Wealth Transfer Newsletter June 2012

Wealth Transfer Team


It is June of 2012 and the windows of opportunity for estate planning that were opened by the passage of the Tax Relief Act of 2010 (“TRA 2010”) in December of 2010 are rapidly closing.  A number of clients have decided to take advantage of the increased lifetime gift and generation skipping transfer tax exemption of $5,120,000 million per taxpayer that will be in effect until January 1, 2013 to transfer assets to children and grandchildren.  Under current law as of January 1, 2013, the exemption will drop to $1,000,000 per taxpayer.

The planning often involves sophisticated techniques to leverage the exemption amounts, including the sale of assets to an intentionally defective grantor trust (IDGT).  New techniques, such as the beneficiary defective inheritors trust (“BDIT”), have also been utilized.  An article outlining the specifics of the options now afforded under a BDIT is also included in this Newsletter.  A number of clients have also taken advantage of the historically low applicable federal rates and federal Section 7520 rate, which has fallen to an unheard low of 1.2% for July 2012, to refinance outstanding promissory notes and to make transfers to grantor retained annuity trusts (“GRATs”).  A brief article exploring some of the planning opportunities afforded by these record low rates is also included in this Newsletter. 

Finally, we have included an article outlining the other potential changes in the estate and tax planning arena that were highlighted in President Obama’s Green Book proposals earlier this year, which serves as a harbinger of anticipated tightening laws and regulations to come in the future.  In addition to higher tax rates and lower exemptions, these changes include the elimination of discounts with respect to intra-family transactions, the elimination of short term GRATs and limiting to 90 years the exclusion of irrevocable trust assets from beneficiaries’ estates for transfer tax purposes.

Should you consider the ramifications of the expiration of TRA 2010 to your particular circumstances before the windows of opportunity slam shut?  Our response is a whole-hearted yes! 

Neill McBryde


2012 Wealth Transfer Opportunities: Act Now Before It’s Too Late

Under current laws set to expire on December 31, 2012, each person has the ability to make gifts of up to $5,120,000 without the imposition of a gift tax or a generation-skipping transfer tax.  To the extent that gifts are made that exceed this exemption level, a transfer tax is assessed at a 35 percent rate.

Unless Congress passes new legislation before year-end, beginning January 1, 2013, the amount that can pass gift tax-free will be lowered to $1,000,000 and the amount that can be transferred to future generations free of generation-skipping transfer tax will be reduced to $1,400,000.  Transfers in excess of these levels will incur gift taxes and, if applicable, generation-skipping transfer taxes at a 55 percent rate.  Due to the expiring tax exemptions, it is critical to consider gift-giving strategies that can be implemented before the end of the year.

Consider Taking Action Now

Given the uncertainty regarding future Congressional action, there is a possibility that we might not see the current exemptions amounts again.  Therefore, consideration should be given to making sizeable gifts in 2012 to take advantage of current estate planning opportunities.  Such transfers can take many forms, including both outright gifts and gifts in trusts.  Prospective recipients of such gifts can include children, grandchildren and trusts for spouses and/or descendants.  We typically recommend that gifts be made in trust.  Assets gifted in trust for the benefit of the beneficiaries are arguably more valuable than assets gifted outright to the beneficiaries because a person can receive more rights in a trust than he or she can obtain by owning property outright, provided that the transfer to the trust is funded by a third party.  Assets received by gift from a third party and retained in a properly structured trust may be protected from unnecessary exposure to the beneficiary’s “predators”, including the IRS (unnecessary income and wealth transfer taxes), judgment creditors, a divorcing spouse, disgruntled family members and business partners.

