Estate Planning Under the 2010 Tax Relief Act

©2011 LEWIS RICE FINGERSH L.C.

Estate Estate Planning Planning Under the Under the 2010 Tax 2010 Tax Relief ActRelief ActKimberly B. McDermottKimberly B. McDermott

August 16, 2011August 16, 2011Commerce BankCommerce Bank

St. Louis, MissouriSt. Louis, Missouri

LEWIS RICE FINGERSH L.C.


DISCLAIMERDISCLAIMERThe information contained in this presentation is intended to be a The information contained in this presentation is intended to be a discussion of current law and issues, for the mutual benefit of the discussion of current law and issues, for the mutual benefit of the presenters, the attendees of this seminar, and their mutual and presenters, the attendees of this seminar, and their mutual and prospective clients. Internal Revenue Service regulations provide that, prospective clients. Internal Revenue Service regulations provide that, for the purpose of avoiding certain penalties under the Internal Revenue for the purpose of avoiding certain penalties under the Internal Revenue Code, taxpayers may rely only on formal opinions of counsel which meet Code, taxpayers may rely only on formal opinions of counsel which meet specific requirements set forth in such regulations. Any tax advice that specific requirements set forth in such regulations. Any tax advice that may be contained in this presentation does not constitute a formal may be contained in this presentation does not constitute a formal opinion that meets the requirements of the regulations. Accordingly, the opinion that meets the requirements of the regulations. Accordingly, the Internal Revenue Service requires that we advise you that (1) any tax Internal Revenue Service requires that we advise you that (1) any tax advice contained in this communication was not intended or written to advice contained in this communication was not intended or written to be used, and may not be used, for the purpose of avoiding penalties that be used, and may not be used, for the purpose of avoiding penalties that the IRS might attempt to impose on a taxpayer, (2) no one, without the IRS might attempt to impose on a taxpayer, (2) no one, without express prior written permission, may use any part of this express prior written permission, may use any part of this communication in promoting, marketing or recommending an communication in promoting, marketing or recommending an arrangement relating to any Federal tax matter to any person or entity, arrangement relating to any Federal tax matter to any person or entity, (3) there is no limitation by Lewis Rice & Fingersh, LC on the disclosure (3) there is no limitation by Lewis Rice & Fingersh, LC on the disclosure of the tax treatment or tax structure of the transaction(s) or matter(s) of the tax treatment or tax structure of the transaction(s) or matter(s) discussed herein. discussed herein.


General CommentsGeneral Comments On December 17, 2010, President Obama signed the Tax On December 17, 2010, President Obama signed the Tax

Relief, Unemployment Insurance Authorization & Job Creation Relief, Unemployment Insurance Authorization & Job Creation Act of 2010 (the “2010 Tax Relief Act”) into law. The 2010 Act of 2010 (the “2010 Tax Relief Act”) into law. The 2010 Tax Relief Act provides temporary estate and gift tax Tax Relief Act provides temporary estate and gift tax guidance for the next two years. It increases the estate, gift guidance for the next two years. It increases the estate, gift and generation-skipping tax exemption amounts to $5 million and generation-skipping tax exemption amounts to $5 million and reduces the estate tax rate to 35%.and reduces the estate tax rate to 35%.

The 2010 Tax Relief Act is temporary law which will sunset on The 2010 Tax Relief Act is temporary law which will sunset on December 31, 2012, it provides excellent planning December 31, 2012, it provides excellent planning opportunities for wealth transfer in the next 2 years but opportunities for wealth transfer in the next 2 years but presents challenges for estate planning too. presents challenges for estate planning too.

Without further action by Congress, estate, gift and Without further action by Congress, estate, gift and generation-skipping transfer (“GST”) tax exemptions revert to generation-skipping transfer (“GST”) tax exemptions revert to $1 million (GST tax exemption indexed for inflation) with top $1 million (GST tax exemption indexed for inflation) with top rate of 55% on January 1, 2013. The 2010 Tax Relief Act does rate of 55% on January 1, 2013. The 2010 Tax Relief Act does not eliminate uncertainty.not eliminate uncertainty.


General CommentsGeneral Comments Many experts estimate the cost of the 2010 Tax Many experts estimate the cost of the 2010 Tax

Relief Act with respect to estate, gift and GST tax Relief Act with respect to estate, gift and GST tax will be $68 billion in the 2 year period it is will be $68 billion in the 2 year period it is effective and $300 billion over a 10 year period, effective and $300 billion over a 10 year period, if extended.if extended.

