No Estate and Gift Tax Reform

Fall, 2007

No Estate and Gift Tax Reform

Our Summer 2006 Advisory focused on the then recent developments in the legislative efforts to repeal or at least revise our Federal estate and gift tax rules.  Those efforts were not successful, and we now approach an election year when expansive tax legislation would not normally be anticipated.

The question remains – Will Congress deal with the uncertainty in our transfer tax system before 2010, when the estate tax is scheduled to be repealed followed in 2011 by a return to the reduced exemption and higher rates that applied in the year 2000?  On October 4, 2007, Max Baucus, the Democrat from Montana who chairs the Senate Finance Committee, announced his intention to hold a hearing later this year on estate tax reform with hopes of presenting an estate tax reform bill by Spring, 2008.  At this stage, most tax practitioners do not overreact to such comments.

Other Planning Developments

While there has been no repeal, or even reform, of our Federal estate and gift tax rules, there have been some important legislative and other developments since the Summer of 2006 that affect our estate and tax planning strategies. Among them:

529 Plan Treatment Made Permanent. The tax advantages accorded to 529 Plans, otherwise set to expire in 2010, were made permanent last year.  Assets contributed to and held in 529 Plans can appreciate free of tax and then be withdrawn to pay tuition and other “higher education expenses” without tax consequences.  A 529 Plan can be front-loaded in the first year with five years’ worth of annual gifts, i.e. a total of $60,000 based on five $12,000 annual gifts per donee (or $120,000 for married donors.) Front-loading presents an opportunity for a tax-free build-up inside the Plan before funds are paid out for educational expenses.

Fractional Interest Gifts to Charity All But Abolished.  The Pension Protection Act of 2006 effectively reduced the use of gifts of fractional interests in artwork to museums and other charitable organizations.  The new rules penalize taxpayers by prohibiting a deduction for any appreciation in the value of artwork after the initial fractional gift and, in the case of any property not completely transferred during lifetime where the balance passes to the charity at death, by limiting the estate tax charitable deduction for the balance due to that fractional share of the value at the date of the donor’s initial gift, thus potentially triggering an estate tax on the difference.

Favorable Capital Gains Tax Rates Extended.  In legislation last year, Congress extended through 2010 the maximum capital gains tax rate of 15% for assets held more than one year.

Special Tax Treatment for IRA Distributions to Charity Set to Expire.  In 2006, Congress added a provision that permits IRA owners to make direct contributions from the IRA to a public charity without tax consequences (“IRA Rollovers.”) Normally, if a plan owner received a withdrawal from his/her IRA, the amount withdrawn would be reported as income and then, if contributed to charity, might produce only a partial deduction due to the limitations on charitable and other itemized deductions and/or potential AMT treatment.  The new provision allows a taxpayer who is age 70-1/2 or older to make an IRA Rollover contribution (up to $100,000) to a charity without treating the distribution as income.  This provision, which has proven to be popular with taxpayers, is set to expire at the end of this year.  Legislation has been introduced in Congress to extend the IRA Rollover rules.

Disbrow Case:  Inclusion of Previously-Transferred Asset in Gross Estate.  The Disbrow case decided last year by the Tax Court is another case in which a senior family member contributed an asset to a family partnership but neither the taxpayer nor the family members who owned the partnership interests treated it like an arm’s length business transaction.  The Tax Court ultimately taxed the asset (in this case, the only asset in the partnership was a principal residence) in her estate at death under Section 2036.  As the facts involved a transfer of Mrs. Disbrow’s residence, the case can also be instructive for senior family members who transfer residences through a Qualified Personal Residence Trust and then continue to use the property, even under the terms of a written lease from the junior family members.  In the case of Mrs. Disbrow, the property she transferred to the partnership seven years before her death was rented back from it on annual leases, but the conduct of the parties was problematic in that (i) there was no security deposit, (ii) the rent paid was determined to be less than fair market rental, (iii) there were no regular appraisals to support the rent paid and (iv) although the rent was not always paid on time, such events were not treated as defaults by the partnership/owner.  Based on its scrutiny of all of the facts and circumstances surrounding both the transfer to the family partnership and the subsequent use of the residence, the Court included it in Mrs. Disbrow’s gross estate following her death. T.C. Memo. 2006-34.

Kiddie Tax Expanded Twice.  Until 2006, the unearned income of children under age 14 was subject to tax at their parents’ highest marginal income tax rate.  The objective of this tax was to discourage the shifting of income to children where it would be taxed in lower brackets.  The age under which children would be taxed at their parents’ bracket was raised to 18 in 2006.  A provision in the Small Business and Work Opportunity Tax Act of 2007 has now raised this age to 24 if the child is a full-time student, although the expanded provision would not apply to children whose earned income exceeds half of their support for the particular year and would not generally be in effect until the tax year 2008.  Earned income from jobs or self-employment is exempt from the “kiddie tax.”

IRS 7520 Interest Rate.  The Section 7520 rate under the IRS valuation tables is used to value certain transfers for gift tax purposes.  Thus, it would be used to value a transferor’s retained interest for a period of years in a Qualified Personal Residence Trust (“QPRT”) or a Grantor Retained Annuity Trust (“GRAT.”) The rate applicable to transfers in October and November, 2007, is 5.2%, the lowest rate since February 2006.  A low rate generally encourages estate planning actions such as the creation of GRAT’s where the amount of the annuity to be paid back to the Grantor can be less, potentially leaving more in the trust to be passed along to the next generation without transfer tax consequences.

To learn more about the subjects of this Advisory, please contact any attorney in the private clients practice group:

Kathleen M. Citera
Monica J. Falcone
Carolyn M. Glynn
Robert H. Goldie
Marisa Guardo
Amy J. Guss
Kirk H. O’Ferrall
Paul J. Powers, Jr.
James W. Reid

This Advisory is provided as general information only. No action should be taken solely on the basis of its contents.
To ensure compliance with IRS requirements, we inform you that any tax advice contained in this communication was not intended or written to be used and cannot be used for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any transaction of matter addressed herein.

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