Legislative Update 46 - STATUS OF THE FEDERAL TRANSFER TAX LAW Real Estate, Probate & Trust Law

C. Notice 2010-19 45

III. Legislative Update 46

A distracted Congress adjourned last year without passing badly needed legislation to address the changes made to Federal estate, gift and generation-skipping transfer taxes by the Economic Growth and Tax Relief Reconciliation Act of 2001, Public Law 107-16 (“EGTRRA”). Under EGTRRA, the estate tax and the generation- skipping transfer tax are “not applicable” to the estates of decedent’s dying in 2010. Also, recipients of property from a decedent dying in 2010 will receive a basis equal to the lesser of the decedent’s adjusted basis or the property’s fair market value on the date of death. Further, an additional $1,300,000 (indexed for inflation in $100,000 increments) of basis can be allocated by the executor to appreciated property, and an additional $3,000,000 can be allocated to property transferred to a surviving spouse (including transfers to “QTIP-like” trust. The gift tax remains in effect for 2010, with a maximum rate of 35%. However on December 31, 2010 the provisions of EGTRRA “sunset” and its provisions will not apply to the estates of decedents dying, gifts made, or generation- skipping transfers made after such date. In general, the estate, gift and generation skipping rates and exemptions as in effect prior to January 1, 2002 will apply for estates of decedents dying, gifts made, or generation skipping transfers made on or after January 1, 2011.

This has given rise to what Senate Finance Committee Chairman Max Baucus characterized as “massive, massive confusion.” To further “confuse” matters, it is possible, if not probable, that Congress will reenact some form of the old estate tax rules retroactively for 2010. On December 16, 2009, in response to the failure of Congress to address the one-year estate tax repeal before the end of 2009, Senator Baucus stated “Clearly the correct public policy is to achieve continuity with respect to the estate tax. We clearly will work to do this [reenact the estate tax] retroactively, so that when the law is changed, it will have retroactive application.” While this indicates that some members of Congress will want to reenact an estate tax for 2010, it is impossible to predict what action, if any, Congress will take in an election year and the ultimate ramifications of any additional legislation passed in this arena.

This section will summarize the various proposals being discussed, possible timing of legislative action and the real problems that planners have been trying to address since January 1, 2010.

A. 2009

In 2009 H.R. 436, H.R. 498, H.R. 2023 and H.R 3905 were introduced (but not passed) in the House of Representatives, and (though Tax Legislation must be introduced in the House) S. 722 and S 2784 were introduced (but not passed) in the Senate. On May 11, 2009, the Treasury Department released its “General Explanations of the Administration’s Fiscal Year 2010 Revenue Proposals” (commonly referred to as the “Greenbook”). On September 8, 2009, the Joint Committee on Taxation (”JCT”) released the “Description of Revenue Provisions in President’s Fiscal Year 2010 Budget Proposal, Part One Individual Income Tax, Estate and Gift Tax Provision (“JCT Description”).

1. H.R. 436

This bill was introduced on January 9, 2009, by Rep. Earl Pomeroy (D- ND) and would:

 Freeze the exemption equivalent at $3,500,000;  Freeze the maximum rate at 45%;

 Add a 5% surtax for amounts between $10,000,000 and $41,500,000;

 Eliminate entity-based valuation discounts on transfers of non- tradable interests in entities holding non-business assets; and  Eliminate a minority discount or discount for lack of control on the

transfer of any non-tradable entity controlled by the transferor and the transferor’s ancestors, spouse, descendants, descendants of a spouse or parent, and spouses of any such descendants.