Tax Proposals for 2013

Congress eventually will update the transfer tax laws, but it is uncertain when this will occur and how extensive the changes will be.  It is possible, for example, that Congress will extend the current laws for a short period of time so that changes can be made in 2013 as part of a significant overhaul of the tax code.  It is important to note that President Obama’s 2013 budget proposes a different transfer tax regime: a $1,000,000 gift tax exemption, a $3,500,000 generation-skipping transfer tax exemption and a tax rate for each of 45 percent.  Other transfer tax related proposals advanced by the Obama administration are discussed in the later article in this Newsletter entitled, “Summary of 2013 Greenbook Proposals Pertinent to Estate Planning.”

Such future uncertainty makes planning in 2012 especially important.  If you have not already spoken to a MVA Wealth Transfer attorney about the 2012 wealth transfer opportunities and have questions, please contact us immediately.


Summary of 2013 Greenbook Proposals Pertinent to Estate Planning

On February 13, 2012, the Department of Treasury released the General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals, commonly referred to as the Greenbook (the “FY13 Greenbook”).  The FY13 Greenbook details the Obama Administration’s revenue proposals for the upcoming fiscal year.  The FY13 Greenbook can be viewed as President Obama’s “wish list” with respect to federal taxes and the budget.

While there are many proposals in the FY13 Greenbook that would affect the taxation of individuals and businesses, the following highlights several proposals which would significantly impact estate planning:

1.  Restore the Estate, Gift, and Generation-Skipping Transfer (“GST”) Tax Parameters in Effect in 2009.  Under current law, the exclusion amount for estate, gift, and GST taxes is $5,120,000 per person and the top tax rate for estate, gift, and GST tax purposes is 35%.  In addition, as discussed elsewhere in this Newsletter, as of January 1, 2013, the exclusion amount for estate and gift taxes will drop to $1,000,000, the exclusion amount for GST taxes will drop to approximately $1,400,000, and the top tax rate for estate, gift and GST tax purposes will increase to 55%.  The FY13 Greenbook proposes instead to return these exclusion amounts and the top tax rate to 2009 levels.  Effectively, this would mean a $3,500,000 exclusion amount for estate and GST tax purposes, a $1,000,000 exclusion amount for gift tax purposes, and a top estate, gift, and GST tax rate of 45%.

2.  Modify Rules on Valuation Discounts.  For many high-net worth individuals, closely held businesses, including limited partnerships and limited liability companies, play an important role in their planning.  One of the many benefits of closely held business interests in the estate planning context is that the fair market value of such interests often includes discounts for the lack of marketability and/or lack of control associated with such interests.  The FY13 Greenbook includes a proposal which would require that certain closely-held business interests which are transferred would be valued by substituting certain assumptions (to be specified in the regulations) for restrictions otherwise applicable to such interests.  As a result, the transfer tax value of such interests would be increased above the price a hypothetical willing buyer would pay to a hypothetical willing seller because an appraiser would be required to ignore certain rights and restrictions that would otherwise support discounts for lack of marketability and lack of control.

3.  Require Minimum Terms for Grantor Retained Annuity Trusts (“GRATs”).  Many of you have created GRATs as part of your ongoing planning.  The FY13 Greenbook proposes to require that GRATs have a minimum term of 10 years.  If the grantor of a GRAT dies during the term of a GRAT, the assets of the GRAT are generally included in his or her estate for estate tax purposes and, as a result, the potential transfer tax benefits are lost.  Currently, many GRATs are drafted with terms as short as two years.  In this regard, the requirement that GRATs have a minimum term of 10 years would effectively increase the mortality risk (i.e., the risk that the grantor of a GRAT does not survive its term) and the risk that there would be little or no transfer tax benefit associated with a GRAT.

4.  Limit Duration of GST Tax Exemption.  Many jurisdictions, including North Carolina, allow individuals to create perpetual trusts (also referred to as dynasty trusts).  Under current law, if an individual allocates GST exemption to such a trust, the trust can continue for hundreds of years without any of its assets, or the appreciation on any such assets, being subjected to additional estate, gift, or GST taxes at the death of one or more beneficiaries of the trust.  The FY13 Greenbook includes a proposal which would provide that on the 90th anniversary of the creation of a dynasty trust, the GST exclusion allocated to the trust would effectively terminate and, in most cases, the property in the trust would immediately be subject to GST tax at the then current GST tax rate (currently, 35%, and scheduled to increase to 55% as of January 1, 2013).