Several commentators believe the IRS will audit Several commentators believe the IRS will audit 100% of estate and gift tax returns filed as a 100% of estate and gift tax returns filed as a result of the loss of revenue caused by the 2010 result of the loss of revenue caused by the 2010 Tax Relief Act.Tax Relief Act.

The 2010 Tax Relief Act did not restrict the use The 2010 Tax Relief Act did not restrict the use of GRATs or valuation discounts for family of GRATs or valuation discounts for family limited partnerships or non-voting stock.limited partnerships or non-voting stock.


Estate TaxEstate Tax Reinstated for 2010 decedents with $5 Reinstated for 2010 decedents with $5

million exemption and maximum rate of million exemption and maximum rate of 35%35%

Exclusion amount for 2011 is $5 million; Exclusion amount for 2011 is $5 million; for 2012, $5 million adjusted for inflationfor 2012, $5 million adjusted for inflation

Eliminates modified carryover basis rules Eliminates modified carryover basis rules (unless executor for 2010 decedent opts (unless executor for 2010 decedent opts to have them apply)to have them apply)


Estate TaxEstate Tax Option for 2010 decedentsOption for 2010 decedents::

Subject estate to estate tax with $5 million Subject estate to estate tax with $5 million exemption, 35% estate tax rate and stepped-exemption, 35% estate tax rate and stepped-up income tax basis (default rule unless up income tax basis (default rule unless executor opts out)executor opts out)

Elect to have pre-2010 Tax Relief Act apply – Elect to have pre-2010 Tax Relief Act apply – no estate tax regardless of value of assets but no estate tax regardless of value of assets but appreciated assets receive only modified appreciated assets receive only modified carryover basis under EGTRAA ($1.3 million carryover basis under EGTRAA ($1.3 million for non-spouse beneficiaries; $3 million for for non-spouse beneficiaries; $3 million for spouse beneficiary)spouse beneficiary)


Gift TaxGift Tax For 2010 gifts maximum exclusion is $1 For 2010 gifts maximum exclusion is $1

million and rate is 35%million and rate is 35% For 2011 and 2012 gifts, top rate is 35% For 2011 and 2012 gifts, top rate is 35%

and maximum exclusion is $5 millionand maximum exclusion is $5 million Even if donor has made $1 million worth of Even if donor has made $1 million worth of

taxable gifts in prior years, he/she will taxable gifts in prior years, he/she will have an additional $4 million with which to have an additional $4 million with which to plan in 2011 and 2012plan in 2011 and 2012

January 1, 2013 gift tax exemption reverts January 1, 2013 gift tax exemption reverts to $1 million with top rate of 55%to $1 million with top rate of 55%


Generation-Skipping Generation-Skipping Transfer TaxTransfer Tax

Retroactively reinstated for 2010 with $5 Retroactively reinstated for 2010 with $5 million exemption and GST tax rate of 0%million exemption and GST tax rate of 0%

For transfers made in 2011 and 2012, GST tax For transfers made in 2011 and 2012, GST tax rate is equal to highest estate and gift tax rate rate is equal to highest estate and gift tax rate (35%) and exemption amount is $5 million (35%) and exemption amount is $5 million (indexed for inflation in 2012)(indexed for inflation in 2012)

Automatic allocation is extended from 2001 lawAutomatic allocation is extended from 2001 law

For 2010 decedent, unused GST exemption can For 2010 decedent, unused GST exemption can be allocated to testamentary trustsbe allocated to testamentary trusts


Generation-Skipping Generation-Skipping Transfer TaxTransfer Tax

Direct skip gifts made to trusts in 2010 do not Direct skip gifts made to trusts in 2010 do not risk having GST tax apply when trust later risk having GST tax apply when trust later makes distribution to grandchild-beneficiarymakes distribution to grandchild-beneficiary

Review all 2010 direct skip gifts to determine Review all 2010 direct skip gifts to determine whether to file timely return to elect out of whether to file timely return to elect out of automatic allocation of 2010 GST exemptionautomatic allocation of 2010 GST exemption

Consider making late allocation of additional Consider making late allocation of additional GST exemption to transfers made in prior GST exemption to transfers made in prior yearsyears


PortabilityPortability Under prior law, the estate tax exemption of the first Under prior law, the estate tax exemption of the first

spouse to die was either used or lost at such spouse’s spouse to die was either used or lost at such spouse’s death. This created a problem if the husband had all of the death. This created a problem if the husband had all of the assets in his name and left all of those assets to his wife assets in his name and left all of those assets to his wife outright at his death. Because the husband did not use his outright at his death. Because the husband did not use his estate tax exemption, the surviving wife could only use her estate tax exemption, the surviving wife could only use her own exemption at her later death. Thus, if the aggregate own exemption at her later death. Thus, if the aggregate assets are valued in excess of the surviving wife’s assets are valued in excess of the surviving wife’s exemption, an unnecessary estate tax liability is created.exemption, an unnecessary estate tax liability is created.