2. H.R. 498

This bill was introduced on January 14, 2009, by Rep. Harry Mitchell (D- AZ) and would:

 Increase the applicable exclusion amount from $3,500,000 to $5,000,000 in phases between 2010 and 2015;

 Adjust the applicable exclusion amount for inflation;  Freeze the maximum rate at 45%;

 Retain adjusted basis at death;

 Restore the full unified credit amount for gift tax purposes; and  Allow a surviving spouse to use the unused unified credit of a

deceased spouse. 3. S.722

This bill was introduced on March 26, 2009, by Sen. Max Baucus (D-MT) and would:

 Freeze the maximum rate at 45%;  Retain adjusted basis at death;

 Restore the full unified credit amount for gift tax purposes; and  Allow a surviving spouse to use the unused unified credit of a

deceased spouse. 4. H.R. 2023

This bill was introduced on April 22, 2009, by Rep. James McDermott (D-WA) and would:

 Reduce the applicable exclusion amount to $2,000,000;  Adjust the applicable exclusion amount for inflation;  Increase the maximum rate to 55%;

 Retain adjusted basis at death;

 Restore the credit for state death taxes;

 Restore the full unified credit amount for gift tax purposes; and  Allow a surviving spouse to use the unused unified credit of a

deceased spouse.

5. Treasury “Greenbook”

On May 11, 2009, the Treasury Department released its “General Explanations of the Administration’s Fiscal Year 2010 Revenue Proposals” (commonly referred to as the “Greenbook”) which proposes the following:

 Freezing the exemption equivalent at $3,500,000 and freezing the maximum rate at 45%;

 Requiring consistency in value for transfer and income tax purposes;

 Modifying “marketability” valuation discounts; and

 Requiring a minimum 10 year term for grantor retained annuity trusts.

6. Joint Committee on Taxation Description of Greenbook Proposals

On September 8, 2009, the Joint Committee on Taxation (”JCT”) released the “Description of Revenue Provisions in President’s Fiscal Year 2010 Budget Proposal, Part One Individual Income Tax, Estate and Gift Tax Provision (“JCT Description”). The JCT Description expands the proposal in the Greenbook as follows:

 Providing that if the estate tax value of an asset is increased on audit, the heir or donee’s basis is not correspondingly increased;  Additional approaches to valuation discounts including “look

through” and “aggregation” rules; and

 Valuation of the remainder interest in a GRAT for gift tax purposes at the end of the GRAT term when the remainder is distributed.

7. H.R. 3905

This bill, (the “Estate Tax Relief Act of 2009”) was introduced on October 22, 2009, by Rep. Shelley Berkley (D-NV) and Rep. Arthur Davis (D-AL) and would:

 For each of the years 2010 – 2019, increase the applicable exclusion amount by $150,000 ($5,000,000 in 2019) and decrease the maximum transfer tax rate by 1% (35% in 2019);

 For each of the years 2010 – 2019, reduce the state death tax credit by 10% (resulting in total elimination in 2019);

 Index the applicable exclusion amount for inflation for years after 2019; and

 Make certain other 2001 transfer changes permanent.

On November 19, 2009, Rep. Earl Pomeroy (D-ND) introduced H.R. 4145, the Permanent Estate Tax Relief for Families, Farmers, and Small Business Act of 2009. This bill was very simply proposed to permanently freeze 2009 law ($3.5 million estate tax exemption, $1 million gift tax exemption, 45% maximum rate, adjusted basis at death, a deduction (and no credit) for state death taxes, special rules for conservation easements and §6166 and allocation of generation-skipping tax exemption) for estates of decedents dying and gifts made, after December 31, 2009. On December 2, 2009 the House passed H.R. 4145 by a vote of 225-200. No Republicans voted for, and 26 Democrats voted against. Ten Representatives (3 Republicans and 7 Democrats) did not vote.

On December 16, 2009, Senator Max Baucus (D-MT) asked the Senate for unanimous consent to bring H.R. 4145 to the floor, approve an amendment to extend 2009 law for two months, and approve the bill as amended. In response, Senator Mitch McConnell (R-KY) asked Senator Baucus to consider an amendment reflecting “a permanent, portable, and unified $5 million exemption that is indexed for inflation, and a 35% top rate.).