5.  Coordinate Certain Income and Transfer Tax Rules Applicable to Grantor Trusts.  Grantor trusts (sometimes referred to as defective grantor trusts) can serve as important vehicles in estate planning.  When an individual creates a trust which is considered a grantor trust with respect to such individual, all trust income will be taxed to him or her, thereby allowing the trust to grow free of income tax.  In addition, under current law, the payment of income taxes attributable to a grantor trust is not deemed a gift to the trust and effectively allows the individual to further decrease his or her estate.  Finally, the sale of assets by an individual to his or her grantor trust will not result in the recognition of gain on such a sale.

The FY13 Greenbook proposes that, to the extent that a trust is treated as a grantor trust, (1) the assets of the trust would be included in the grantor’s gross estate for estate tax purposes, (2) any distributions from the trust to one or more beneficiaries during the grantor’s lifetime would be subject to gift tax, and (3) upon termination of grantor trust status during the grantor’s life, the entire value of the trust would be subject to gift tax.  The proposal would also apply to any non-grantor who is deemed to be the owner of a trust for income tax purposes and who takes part in a sale or exchange transaction with a trust which would have been subject to capital gains if the person was not deemed the owner of the trust.

This proposal is very broad and would have unintended consequences (e.g., subjecting many life insurance trusts to estate taxes at the death of a grantor).  For this reason, most practitioners believe it is unlikely to be enacted as proposed; however, it seems clear that reform of the grantor trust rules is likely.

Consider Planning Now.  The above proposals, if enacted, would generally be effective prospectively beginning with the date of enactment of the respective statute.  For this reason, 2012 continues to be an excellent time for planning to take advantage of the current tax laws and the favorable planning environment.


Beneficiary Defective Inheritor’s Trust - An Interesting New Estate Planning Strategy

The Beneficiary Defective Inheritor’s Trust (“BDIT”) undoubtedly is one effective estate, tax and asset protection technique available for planning professionals to recommend to their clients.  Essentially, a BDIT is a third-party settled trust (i.e., the trust is established by someone other than the client such as a parent) designed: (1) to give the client control (as Investment Trustee) beneficial enjoyment (as primary beneficiary) of trust property such that the client can use and manage the trust assets without compromising the trust’s ability to avoid transfer taxes at the client’s death, and (2) to protect the trust assets from the client’s creditors. After the death of the client (the primary beneficiary), control of the trust passes to client’s descendants, subject to the client’s ability to change the disposition of the trust assets through the exercise of a special power of appointment.  In addition to receiving control of the trust, the subsequent primary beneficiaries also may receive the benefits of trust owned property such as: (1) transfer tax avoidance, and (2) creditor protection, including protection from a divorcing or separated spouse.

The critical concept empowering the BDIT is the axiom that assets received by gift or inheritance from a third party and retained in a properly structured trust are protected from unnecessary exposure to the IRS (unnecessary wealth transfer taxes) and the client’s creditors, including judgment creditors, a divorcing spouse, disgruntled family members and business partners.

A standard third-party, discretionary trust becomes “beneficiary defective” when it is drafted so that a single primary beneficiary of the trust (one person) is treated as the owner of the trust for all income tax purposes pursuant to the IRC’s grantor trust rules.  Specifically, pursuant to IRC §§678(a) and (b) and 671 the general rule is that a person other than the grantor is treated as the owner of the trust income if that person has the power to withdraw trust corpus or income pursuant to a Crummey power of withdrawal and the power is allowed to lapse within the “five or five” exceptions of IRC §§2514(e) and 2041(a)(2).  If the Crummey power is given to only one primary beneficiary, the Crummey power is allowed to lapse as to that beneficiary and the trust otherwise is not treated as a grantor trust as to the original trust grantor, the primary beneficiary will be considered the grantor of the trust for all income tax  purposes.  The lapsed Crummey power (1) requires the primary beneficiary to pay the income taxes on the income generated by the trust and (2) also permits the beneficiary to engage in transactions with the trust (e.g., sell assets to the trust in return for a promissory note) income tax free.  Significantly, this also allows trust assets to grow income and wealth transfer tax-free, which compounds the multigenerational accumulation of wealth in the trust.