The 2010 Tax Act allows the surviving spouse to take The 2010 Tax Act allows the surviving spouse to take advantage of any unused estate tax exemption of the advantage of any unused estate tax exemption of the predeceasing spouse. predeceasing spouse.

No portability for 2010 decedents. This only applies for No portability for 2010 decedents. This only applies for 2011 and 2012 decedents.2011 and 2012 decedents.

No portability of GST tax exemption.No portability of GST tax exemption. Careful consideration must be given to situations with Careful consideration must be given to situations with

remarriage.remarriage.


The idea behind this is to simplify estate planning; however, we The idea behind this is to simplify estate planning; however, we must be cautious. It can assist clients with avoiding estate taxes but must be cautious. It can assist clients with avoiding estate taxes but under current law, it is only a temporary allowance. In addition, under current law, it is only a temporary allowance. In addition, there are many other compelling reasons to plan with a credit there are many other compelling reasons to plan with a credit shelter trust, including:shelter trust, including:

The deceased spouse’s unused estate tax amount may only be used for The deceased spouse’s unused estate tax amount may only be used for the “last” deceased spouse so if a widower remarries, she may lose her the “last” deceased spouse so if a widower remarries, she may lose her first husband’s entire unused exemption amount.first husband’s entire unused exemption amount.

An election must be made on the first spouse to die’s timely filed estate An election must be made on the first spouse to die’s timely filed estate tax return.tax return.

Credit shelter trusts protect appreciating assets from estate tax at the Credit shelter trusts protect appreciating assets from estate tax at the second spouse’s death.second spouse’s death.

Credit shelter trusts provide asset protection, keeping trust assets from Credit shelter trusts provide asset protection, keeping trust assets from the reach of the surviving spouse’s creditor.the reach of the surviving spouse’s creditor.

Portability does not apply to the GST tax. In order to fully leverage the Portability does not apply to the GST tax. In order to fully leverage the GST exemptions of both spouses for dynasty trust planning (so future GST exemptions of both spouses for dynasty trust planning (so future generations do not have to pay estate taxes), a trust must be created at generations do not have to pay estate taxes), a trust must be created at the death of the first spouse to die.the death of the first spouse to die.

Probate avoidanceProbate avoidance Business succession planningBusiness succession planning Asset managementAsset management

PortabilityPortability


Essential Estate Planning in Essential Estate Planning in 2011 & 20122011 & 2012

Portability vs. Credit Shelter TrustPortability vs. Credit Shelter Trust:: Many clients may be wondering if they need estate tax planning in light of Many clients may be wondering if they need estate tax planning in light of

portability. Even if clients have estates under $10 million, relying on portability portability. Even if clients have estates under $10 million, relying on portability has several downsides (in addition to those on highlighted on previous pages), has several downsides (in addition to those on highlighted on previous pages), including that the deceased spouse’s unused exclusion amount is not adjusted including that the deceased spouse’s unused exclusion amount is not adjusted to reflect inflation. A Credit Shelter Trust shelters future growth from estate to reflect inflation. A Credit Shelter Trust shelters future growth from estate and generation-skipping tax.and generation-skipping tax.

Example: John dies in 2012 and made no lifetime taxable transfers. He leaves Example: John dies in 2012 and made no lifetime taxable transfers. He leaves his entire estate, worth $8 million, to his wife, Jane, outright. His estate is not his entire estate, worth $8 million, to his wife, Jane, outright. His estate is not taxable because of the marital deduction. John’s executor elects, on a timely taxable because of the marital deduction. John’s executor elects, on a timely filed estate tax return, portability, allowing Jane to use John’s unused exclusion filed estate tax return, portability, allowing Jane to use John’s unused exclusion amount ($5 million). Thus, Jane’s combined exclusion amount is $10 million. amount ($5 million). Thus, Jane’s combined exclusion amount is $10 million. Jane later dies in 2022 and let’s assume portability is allowed. Although she has Jane later dies in 2022 and let’s assume portability is allowed. Although she has lived off of the income from the assets, we can assume a net growth rate on the lived off of the income from the assets, we can assume a net growth rate on the principal of 4%. The value of Jane’s estate at her death is roughly $11,840,000 principal of 4%. The value of Jane’s estate at her death is roughly $11,840,000 ($8 million plus 4% growth for 10 years). Therefore, Jane’s estate will be over ($8 million plus 4% growth for 10 years). Therefore, Jane’s estate will be over her combined exclusion amount (note however that her $5 million should be her combined exclusion amount (note however that her $5 million should be indexed for inflation) and estate taxes will be due.indexed for inflation) and estate taxes will be due.

