February 15, 2012
Obama's Budget Proposal Part II
Require a Minimum Term for Grantor Retained Annuity Trusts (GRATs)
Currently: If a grantor transfers an interest in a trust to a family member, for purposes of determining the transfer tax value of a gift to family members, the value of any interest retained by the grantor is zero. If the retained interest is a qualified interest, the rule does not apply. A fixed annuity, like the annuity interest retained by the grantor of a GRAT is a type of qualified interest. The gift of the remainder interest is found by subtracting the present value of the retained annuity during the GRAT term from the fair market value of the property contributed to the trust.
Proposed Change: GRATs have aided people in transferring wealth and minimizing the gift tax cost of transfers as long as the grantor survives the GRAT term and the trust assets do not appreciate in value. Taxpayers have kept the GRAT term short to reduce the risk of the grantor’s death during that period and have reduced the gift tax value of their remainder interest to little or nothing. Obama proposes that the GRAT term be a minimum of ten years and a maximum term of the life expectancy of the annuitant plus ten years. The proposal also requires that the remainder interest have a value greater than zero when created and prohibit a decrease in the annuity during the GRAT term. A longer minimum period increases the risk of using these devices.
Limit Duration of Generation-Skipping Transfer Tax Exemption
Currently: The GST is imposed on gifts and bequests made to transferees who are two or more generations younger than the transferor. The GST was imposed so that people could not avoid estate and gift taxes through a trust that gives successive life interests to multiple generations of beneficiaries. The GST tax is a flat tax on the value of the transfer determined by what the highest estate tax bracket is that year. Each individual has a lifetime GST tax exemption ($5,120,000 in 2012) that can be allocated to transfers made. At the time that the GST was enacted, most states had the law against perpetuities and all trusts had to terminate no later than 21 years after the death of a life in being at the time of the creation of the trust.
Proposed Change: Now that many states have repealed the rule against perpetuity statutes, trusts created subject to the law of these states can continue in perpetuity. Now, the transfer tax protection that the GST exemption provided is effectively expanded from trusts funded with $1 million to trusts funded with $5,120,000 and continuing indefinitely. Obama proposes that on the 90th anniversary of a trust, the GST exclusion shall terminate.
Coordinate Certain Income and Transfer tax Rules Applicable to Grantor Trusts
Currently: Grantor trusts are irrevocable or revocable trusts where an individual is treated as the owner for income tax purposes. A grantor trust is taxed as though the grantor or another person owns the trust assets directly, The owner and the trust are treated as one, so transactions between the trust and the deemed owner are ignored. For transfer tax purposes, the trust and the owner are separate persons and under some circumstances, the trust is not included in the owner’s gross estate for estate tax calculations at the time of death.
Proposed Change: The current inconsistency allows for individuals for the deemed owner to make transactions with the trust that result in significant wealth transfer free of the transfer tax. Obama’s proposal suggests that the owner’s trust assets be included in the gross estate of that grantor for estate tax purposes, be subject to gift tax for any distribution to one or more beneficiaries during the grantor’s life, and for the remaining trust assets to be subject to gift tax at any time during the grantor’s life if the grantor ceases to be the deemed owner at any point in his life. The proposal would also apply to non-grantor owners of the trusts who engage in sale, exchange, or comparable transaction with the trust that would have been subject to capital gains if they were not deemed the owner of the trust. In these cases, the portion of the trust attributable to the property received by the trust in that transaction would be subject to transfer tax.
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