In conclusion, a BDIT combines the benefits of a traditional intentionally defective grantor trust (IDGT) created for others with the enhanced wealth, transfer tax and asset protection advantages of a trust created and funded by a third party for the benefit of the beneficiary.  Because of the enhanced planning benefits available through a BDIT, particularly the investment control of the trust assets and the access to and enjoyment of the trust property by the client (who is the primary beneficiary of the trust), many clients who otherwise are reluctant to effect comprehensive planning or make significant inter vivos wealth transfers now can enjoy the benefits of advanced wealth and asset protection planning with minimal personal, financial and tax risk.

If you would like to find out more about BDITs, please contact a MVA Wealth Transfer attorney.


Planning Opportunities in a Favorable Interest Rate Environment

As discussed in prior newsletters, a lower interest rate environment presents unique and unprecedented planning opportunities to maximize wealth transfer to children and younger generations.  These opportunities are due in large part to several important factors (e.g., depressed asset value and a potentially limited time frame to continue receiving higher valuation discounts), but perhaps most importantly are due to a favorable interest rate environment.  The Section 7520 rates and the applicable federal rates recently announced for July 2012, as discussed below, are new historic lows and should give many taxpayers food for thought. 

Low Section 7520 Rates - Perfect for GRATs and CLATs

The Code Section 7520 interest rate (the “Section 7520 Rate”) is used to discount the value of annuities, life interests, and remainder interests to present value, and is revised monthly.  A lower Section 7520 Rate makes certain estate planning “freeze” techniques such as grantor retained annuity trusts (GRATs) and charitable lead annuity trusts (CLATs) more attractive.  The present value of the annuity payments is deducted from the fair market value of the property contributed to the trust to determine the value of the remainder interest and the resulting taxable gift.

Generally, a lower Section 7520 Rate results in a smaller taxable gift.  The following table compares the Section 7520 Rate for July 2012 with the rates in June 2009 and June 2006:

                                    July 2012               June 2009               June 2006

Section 7520 Rate        1.2%                          2.8%                       6.0%

As an example, with a GRAT, assets are transferred to a trust and the grantor retains an annuity from the trust for a fixed period of time.  At the end of the term, any remaining trust principal passes to the remainder beneficiaries (e.g., children) free of gift or estate tax.  The GRAT will be an economic success if the assets perform well and the growth in the trust exceeds the Section 7520 Rate, with the resulting gain passing to the remainder beneficiaries.  At a 6% Section 7520 Rate and an assumed growth rate of 7%, the required annuity payment needed to “zero out” (i.e., no taxable gift) a 10 year, $1,000,000 GRAT is $135,867 with an anticipated remainder interest of $89,942 passing to heirs.  By contrast, at a 1.2% Section 7520 Rate, the required annuity payment needed to “zero out” the same GRAT is only $106,717 and the anticipated remainder interest is $492,690. 

If you are philanthropically minded, a CLAT produces a similar benefit for remainder beneficiaries except that charitable organizations receive the annuity payments during the term of the trust.  As with the GRAT, any growth in the CLAT in excess of the Section 7520 Rate passes to the non-charitable remainder beneficiaries with significant gift and estate tax savings.

