We close this week with Bruce Steiner’s review of the Obama Administration’s Revenue Proposals for Fiscal Year 2012 that was released on February 14, 2011. An administration’s revenue proposal is commonly referred to as the “Green Book,” and while the Green Book doesn’t contain the statutory language that underpins the various revenue proposals, it does provide clients and advisors with significant insights into where things could be headed in the future.

LISI members who would like to review the Green Book may click this link: General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals

Bruce D. Steiner, of the New York City law firm of Kleinberg, Kaplan, Wolff & Cohen, P.C., and a member of the New York, New Jersey and Florida Bars, is a long time LISI commentator team member and frequent contributor to Estate Planning, Trusts & Estates and other major tax and estate planning publications.  He is on the editorial advisory board of Trusts & Estates, and is a popular seminar presenter at continuing education seminars and for Estate Planning Councils throughout the country.  He was named a New York Super Lawyer in 2010.

Here is Bruce’s commentary:

EXECUTIVE SUMMARY:

Certain provisions of the Administration’s fiscal year 2012 revenue proposals could have a significant impact on individual taxpayers.  

FACTS:

The Administration recently released its fiscal 2012 revenue proposals. The key provisions affecting individual taxpayers are as follows:

                   

Tax Rates for Qualified Dividends and Long-Term Capital Gains

·        The maximum income tax rate on qualified dividends and long-term capital gains is 15%.

·        The 15% rate is in effect through 2012.  Beginning in 2013, qualified dividends are taxable as ordinary income, and the maximum rate on long-term capital gains is 20% (18% for assets purchased after 2000 and held for more than five years).

·        The Administration proposes to continue the 15% maximum income tax rate on qualified dividends and long-term capital gains for taxpayers with adjusted gross income up to $200,000 (single) or $250,000 (joint), indexed from 2009.  However, the administration proposes a 20% tax rate on qualified dividends and capital gains beginning in 2013 for taxpayers with adjusted gross income over $200,000 (single) or $250,000 (joint), indexed from 2009.

Minimum Required Distributions

In general, qualified plan participants and IRA owners must begin taking required distributions upon reaching age 70 ½.  Qualified plan participants owning less than 5% of the employer can postpone distributions until retirement.  There are no required distributions during lifetime in the case of a Roth IRA.

The Administration proposes to exempt participants and IRA owners from having to take distributions if the aggregate value of their qualified plan and IRA benefits does not exceed $50,000.  For this purpose, benefits under qualified defined benefit plans that have already begun to be paid in life annuity form would not count.  The requirement to take distributions would be phased in for individuals with benefits between $50,000 and $60,000.  The initial measurement date would be the beginning of the year in which the taxpayer reaches age 70 ½ (or the year of death, if earlier).  Additional measurement dates would occur at the beginning of the year following any year in which there are additional contributions, rollovers or transfers that were not previously taken into account.

This proposal would be effective for taxpayers attaining age 70 ½ after 2011.

60-Day Rollover for Inherited Retirement Benefits

A participant, IRA owner or spouse can take distributions of qualified plan or IRA benefits and roll them over into another qualified plan or IRA within 60 days.  However, a beneficiary other than a spouse cannot do so other than by direct trustee-to-trustee transfer.

The Administration proposes to permit nonspousal beneficiaries to roll distributions over to an inherited IRA with 60 days, effective for distributions after 2011.

Making Portability Permanent

Under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“TRUIRJCA”), the deceased spouse’s unused exclusion amount (“DSUEA”) can be transferred to the surviving spouse.  This is commonly known as portability.

The provision allowing portability is in effect through 2012. The Administration proposes to make portability permanent.

Consistency in Valuation

The basis of property acquired from a decedent is generally equal to the value as of the date of death. The basis of property acquired by gift is generally equal to the donor’s basis, increased by the gift tax paid on the appreciation.  However, for purposes of loss, the donee’s basis is limited to the fair market value as of the time of the gift.

In the case of persons dying in 2010, if the executor elects carryover basis in lieu of estate tax, the estate and beneficiaries generally take a carryover basis. It is not clear that the recipient’s basis must be the same as the estate tax value.

