What is the Future of Estate Tax?

It has been said that nothing in life is certain but death and taxes. This statement looks like it will continue to hold true; however, what is uncertain is what the estate tax will look like in the future. As many of you know, in 2001 President Bush changed the estate tax. However, his change was only temporary and will revert back in 2011 to the law that existed in 2001. In 2001, the estate tax was increased in increments until full elimination of the estate tax in 2010 and a sunset of the law in 2011 as follows:

Year of Death
Applicable Exclusion Amount
2008 $2,000000
2009 $3,500,000
2010 Taxes repealed
2011 $1,000,000

As you can see above, in 2009 the last increase in the exemption amount raises it to $3,500,000 per individual with an estate tax rate of 45%. This permits each couple to pass $7,000,000 free of tax to their families. However, 2011 would reduce the joint exemption to $2,000,000. With this prospect there have been discussions and proposed bills in the House and Senate to amend the estate tax permanently.

The Presidential election has placedmore focus on these proposals, as the estate tax has become a key issue for the candidates. Each candidate has taken a different position on the permanent change to the estate tax. It is important to note that the Republicans and Senator John McCain (R-Arizona) have backed away from their previous position for a permanent full repeal of the estate tax. This is most likely due to the economic condition in our country, including the war in Iraq, the stock market, the price of gas and the rising cost of food and other commodities. Before running for President in 2008, Senator McCain supported a proposal by Senator Jon Kyl (R-Arizona) that the exemption be raised to $5,000,000 and that the estate tax rate be reduced to 35%. Now that he is vying for the White House, Senator McCain is looking to increase the exemption to $5,000,000 per individual with a 15% to 20% estate tax rate. He would index the exemption for inflation over time.

Senator Barack Obama (D-Illinois) has not focused on the estate tax as much as Senator McCain. However, he has said that he supports an exemption of $3,500,000 and an estate tax rate of 45%. In essence, he would freeze the current estate tax law for 2009. He would index the $3,500,000 exemption for inflation.

The issue of the estate tax has not played a large role in the presidential debates. However, both the Democrats and the Republicans know that they must act to eliminate the repeal and then the sunset of the estate tax. The consensus between the parties is that legislation will emerge from Congress subsequent to the presidential election and will be sent to the new president for his signature. The legislation will be driven by the politics of both houses of Congress and the estimates of how much revenue will be lost as a result of the reform. The estimates and how they are characterized will depend, in part, on which party controls the House and the Senate in 2009.

Estate Tax Will Survive

We do not know which candidate will win the presidential election and whether such candidate will be successful in implementing his preferred plan for the estate tax. We do know one thing for sure, the estate tax will be an issue to address in your estate planning for some time to come. Most are pleased that it looks like the exemption amount will be increased regardless of who gets into office, and will thus provide much needed relief to many. However, there is still a need to address the estate tax in your lifetime planning and in the documents which take effect at death. Due to the depressed state of our economy and the low interest rates set by the government, currently there is a very effective lifetime planning tool that we recommend and use for our clients. This tool is called a Grantor Retained Annuity Trust (GRAT), a gift of a remainder interest in a trust. In other words, the gift is of the right of one or more remaindermen (either individuals or one or more trusts) to receive the GRAT assets at the end of a trust term. The grantor (the person who makes the gift to the GRAT) retains an interest in the GRAT in the form of an annuity for a term of years (e.g., ten years). Typically, the annuity is equal to a fixed percentage of the value of the assets transferred to the GRAT, but a GRAT can be designed with increasing annuity payments. The annuity must be paid, at least annually, during the GRAT term. The value of the annuity is determined by reference to an IRS interest rate (the “7520 rate”) which is set each month. The rate for the month in which the transfer to the GRAT is made is utilized. The 7520 rate for September is 4.2%. The value of the annuity is subtracted from the value of the property placed in the GRAT and the difference is the taxable gift.

All of the GRAT income, including income accumulated in the GRAT because it is not needed to pay the annuity to the grantor, is taxable to the grantor. This typically also applies to gains. Payment of tax on the accumulated income and gains of the GRAT by the grantor enables the GRAT assets to appreciate tax-free and is an added estate planning benefit of the GRAT. If the assets produce income and grow at a rate above the 7520 rate (4.2%) the GRAT could be very successful in transferring wealth to the remainderman at a minimal or no gift tax cost.

The future of our economy is clearly uncertain. However, it does seem that nothing in life is certain but death and taxes.

AnnMarie P. Smits is a Partner at WJ&L and serves as the Chairperson of our Tax, Trusts, and Estates Department.

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