Low AFRs - Perfect for Intra-Family Loans and Sales to Intentionally Defective Grantor Trusts

Another key interest rate, the Applicable Federal Rate (“AFR”) is used to determine the adequacy of interest for certain non-commercial loans.  The Short Term AFR is used to determine the adequacy of interest for loans having a term of three years or less; the Mid Term AFR, for loans between three and nine years; and the Long Term AFR, for loans in excess of nine years.  Lower AFRs make loan-based estate planning techniques, such as sales to intentionally defective grantor trusts (IDGTs) and intra-family loans, more attractive.

The following table details the applicable federal rates for short term loans (zero to three years), mid-term loans (three to nine years) and long-term loans (nine to twenty years) for July 2012.

JULY AFRs    Annual      Semi-annual      Quarterly      Monthly

Short-term        0.24%            0.24%              0.24%           0.24%

Mid-term           0.92%            0.92%              0.92%           0.92%

Long-term        2.30%            2.29%              2.28%           2.28%

No, 0.24% is not a typo!  For example, you could loan $100,000 to a child or grandchild for three years and the required interest payments would only be $240 annually (assuming an interest-only balloon loan).  Any growth in the funds in excess of the 0.24% Short Term AFR would remain with the child or grandchild.  In contrast, the same loan six years ago (June 2006) when the short-term interest rate was 5.99% would require $5,990 in annual interest payments. 

Additionally, now is a great time to refinance outstanding intra-family loans to lock in a lower, more favorable rate.  For example, refinancing a $500,000, nine-year interest-only balloon loan made in October 2006 would cause the annual interest payment to drop from $25,300 to $4,600.

If any of these opportunities appeal to you, we recommend that you contact one of the MVA Wealth Transfer attorneys to discuss.


MVA Attorneys Visit Fort Bragg

On April 24, Wealth Transfer Members Chris Jones and Brad Van Hoy along with MVA Financial Services Member John Chinuntdet had the privilege of spending a day with the U.S. Army’s Special Operations Forces at Fort Bragg with MVA clients/friends John Felix of Consortium Finance and Rone Reed of U.S. Trust – Bank of America Private Wealth Management.  The day was hosted by Reed and Rick Cantwell of the Military Family Lifestyle Charitable Foundation (MFLCF), an organization dedicated to supporting our military and their family members.  Reed and Cantwell are retired U.S. Army Special Forces Green Berets.

The group participated in several Special Operations simulations, including being taken hostage by a hostile country’s forces, riding in MH-47 Chinook helicopters, and shooting sniper rifles, automatic weapons and handguns.  The participants also observed U.S. Army Rangers raid and secure a building and Airborne paratroopers “halo” into a drop zone. The participants gained insight into the unique situation faced by members of our armed forces who have been deployed in continuous combat operations for the last 11 years and in particular the toll it takes on our military families.


Team Accomplishments and Accolades

Mark Horn was selected as a North Carolina Super Lawyer in Estate Planning and Probate. Horn also published an article in the Estate Planning Journal in May 2012, entitled “Ideas to Consider in Making Trusts a Part of an Estate Plan.” 

The Wealth Transfer Team welcomes Caitlin Horne as an attorney in the Charlotte office.

Chris Jones was recently elected to the Board of Trustees of the Southern Federal Tax Institute.

Neill McBryde was recognized as a national leader in the 2012 Chambers USA Guide.

Triangle Tax and Estate Planning Senior Counsel Sue Sprunger assisted the NCBA Young Lawyers’ Division with their Wills for Heroes event on February 18.  Sprunger also partnered with Margaret Currin from Campbell University School of Law to provide 8th grade Luftin Road Middle School students with first-hand perspective on life as a lawyer at their Career Fair on February 17.

Brad Van Hoy was appointed to the Cabinet of Professional Advisors for the Foundation for the Carolinas.

Trudy H. Robertson, Moore & Van Allen PLLC, 40 Calhoun Street, Suite 300, Charleston, SC 29401, is the lawyer in South Carolina responsible for any advertising content in this communication.

To comply with certain U.S. Treasury regulations, we inform you that, unless expressly stated otherwise, any U.S. Federal tax advice contained in this newsletter is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.



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