On December 24, 2009 before it adjourned for the year, the Senate leadership arranged without objection to place H.R. 4145 on the Senate calendar as “read for the first time” and scheduled the second reading for the Senates next legislative day (sometime in January of 2010).

B. 2010

On January 20, 2010, H.R. 4145 was considered as having been read for the second time in the Senate. Accordingly, it now be can considered by the Senate at any time. On January 28, 2010, by a vote of 60-39 the Senate passed the Pay-As-You-Go Act, H. J. Res. 45, which contained a two year exception for continuing the 2009 estate tax law.

On March 16, 2010 H.R. 4849, the Small Business and Infrastructure Jobs Act of 2010 was introduced in the House. Section 307 of the bill contained a provision requiring a minimum 10 year term for grantor retained annuity trusts (as provided for in the Treasury “Green Book.”) On March 17, 2010 H.R. 4849 was favorably reported to the House by a vote of 25-15, and on March 24, H.R. 4849 was passed in the House by a vote of 246-178.

Also on March 16, Representative Sander Levin, the new acting chairman of the House Ways and Means Committee, that commented that the committee would begin work on retroactively reinstating the estate tax which expired on December 31, 2009. Mr. Levin stated that “the sooner we do it the better” and added that one possibility being considered would let heirs choose to pay the capital gains tax that replaced the estate tax if that is more beneficial. “I think the main point is we have to act,” Levin said. “I think this interval is not helpful; people need to be able to plan.”

Unfortunately, as of the deadline for submitting this article, Congress has done nothing to address the one year suspension of the federal estate and generation-skipping-transfer tax. This raises a number of issues in 2010. Further, the “sunset” provision contained in §901(b) of EGRTTA provides “The Internal Revenue Act of 1986 and the Employee Retirement Income Security Act of 1974 shall be applied and administered to estates, gifts, and transfers described in subsection (a) as if the provisions and amendments described in subsection (a) had never been enacted.” This creates a number of concerns for planning that will continue into 2011 and beyond. Some of these issues and concerns include:

 The interpretation of wills and trusts that include formula provisions based on estate and generation-skipping-transfer tax concepts that do not apply

in 2010 (to address this issue, some states have passed remedial legislation);

 Calculation of the estate tax for decedent’s who make gifts in 2010 at the 35% rate and die after 2010;

 How to allocate generation-skipping-transfer tax exemption to trusts created in 2010 and transfers made to pre-2010 GST trusts;

 The identity of the “transferor” and “skip persons” and the tax consequences of distributions and taxable terminations from trusts created in 2010;

 The application of the “move down rule” for 2010 trusts created for the exclusive benefit of grandchildren and their descendants;

 The ability to make a “reverse QTIP election” under IRC §2652(a);

 The effect of the “had never been enacted” sunset language on inclusion ratio of trusts to which more than $1 million of GST exemption had been previously allocated;

 The effect of the “had never been enacted” sunset language on a qualified severance of a GST trust from 2001 – 2009;

 The effect of the “had never been enacted” sunset language on a late allocation of GST exemption;

 The effect of the “had never been enacted” sunset language on deemed allocations of GST exemption;

 The effect of the “had never been enacted” sunset language on the basis of assets received from decedent’s dying in 2010; and

 The effect of the estate tax not applying in 2010 on the estate tax inclusion period (“ETIP”).

4/19/2010

Estate and Gift Tax Update

Harry W. Wolff, Jr.

Cox Smith Matthews Incorporated

112 East Pecan Street Suite 1800

112 East Pecan Street, Suite 1800

San Antonio, Texas 78205-1521

(210) 554-5500

State Bar of Texas Annual Meetingg

Hot Topics and Updates

4/19/2010

Estate of Petter v. Commissioner. T.C.

Memo 2009-280 (December 7, 2009

Another taxpayer victory upholding the use of a

defined value clause in connection with inter vivor gifts

and sale to grant trusts.