In order to take advantage of both individual’s GST exemptions, the couple must In order to take advantage of both individual’s GST exemptions, the couple must create a credit shelter trust at the death of the first spouse.create a credit shelter trust at the death of the first spouse.

Leaving assets outright does not afford the other non-tax benefits of leaving Leaving assets outright does not afford the other non-tax benefits of leaving assets to a beneficiary in trust (credit protection, asset management, etc.).assets to a beneficiary in trust (credit protection, asset management, etc.).

Using portability correctly would give the surviving spouse a full step-up in Using portability correctly would give the surviving spouse a full step-up in income tax basis at her later death and assets in a credit shelter trust would not income tax basis at her later death and assets in a credit shelter trust would not receive such a step-up. Those assets would have received a step-up in basis at receive such a step-up. Those assets would have received a step-up in basis at the death of the first spouse though and they will not be subject to estate taxes the death of the first spouse though and they will not be subject to estate taxes at the death of the surviving spouse regardless of their value.at the death of the surviving spouse regardless of their value.



Clients can make gifts of up to $5 million (less any used Clients can make gifts of up to $5 million (less any used gift exemption for prior years) free of gift and GST tax.gift exemption for prior years) free of gift and GST tax.

Valuation discounts, such as those obtained with the Valuation discounts, such as those obtained with the use of family limited partnerships, were not abolished use of family limited partnerships, were not abolished by the new law but very well may be in any future laws.by the new law but very well may be in any future laws.

If clients want to make gifts in excess of $5 million, If clients want to make gifts in excess of $5 million, they will pay only 35% gift tax rate. This is much lower they will pay only 35% gift tax rate. This is much lower than the 55% rate to take effect on January 1, 2013. than the 55% rate to take effect on January 1, 2013. Nearly all experts believe this rate will be increased in Nearly all experts believe this rate will be increased in 2013 and beyond.2013 and beyond.

The term of a Grantor Retained Annuity Trust can still The term of a Grantor Retained Annuity Trust can still be less than 10 years so short term GRATs with 2 or 3 be less than 10 years so short term GRATs with 2 or 3 year terms are still viable. GRATs are particularly year terms are still viable. GRATs are particularly effective when interest rates are low so this is an effective when interest rates are low so this is an attractive way to make gifts of appreciating assets.attractive way to make gifts of appreciating assets.



The sale to the intentionally defective The sale to the intentionally defective irrevocable trust is still a feasible and appealing irrevocable trust is still a feasible and appealing option. If a client has already made a sale to option. If a client has already made a sale to such a trust, he could make additional such a trust, he could make additional discounted gifts to this trust. Keep in mind that discounted gifts to this trust. Keep in mind that for new sale transactions, the “seed gift” made for new sale transactions, the “seed gift” made to initially fund the trust could be much larger to initially fund the trust could be much larger now with the increased exemption amounts.now with the increased exemption amounts.

Although it is uncertain whether “clawback” Although it is uncertain whether “clawback” will apply, most commentators believe that a will apply, most commentators believe that a client who makes lifetime gifts while the client who makes lifetime gifts while the exemption is $5 million should not be required exemption is $5 million should not be required to make-up the difference for the tax on those to make-up the difference for the tax on those gifts. gifts.


Pre-2010 Tax Act Planning: For nearly all clients, Pre-2010 Tax Act Planning: For nearly all clients, attorneys used a formula clause with the exemption attorneys used a formula clause with the exemption amount passing to a credit shelter trust and the amount passing to a credit shelter trust and the remaining assets passing using the marital deduction at remaining assets passing using the marital deduction at the death of the first spouse. The main goal was to the death of the first spouse. The main goal was to make certain that the exclusion amount of the first make certain that the exclusion amount of the first spouse to die was fully used.spouse to die was fully used.

Assuming the clients’ goal is to have all assets pass at Assuming the clients’ goal is to have all assets pass at the death of the first spouse to or for the benefit of the the death of the first spouse to or for the benefit of the surviving spouse and to or for the benefit of the children surviving spouse and to or for the benefit of the children at the later death of the survivor. What is the at the later death of the survivor. What is the appropriate estate plan?appropriate estate plan? If the aggregate value of the clients’ estate is $5 million or less, If the aggregate value of the clients’ estate is $5 million or less,

you should consider the credit shelter formula clause as well as you should consider the credit shelter formula clause as well as a disclaimer trust. It is generally not prudent to rely on a disclaimer trust. It is generally not prudent to rely on portability because it is temporary (unless the law is changed), portability because it is temporary (unless the law is changed), it does not provide the greatest protection of the assets and it does not provide the greatest protection of the assets and there are potential pitfalls if the surviving spouse remarries.there are potential pitfalls if the surviving spouse remarries.

