Year-End Checklist for 2009

Consider the following before 2009 is over:

Make year-end annual exclusion gifts of $13,000 ($26,000 for a married couple).

Make year-end IRA contributions.

Create 529 Plan accounts before year-end for children and grandchildren, and consider front-loading the accounts with five years’ worth of annual exclusion gifts, taking into account any gifts made during the year to children and grandchildren. Pay tuition and medical expenses directly to the school or medical provider.

Consider making charitable gifts before year-end to use deduction on 2009 income tax return.

Planning Ideas for 2010

As mentioned above, there is considerable uncertainty as to what the estate and gift tax regime will be in 2010. Our best prediction is that the current 2009 estate and gift tax system will be extended for at least one year. However, it is possible that no legislation will be passed and that there will be no estate and GST tax for at least part of 2010, and thereafter the estate and GST taxes may go back to 2001 levels (i.e., only $1 million of applicable exclusion). Less likely, we think, but also possible, is that H.R. 3905 or some variation that increases the estate tax exclusion amount will be passed.

Planning Ideas for 2010 Regardless of Outcome of Estate and Gift Tax Regime

Below are a number of estate tax planning ideas that you might consider in 2010, in addition to those set forth above.

Gift Residence or Vacation Home Using Qualified Personal Residence Trusts

A discounted and leveraged gift of a residence is possible using a qualified personal residence trust (QPRT). After the gift to the QPRT you can continue to reside in the residence until the QPRT ends, and even thereafter, if the property is leased back at fair market value from the new owners.

This planning is most effective when the value of the residence to be given is low and the IRS assumed rate of return is high. However, even though the IRS assumed rate of return is now low, housing prices have dropped across the country, which makes use of a QPRT beneficial. As a result, QPRT gifting is an important alternative to consider in 2010.

Alternatives to Section 1031 Exchanges: Gifts to Charitable Remainder Trusts

Many taxpayers owning certain kinds of appreciated real estate sell that property and “roll over” the gain, using Section 1031 of the IRC, into another property—using this “like kind exchange” to defer income taxes. However, the economy is such that taxpayers desiring to sell properties now are finding it harder to find properties to purchase to accomplish this rollover.

An alternate approach to consider is a gift of the property to a charitable remainder trust, retaining for life a payment equal to up to 90% of the value of the gifted property. You would be allowed an income tax deduction equal to a portion of the gifted property. (In the case where 90% of the value is retained by you in the form of lifetime payments, the deduction is equal to 10% of the value of the gifted property.)

When the charitable remainder trust sells the property it recognizes no gain or loss. When you receive payments from the charitable remainder trust, part will be taxed as income, part as capital gain, and (potentially) part will be treated as a distribution from principal of the trust and not taxable at all.

At your death, the charitable remainder trust can pay over to a family foundation, allowing your family to use those funds to accomplish the family’s charitable goals.

Consider Buy-Back of Appreciated Low Basis Assets from Grantor Trusts

Some clients sold or gave (through a GRAT) an asset that was expected to appreciate in value. The tax planning idea that motivated them was to pass that appreciation on to trusts for their children without gift or estate tax. The children’s trust that ends up owning the asset typically has a very low basis, meaning that a significant capital gains tax will be due if the trust sells the appreciated asset.

Where those plans succeeded, that appreciated asset now sits in a defective grantor trust for the children. That grantor trust has a low basis in the asset. If you purchase the asset back from the grantor trust for fair market value, no gain or loss is recognized. The trust would then hold cash equal to the value of the appreciated asset that was repurchased, leaving the same amount to escape estate tax. Alternatively, many GRAT instruments give the grantor the power to substitute the GRAT assets with other assets, which would allow the appreciated assets to be removed from the GRAT.

The advantage is that, on your death, the purchased or reacquired asset will be included in your taxable estate and will receive a step-up in basis equal to fair market value. This means that the capital gains tax on sale of that asset is eliminated. The children benefit from the grantor trust’s cash—and each dollar of cash has a dollar of basis—so truly the capital gain is eliminated forever.

Use of Intra-Family Loans

Because interest rates are so low, many techniques involving use of intra-family loans should be considered, including the following:

• The purchase of life insurance on the life of one family member by an irrevocable life insurance trust, with premium payments funded by loans from other family members.
• The creation of trusts by older generation members for the benefit of younger family members, to which the older generation members loan funds. The spread between the investment return earned by the trust and the interest owed will create a transfer tax-free gift.

Planning Idea to Protect against the Potential Loss of the $3.5 Million GST Tax Exemption

In order to avoid the loss of this year’s $3.5 million of GST tax exemption if the law reverts to 2001 levels, you should consider the possibility of making lifetime gifts now. For married U.S. citizens, this can be achieved without paying gift tax. You would make a gift to your spouse of an amount equal to the unused portion of your current $3.5 million GST tax exemption before the end of this year in the form of a qualified terminable interest property (QTIP) trust. Your spouse will be the only beneficiary of this trust during his or her lifetime so that the trust will qualify for the unlimited marital gift deduction. The trust would be created before the end of 2009 but not funded until the very end of 2009 to allow time to see if Congress extends the $3.5 million GST tax exclusion into 2010. If the exclusion is not extended, the trust would be funded and treated as a QTIP. Your remaining GST exemption could then be allocated to the QTIP trust by making what is known as a “reverse QTIP election.”

To allow for the most flexible planning, you could wait until October 15, 2010 (by going on extension), to file your gift tax return so that the choices as to what tax treatment to elect for the trust can be delayed as long as possible to allow Congress to act.

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