Obama’s New Budget Plan

As I have blogged about before, the exemption estate and gift tax rules are set to return to less favorable amounts if Congress does not act before the end of the year. Obama’s budget that was just released yesterday gives us a clear idea of what Obama would like to see happen. According to his plan, the estate and generation-skipping transfer tax exemptions would drop from $5.12 million per person to $3.5 million per person. Additionally, the tax-free ceiling for lifetime gifts would go down to $1 million and the top tax rate would go up from 35% to 45%.

President Obama is also going after “leveraging techniques” in his new budget – estate planning strategies that “pack more into the lifetime exemption amount and minimize the gift tax owed.” The following devices are at risk:

• Grantor Trusts: A grantor can shrink his estate with these trusts and appreciate assets inside the trust without being subject to income taxes or capital gains taxes.Obama wants these trusts to be taxable as part of the grantor’s estate. Furthermore, he wants distributions that the grantor makes during his life from the trust to the beneficiaries to be subject to gift tax.
• Dynasty Trusts: Several states have abolished the rule against perpetuities and they allow you to create dynasty trusts that continue in perpetuity to pass wealth through multiple generations. Obama’s plan wants to do away with these trusts entirely.
• The Low-risk grantor retained annuity trust or GRAT: These trusts allow someone to put assets into an irrevocable trust and then to receive distributions from the trust over the term. The Treasury sets an interest rate every month that determines an annuity. If the trust increases more than the hurdle does, then the GRAT is economically successful and the appreciation goes to family members or to trusts for their benefits. If no appreciation occurs, the trust can return more of the assets to the grantor to satisfy its payout obligations. Currently, you can form a zeroed-out grant where the remainder is worth nothing and there would be no taxable gift. Obama wants to get rid of that and also require that a GRAT last for a minimum of ten years instead of the required two-year minimum now.
• Using Family entities to Achieve Discounts: Some people use family limited partnerships and LLCs to discount assets and then they transfer them to family members or their trusts. Reducing the value of the assets minimizes the tax cost of transferring the assets.Obama’s proposal suggests that we cut back on the use of discounts and apply the restriction retroactively.

Deborah L. Jacobs, Obama Declares War On Rich Folks and Wealth Advisors, Forbes, Feb. 14, 2012.

Note that this “war” is not just on the ultra-rich – “normal” people who live in high-priced real estate markets with life insurance could get swept into tax trouble under the proposed changes, especially if proper planning is not done.