The Administration proposes a consistency requirement and a reporting requirement.  The basis of property acquired from a decedent would generally be equal to the value for estate tax purposes.  The executor of an estate, and the donor of a gift, would be required to provide the necessary valuation information to the recipient and to the Internal Revenue Service.  Regulations would provide for cases where no estate tax is required, where the gift is covered by the annual exclusion, or where the recipient may have better information that the executor. This proposal would be effective upon enactment.

Valuation Discounts

Certain “applicable restrictions” are disregarded for estate and gift tax purposes.

The Administration proposes to create an additional category of restrictions (“disregarded restrictions”) that would be ignored in valuing an interest in a family-controlled entity transferred to a member of the family if, after the transfer, the restriction will lapse, or may be removed by the family.

A limitation on a holder’s right to liquidate his or her interest that is more restrictive than a standard to be identified in regulations would be disregarded. A limitation on a transferee’s ability to be admitted as a partner would be disregarded. This proposal would be effective upon enactment.

Grantor Retained Annuity Trusts

It is possible to create a short-term grantor retained annuity trust (“GRAT”) in which the remainder interest has little or no value.

The Administration proposes that a GRAT would be required to have a minimum term of 10 years.  The remainder interest must have a value greater than zero.  There could be no decrease in the annuity payments during the GRAT term. This proposal would be effective upon enactment.

Limit Duration of GST Exemption

Each taxpayer has a GST exemption.  The GST exemption is $5 million for 2011 and 2012, and is scheduled to revert to $1 million (indexed for inflation) beginning in 2013.  The $1 million amount, indexed for inflation, would be $1,360,000 in 2011.

The common law rule against perpetuities is lives in being plus 21 years.  Some states have a 90-year statutory rule against perpetuities.

In recent years, approximately one-half of the states have either repealed their rule against perpetuities or lengthened the permissible period of time under the rule against perpetuities, in some cases to as long as 1,000 years.

The administration proposes that allocations of GST exemption would expire after 90 years, whereupon the inclusion ratio of the trust would be increased to one. There would be an exception for distributions to a new trust described in Section 2642(c) (a trust with one beneficiary, where the trust is included in the beneficiary’s estate).  Distributions to the beneficiary could be made free of GST tax.

The proposal would apply to trusts created after enactment, and to the portion of existing trusts attributable to subsequent additions.

Reduce Value of Itemized Deductions

Itemized deductions reduce taxable income, thus reducing tax at the taxpayer’s tax rate. The Administration proposes to limit the value of itemized deductions to 28% for high income taxpayers. This proposal would be effective beginning in 2012.

COMMENT:

The Administration’s revenue proposals are not law, nor even a bill.  After TRUIRJCA, attempting to predict tax legislation is difficult.  However, these revenue proposals are worth watching.  Some of them may be enacted soon.  Some of them may be enacted eventually.  Some of them may never be enacted.

To put these proposals in context, some combination of tax increases, spending reductions and economic growth will be necessary if Congress wants to reduce the projected budget deficits.

The Administration’s Baseline

The baseline under the Budget Enforcement Act reflects the projected receipts under current law, with very limited exceptions.

The Administration says that it is widely believed that a number of future tax law changes scheduled under current law are unlikely to occur.  These include the expiration of many of the tax cuts enacted by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Job Growth and Tax Relief Reconciliation Act of 2003 (JGTRRA), and extended by TRUIRJCA.

In this regard, the Statutory Pay-As-You-Go Act of 2010 (“PAYGO”) generally requires that new legislation changing taxes, fees or mandatory expenditures may not increase projected deficits.  However, four provisions are exempted from PAYGO if they are enacted by December 31, 2011.  The Administration views adoption of these PAYGO adjustments as the appropriate baseline, with two modifications.

More specifically, the Administration’s baseline assumes the following:

Estate and Gift Tax.  The estate and gift tax provisions in effect for 2009 will be permanently extended beginning in 2013.  In other words, the estate tax exempt amount will be $3.5 million, rather than the current $5 million or the $1 million scheduled to take effect again in 2013.  The tax rate will be 45%, rather than the current 35% rate or the 55% rate (with a 60% notch) scheduled to take effect in 2013.  The Administration explains that since Congress recently enacted more generous estate tax provisions through 2012, there is considerable expectation that future legislation will provide more generous treatment than pre-2001 law.

Alternative Minimum Tax.  PAYGO allows an adjustment for the cost of extending AMT relief through 2011.  The Administration assumes that the AMT relief for 2011 will be continued and permanently indexed for inflation after 2011 since Congress has repeatedly extended AMT relief.