The specific language used for the gifts was as

follows:

“Transferor wishes to assign 940 Class T Membership

Units in the Company (the “Units”) including all of the

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d i t

t i

th

i

Transferor’s right, title and interest in the economic,

management and voting rights in the Units as a gift to the

Transferees.”

4/19/2010

Petter Gift Language Cont’d

Transferor * * *

1.1.1 assigns to the Trust as a gift the number

of Units described in Recital C above that

equals

one-half

the

minimum

dollar

amount that can pass free of federal gift

tax by reason of Transferor’s applicabley

pp

exclusion

amount

allowed

by

Code

Section 2010(c).

Transferor currently

understands

her

unused

applicable

l

i

t t b $907 820

th t

exclusion amount to be $907,820, so that

the

amount

of

this

gift

should

be

$453,910; and

4/19/2010

Petter Gift Language Cont’d

1.1.2 assigns to the Seattle Foundation asg

a gift to the A.Y. Petter Family Advised

Fund of the Seattle Foundation the

ff

f

difference between the total number of

Units described in Recital C above and

the number of Units assigned to the

Trust in Section 1.1.1.

4/19/2010

Petter Gift Language Cont’d

The gift documents also provided in section 1.2:

The Trust agrees that, if the value of the Units it

initially receives is finally determined for federal

gift

tax

purposes

to

exceed

the

amount

described in Section 1.1.1., Trustee will, on

behalf of the Trust and as a condition of the gift

to it, transfer the excess Units to The Seattle

Foundation as soon as practicable.

4/19/2010

Petter Gift Language Cont’d

The Foundations similarly agree to return

excess units to the trust if the value of the

units is “finally determined for federal gift tax

”

t

b

l

th

t

purposes”

to be less

than the amount

described in section 1.1.1.

4/19/2010

The specific language for the sales was as

follows:

“Transferor wishes to assign 8,459 Class T [or

Class D] Membership Units in the Company (the

“Units”) including all of the Transferor’s right, title

and interest in the economic, management and

oting rights in the Units b sale to the Tr st and

voting rights in the Units by sale to the Trust and

as a gift to The Seattle Foundation.”

4/19/2010

Petter Sale Language Cont’d

Transferor * * *

1.1.1. assigns and sells to the Trust the

number of Units described in Recital C

above that equals a value of $4,085,190

as finally determined for federal gift tax

purposes; and

4/19/2010

Petter Sale Language Cont’d

1 1 2

i

t

Th

S

ttl

F

d ti

1.1.2 assigns to The Seattle Foundation as

a gift to the A.Y. Petter Family Advised

Fund

of

The

Seattle

Foundation

the

Fund

of

The

Seattle

Foundation

the

difference between the total number of

Units described in Recital C above and the

number of Units assigned and sold to the

Trust in Section 1.1.1.

4/19/2010

Petter Sale Language Cont’d

“The Trust agrees that, if the value of the

Units it receives is finally determined to

exceed $4,085,190, Trustee will, on behalf of

the Trust and as a condition of the sale to it

the Trust and as a condition of the sale to it,

transfer the excess Units to The Seattle

Foundation

as

soon

as

practicable.”

Likewise, the Seattle Foundation agrees to

transfer shares to the trust if the value is

found to be lower than $4 085 190 ”

found to be lower than $4,085,190.

4/19/2010

Analysis – Savings Clause vs. Formula Clause

The Court distinguished the difference between “savings

clauses” and “formula clauses”.

“A shorthand for this

distinction is that savings clauses are void, but formula

clauses are fine

But figuring out what kind of clause is

clauses are fine.

But figuring out what kind of clause is

involved in this case depends on understanding just what it

was that Anne was giving away. She claims that she gave

stock to her children equal in value to her unified credit and

gave all the rest to charity. The Commissioner claims that

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y

she actually gave a particular number of shares to her

children and should be taxed on the basis of their now-

agreed value.

