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Archive for January, 2010

Life Insurance Trusts in 2010

Sunday, January 17th, 2010

by McGuireWoods Private Wealth Management

An irrevocable life insurance trust is an estate planning tool commonly used to prevent life insurance proceeds from being subject to estate tax at the death of the insured. In today’s unpredictable legislative environment, use of standard funding techniques for insurance trusts may have unknown and unintended generation-skipping transfer (GST) tax consequences.

Absent legislation from Congress, the GST tax, like the estate tax, “shall not apply to generation-skipping transfers after Dec. 31, 2009.” The GST tax is scheduled to return Jan. 1, 2011. For grantors and trustees funding or administering life insurance trusts during 2010 and beyond, the temporary suspension of the GST tax regime raises significant questions regarding the best and safest way to pay insurance premiums.

When premium levels permit, gifts from the grantor is a common method of funding the necessary insurance premiums. If such gifts are subject to so-called Crummey rights of withdrawal, they may qualify for the gift tax annual exclusion and not be subject to gift tax. In this respect, 2010 is the same as previous years. The significant difference that arises in 2010 is that because the GST tax does not apply to generation-skipping transfers, including some transfers to trusts, it therefore is not always clear if and how GST exemption can be allocated to those transfers.

In that case, when 2011 arrives and the GST tax returns, the trust may contain assets to which no GST tax exemption was allocated. A trust that was intended to be wholly exempt from GST tax may now be only partially exempt unless a late allocation of GST exemption is made on or after Jan. 1, 2011. A risk in waiting to make a late allocation is that the insured may die in the interim.

This result is unclear, and regardless of the result under current law, Congress may legislatively provide, clarify, or change the treatment of such transfers during 2010. If congressional action is retroactive (and survives constitutional challenge), it is possible that allocations may be made (or may be automatic) as though the lapse in the estate and GST taxes had never occurred.

During this period of uncertainty, one solution is for the trustee to borrow funds from the grantor or a third party to use to pay insurance premiums. If legislation during 2010 reinstates the GST tax or otherwise clarifies these issues for this year, the grantor can make gifts to the trust later in 2010 for the trust to use to pay off the loan. If no legislation is passed during 2010, a loan to the trust eliminates the concern about the trust’s fully exempt status for GST tax purposes for 2011 and beyond, and the grantor may make gifts to the trust in 2011 for the trust to use to pay off the loan. To avoid gift implications, any loan from the grantor or a family member must bear interest at no less than the Applicable Federal Rate as announced by the IRS and in effect at the time of the loan.

Although loans to fund life insurance premiums may be classified as a “split-dollar arrangement,” loans described above should not cause concern as long as the terms of the promissory note are respected and the trust has the ability to pay the principal and interest when due.

Another possible solution is to skip paying premiums during 2010 by using a portion of the policy’s existing cash value to maintain the policy, and then in 2011 to reinstitute the gift program. Life insurance advisors should be consulted before making a decision of this nature.

If loans or policy values instead of gifts are used in 2010 to maintain the insurance, attention should be given to other possible uses of the 2010 gift tax annual exclusions.

The Current Uncertain Estate Tax Environment

Saturday, January 9th, 2010

By Ron Alcutt, McGuireWoods, LLP Private Wealth Services Group

The 2010 Estate Tax Earthquake

Because Congress did not act in 2009 to preserve the federal estate and generation-skipping transfer (“GST”) taxes in 2010, the federal estate, gift, and GST taxes, which are sometimes collectively referred to as transfer taxes, have changed greatly from what they were in 2009.  As a result of the provisions of the 2001 Tax Act, the official title of which is the Economic Growth and Tax Relief Reconciliation Act of 2001 and which is sometimes referred to as “EGTRRA,” the estate and GST taxes have been repealed for one year while the gift tax remains in place with a $1 million exemption and 35% maximum rate and a “modified carryover basis” regime has been implemented to generally deny a step-up in basis of appreciated assets at death.  Unless Congress acts, the estate, gift, and GST taxes as they existed before 2002 will be reinstated in 2011 with a 55% rate (with a 5% surcharge on estates or cumulative gifts between $10 million and $17.184 million), a $1 million exemption for lifetime and testamentary transfers, and a $1 million exemption from GST tax (as indexed for inflation since 1999).  Because of this changed and unpredictable environment, clients and their advisors now face significant uncertainty in planning the gratuitous transfer of assets given the current state of transfer tax exemptions and rates.

What Will Congress Do?

It is impossible in this time of increased polarization and partisanship in Congress to predict if and when Congress will act to eliminate the uncertainty and disparity in the transfer tax laws.  If Congress acts, it is impossible to predict the effective date of the legislation, specifically whether the legislation will be retroactive to January 1, 2010 or effective as of the date of introduction or enactment.  If Congress acts and the legislation is retroactive, there undoubtedly will be a constitutional challenge to the retroactive application of the legislation.  Predicting the outcome of such a challenge is impossible.

Congressional action could involve any of the following possibilities:

  • Congress could enact transfer tax legislation, effective retroactively to January 1 2010, and either extend the 2009 transfer tax rates and exemptions or enact new rates and exemptions.
  • Congress could enact transfer tax legislation, effective as of the date of enactment, introduction, or some other action, and either extend the 2009 transfer tax rates and exemptions or enact new rates and exemptions.
  • Congress could continue the deadlock and not enact any legislation so the above transfer tax rates and exemptions will remain in place in 2010 and 2011 and beyond.

What Must We Do? Review of Estate Plans

Congress’s inaction may mean that some estate plans no longer meet the client’s objectives and goals.  In particular plans based on formulas or decisions tied to transfer taxes may be significantly impacted by the current state of flux.  For example, if a married client directs in the client’s will or trust that property equal to the estate tax exemption is distributed to the client’s children to the exclusion of the client’s spouse or that property equal to the GST tax exemption is distributed to the client’s grandchildren, the disposition of the client’s assets will vary significantly depending on the year of the client’s death and whether and in what manner Congress acts.

Also, many wealthy individuals have estate plans that use charitable gifts or techniques, such as charitable reminder trusts or charitable lead trusts that are designed to take advantage of the federal estate tax charitable deduction with the intention of lowering or eliminating the estate tax associated with a particular vehicle or plan.

There are other situations where a client’s estate plan will no longer accomplish the client’s estate planning objectives depending on when and how Congress acts.  Accordingly, clients and their advisors should review their estate planning documents to determine whether changes are in order or necessary to accomplish the client’s planning objectives.  Also, clients should monitor activity in Congress to see if Congress quickly clears up this mess and thereby eliminates the need for changes.

If Congress fails to act quickly and there is a carryover basis regime for part or all of 2010, estate plans must be reviewed to make sure that adequate provisions have been or are made to take advantage of the adjustments available to reduce the impact on a decedent’s estate because the appreciated assets it holds no longer receive a step-up in basis to the fair market value on the date of death.