If the aggregate value of the clients’ estate is more than $5 If the aggregate value of the clients’ estate is more than $5 million (although some say $7 million), in most situations, the million (although some say $7 million), in most situations, the credit shelter formula clause may still have the most utility.credit shelter formula clause may still have the most utility.

Essential Estate Planning in Essential Estate Planning in 2011 & 2012 2011 & 2012


Should Pre-2011 Estate Planning Documents Should Pre-2011 Estate Planning Documents Be Amended?Be Amended? In the majority of cases with a formula credit In the majority of cases with a formula credit

shelter/marital division, the surviving spouse is not only shelter/marital division, the surviving spouse is not only the beneficiary of the marital trust but is also a the beneficiary of the marital trust but is also a beneficiary of the credit shelter trust. Assuming a beneficiary of the credit shelter trust. Assuming a client’s circumstances have not changed since the client’s circumstances have not changed since the documents were drafted, the formula clause should still documents were drafted, the formula clause should still work and achieve the clients’ goal of having all assets work and achieve the clients’ goal of having all assets available to the surviving spouse. available to the surviving spouse.

If the credit shelter trust does not name the surviving If the credit shelter trust does not name the surviving spouse as a beneficiary, the clients’ plan should be spouse as a beneficiary, the clients’ plan should be reviewed and possibly changed to make sure the reviewed and possibly changed to make sure the surviving spouse will still receive benefits consistent surviving spouse will still receive benefits consistent with the clients’ wishes prior to the enactment of the with the clients’ wishes prior to the enactment of the 2010 Tax Law.2010 Tax Law.

EssentialEssential Estate Planning in 2011 Estate Planning in 2011 & 2012& 2012



Should you consider using a Disclaimer Trust?Should you consider using a Disclaimer Trust? For clients in stable marriages with only mutual children who might For clients in stable marriages with only mutual children who might

otherwise allow their spouse to inherit their entire estate outright, otherwise allow their spouse to inherit their entire estate outright, the disclaimer trust could be an option. The trusts would be drafted the disclaimer trust could be an option. The trusts would be drafted such that all assets would pass into a marital trust and if the such that all assets would pass into a marital trust and if the surviving spouse decided to disclaim all or a portion of the assets surviving spouse decided to disclaim all or a portion of the assets (usually equal to the exemption amount), the disclaimed assets (usually equal to the exemption amount), the disclaimed assets would pass into a credit shelter trust. would pass into a credit shelter trust.

What are the disadvantages?What are the disadvantages? The surviving spouse cannot direct how the disclaimed assets will pass. The surviving spouse cannot direct how the disclaimed assets will pass.

The surviving spouse cannot retain a power of appointment over the The surviving spouse cannot retain a power of appointment over the assets. They must pass in accordance with the terms of the predeceasing assets. They must pass in accordance with the terms of the predeceasing spouse’s trust.spouse’s trust.

Surviving spouses often do not make the right decisions with respect to Surviving spouses often do not make the right decisions with respect to disclaimer. The disclaimer must be made within 9 months of the date of disclaimer. The disclaimer must be made within 9 months of the date of death of the predeceasing spouse death of the predeceasing spouse andand they must be made before the they must be made before the surviving spouse enjoys, uses or accepts the assets. Thus, if a surviving surviving spouse enjoys, uses or accepts the assets. Thus, if a surviving spouse does not seek the necessary legal and tax advice in a timely spouse does not seek the necessary legal and tax advice in a timely fashion, the surviving spouse made be disallowed from disclaiming any of fashion, the surviving spouse made be disallowed from disclaiming any of the assets.the assets.

This is almost never appropriate in a second marriage situation with This is almost never appropriate in a second marriage situation with blended families.blended families.



What about using a Clayton QTIP Trust? What about using a Clayton QTIP Trust? A trust funded at the death of the first A trust funded at the death of the first spouse can allow a third party trustee spouse can allow a third party trustee (i.e., not the surviving spouse) to decide (i.e., not the surviving spouse) to decide whether the trust will be a QTIP marital whether the trust will be a QTIP marital deduction trust, a credit shelter trust or deduction trust, a credit shelter trust or whether both trusts will be funded.whether both trusts will be funded.

This is a bit trickier to draft but can be a This is a bit trickier to draft but can be a useful tool.useful tool.

Estate Planning Under the 2010 Tax Relief Act

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