The plain language of the documents

shows that Anne was giving gifts of an ascertainable

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f

t

k

h

did

t

i

ifi

dollar value of stock; she did not give a specific

number of shares or a specific percentage interest in

the PFLLC. The number of shares given to the trusts

was set by an appraisal occurring after the date of the

gift

This makes the Petter gift more like a Christiansen

gift. This makes the Petter gift more like a Christiansen

formula clause than a Procter savings clause.

4/19/2010

Analysis - Public Policy Argument Rejected

The Court rejected the government’s public policy arguments

based on a general public policy encouraging gifts to charities

under United States v. Benedict, 338 U.S. 692 , 696—97

(1950) and the warning of the Supreme Court in

Commissioner v. Tellier, 383 U.S. 687, 694 (1996) concluding

as follows:

“In summary, Anne’s transfers, when evaluated at the y

time she made them, amounted to gifts of an aggregate

and set number of units, to be divided at a later date

based on appraised values. The formulas used to effect

these transfers were not void as contrary to public policy,

as there was no “severe and immediate” frustration of

public policy as a result, and indeed no overarching

public policy against these types of arrangements in the

first place ”

first place.

4/19/2010

Estate of Price v. Commissioner

T.C.

Memo. 2010-2 (January 4, 2010), is a

troubling case wherein the Tax Court held

th t

ift

f li it d

t

hi

i t

t

that gifts of limited partnership interests

did not qualify for the annual gift tax

exclusion

exclusion.

4/19/2010

Partnership Agreement Language

The PILP partnership agreement prohibited any

partner from withdrawing from the partnership and

contained the following restrictions on the transfer

and assignment of partnership interests:

“11.1

Prohibition Against Transfer.

Except as

hereinafter set forth no partner shall sell assign

hereinafter set forth, no partner shall sell, assign,

transfer, encumber or otherwise dispose of any

interest in the partnership without the written

consent of all partners; provided, however, a limitedp

; p

,

partner may sell or otherwise transfer his or her

partnership interest to a general or limited partner,

or to a trust held for the benefit of a general or

limited partner.

4/19/2010

Partnership Agreement Language – Cont’d

11.2 Assignment. Any assignment made to

anyone, not already a partner, shall be effective

only to give the assignee the right to receive the

share of profits to which his assignor would

otherwise be entitled, shall not relieve the

i

f

li bilit

d

t t

assignor from liability under any agreement to

make additional contribution to capital, shall not

relieve the assignor from liability under theg

y

provisions of the partnership agreement, and

shall not give the assignee the right to become a

substituted limited partner * * *

substituted limited partner.

4/19/2010

Analysis

In denying the annual exclusion, the Court declined to

reconsider its holding in Hackl v. Commissioner, 118

h

T.C. 279,294 (2002), affd. 335 F.3d 664 (7th

_{Cir. 2003),}

and applying the Hackl methodology, found that because

there was no ability to withdraw their capital accounts or

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t

ith

t

itt

t

f

ll

th

sell their interests without written consent of all other

partners, there was no immediate enjoyment of the gifted

interests. The Court also noted that there was no

immediate enjoyment of income from the gifted interests

because

the

partnership

agreement

provided

that

distributions were secondary to PILP’s primary purpose

of generating a long term reasonable rate of return

of generating a long-term reasonable rate of return.

4/19/2010

Economic Growth and Tax Relief

Reconciliation Act of 2001 (“EGTRRA”)

Under EGTRRA:



The estate tax and the generation-skipping transfer tax

are “not applicable” to the estates of decedent’s dying in

2010.



Recipients of property from a decedent dying in 2010 will

i

b

i

l t

th

l

f th

d

t’

receive a basis equal to the lesser of the decedent’s

In document STATUS OF THE FEDERAL TRANSFER TAX LAW Real Estate, Probate & Trust Law Section Program Hot Topics and Updates (Page 51-93)