tax Notes.

33 Transfer Taxes in Transition Planning Issues – GST – Irrevocable Life Insurance Trusts How to deal with Premium Payments? Late allocation of GST exemption? Risks Timing

34 Transfer Taxes in Transition Planning Issues – GST – Irrevocable Life Insurance Trusts How to deal with Premium Payments? Loan amount required for premium to the trust?

35 Transfer Taxes in Transition Inter Vivos QTIP Trusts Ideal vehicle to keep all options open Trust is QTIP-able and thus could qualify for gift tax marital deduction if gift tax retroactively raised from 35% to 45%. Election not due until as late as October 15 th, 2011(on Donor’s 2010 gift tax return) Spouse can also disclaim for up to 9 months and allow property to pass to alternate family beneficiaries or to revert to Donor (desired outcome must be drafted into the trust terms)

36 Transfer Taxes in Transition Consider gifts of appreciated property to terminally ill spouse Takes advantage of “Basis Increase” available to such spouse $1,300,000 Basis Increase:  Donee spouse bequeaths donated property to discretionary trust for donor spouse and descendants (eligible for $1,300,000 Basis Increase)

37 Transfer Taxes in Transition $3,000,000 Basis Increase  Unlike Section 1014(e) restriction, property given to a spouse may be bequeathed back to donor spouse without restriction as to time and $3,000,000 Basis Increase will be fully available.  However, since spouse may not die in 2010 and 1014(e) may be revived with pre-EGTRRA laws, consider having Donee spouse bequeath donated assets to QTIP-able Trust for donor spouse if death occurs within one year

38 Transfer Taxes in Transition Client Considerations Review existing Marital Deduction and GST Formula Clauses (especially for clients of advanced age or in poor health) MA has not enacted a “patch” law that will construe a tax driven formula bequest which relies on federal estate and or GST Tax exemption amounts to determine funding of marital/by-pass/GST Tax exempt trusts based on 2009 tax law.

39 Transfer Taxes in Transition Client Considerations Possible to seek judicial constructions of will or trust but concerns about possible need to have Bosch protection of SJC decision.

40 Transfer Taxes in Transition QDOTs Terminating QDOTs by full distribution – a trap for the unwary? Suggestion is that in 2010 you “disqualify” existing Qualified Domestic Trusts (QDOT) for the benefit of non-citizen surviving spouses of decedents who died prior to 2010.

41 Transfer Taxes in Transition QDOTs Disqualification causes surviving (non-citizen) spouse to be treated as having died immediately. Disqualification can be accomplished by having US citizen or domestic corporation trustee resign and appointing n on US trustee.

42 Transfer Taxes in Transition QDOTs Death of spouse non taxable? No; estate tax on QDOT is tax computed on earlier decedent’s estate which was deferred due to existence of QDOT. Disqualification will accelerate (but not avoid) delayed estate tax since tax will be collected based on estate tax rates and exemptions available in the year of the death of the earlier decedent.

CARNAC THE MAGNIFICENT TAX WIZARD Investment Council Wealth Management

44 CARNAC THE MAGNIFICENT Answer: SIS BOOM BAH! Investment Council Wealth Management

45 Question: Describe the sound made when a sheep explodes! Investment Council Wealth Management

46 CARNAC THE MAGNIFICENT Answer: George Clooney Brad Pitt Jon Hamm George Cushing Tom Peckham Investment Council Wealth Management

47 Question: Name 5 men who were NOT selected as “Sexiest Man of the Year” by People Magazine! Investment Council Wealth Management

48 CARNAC THE MAGNIFICENT Answer: 13% Investment Council Wealth Management

49 Question: How much will the top tax bracket increase in 2011? Investment Council Wealth Management

50 CARNAC THE MAGNIFICENT Answer: 25% Investment Council Wealth Management

51 Question: How much will the Capital Gains tax increase in 2011? Investment Council Wealth Management

52 CARNAC THE MAGNIFICENT Answer: 264% Investment Council Wealth Management

53 Question: How much will the tax on Dividends increase? Investment Council Wealth Management

54 CARNAC THE MAGNIFICENT Answer: Who the hell knows? Investment Council Wealth Management

55 Question: Will Congress roll back the 2011 tax increases? Investment Council Wealth Management

56 CARNAC THE MAGNIFICENT Answer: To Save Taxes…Stupid! Investment Council Wealth Management

57 Question: Why would someone accelerate gains? Investment Council Wealth Management

58 CARNAC THE MAGNIFICENT Answer: With an IRA Rollover Switcheroo! Investment Council Wealth Management

59 Question: How do you avoid underpayment penalties? Investment Council Wealth Management

60 CARNAC THE MAGNIFICENT Answer: George Cushing, Esq. Tom Peckham, Esq. Investment Council Wealth Management

61 Question: Name two world famous attorneys we want to thank for a great talk this morning! Investment Council Wealth Management

62 Transfer Taxes in Transition Stump the Chumps (Thanks, Car Talk!) Questions? Answers?