Middle-Class Tax Cuts.  The PAYGO exceptions include making certain tax cuts permanent.  The Administration assumes the income tax rate cuts will be made permanent for taxpayers with adjusted gross income not exceeding $200,000 (single) or $250,000 (joint), indexed from 2009.

Tax Rates for Qualified Dividends and Long-Term Capital Gains

The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced the maximum tax rate on long-term capital gains from 20% to 15%, and provided that qualified dividends would be taxable as capital gains.

The 15% tax rate on qualified dividends and capital gains was scheduled to be in effect through 2010. The President had proposed increasing the 15% tax rate on qualified dividends and long-term capital gains to 20% for taxpayers with income over $200,000 (single) or $250,000 (joint). The Republicans proposed to make the 15% tax rate on qualified dividends and capital gains permanent.

The 2010 Act extended the 15% tax rate on qualified dividends and long-term capital gains through 2012.  Beginning in 2013, dividends are scheduled to be taxed as ordinary income, and the top tax rate on capital gains is scheduled to revert to 20%.

The Administration now proposes to continue the 15% tax rate on qualified dividends and long-term capital gains for taxpayers with adjusted gross income up to $200,000 (single) or $250,000 (joint), indexed from 2009.  However, the Administration proposes a 20% tax rate on qualified dividends and long-term capital gains beginning in 2013 for taxpayers with adjusted gross income over $200,000 (single) or $250,000 (joint), indexed from 2009.

While the President and the Republicans differ as to whether the top rate on qualified dividends and long-term capital gains should be 15% or 20%, they agree that qualified dividends should be taxable at the same rates as long-term capital gains. If the top tax rate on qualified dividends is increased from 15% to 20% beginning in 2013, some corporations may accelerate some dividend payments from early 2013 to late 2012.

If the top tax rate on long-term capital gains is increased from 15% to 20% beginning in 2013, some taxpayers may wish to consider accelerating sales to 2012 to take advantage of the 15% capital gains tax rate.  This may provide a benefit in the case of sales that would have occurred soon thereafter.  However, in the case of appreciated property that the taxpayer was not planning to sell in the near future, the benefit of the 15% tax rate may be outweighed by the cost of accelerating the tax and giving up the potential for a basis step-up by holding the asset until death.

Minimum Required Distributions

The rules governing distributions from qualified plans and IRAs are complicated, but have been liberalized several times, most significantly with respect to Roth conversions. Exempting participants and IRA owners with benefits under $50,000 from having to take required distributions will provide these individuals with one of the major benefits of the Roth conversion without having to convert to a Roth IRA.

As with the Roth conversion, if this proposal is enacted, there is a chance it will be expanded to a larger class of participants and IRA owners.  If so, it will provide a benefit to taxpayers with larger account balances who would not benefit from the Roth conversion.  This would include participants and IRA owners who plan to leave their retirement benefits to charity.  It would also benefit taxpayers in high income tax brackets who expect their beneficiaries to be in low income tax brackets.

It is also worth watching to see how this proposal will apply to beneficiaries of deceased participants and IRA owners who left benefits of $50,000 or less.

60-Day Rollover for Inherited Retirement Benefits

Limiting 60-day rollovers to participants, IRA owners and spouses is a trap for the unwary.  Nonspouse beneficiaries sometimes collect retirement benefits payable to them, either thinking they have 60 days to roll them over into an inherited IRA, or not realizing that they can set up inherited IRAs.

For distributions after 2001, the IRS has discretion to waive the 60-day deadline for participants, IRA owners and spouses to roll the benefits over where the failure to waive the deadline would be against equity or good conscience, including casualty, disaster, or other events beyond the reasonable control of the taxpayer.

However, the IRS does not have similar discretion in the case of a non-spouse beneficiary. Allowing non-spouse beneficiaries 60 days to roll over qualified plan or IRA distributions will eliminate this trap.

Making Portability Permanent

Many provisions of United States tax law are derived from provisions of United Kingdom tax law.  Portability is one example of this. The inheritance (estate) tax rate in the United Kingdom is 40%.  The nil rate band (exempt amount), is currently £325,000.

If the surviving spouse or registered civil partner dies on or after October 9, 2007, the deceased spouse or registered civil partner’s unused nil rate band amount can be transferred to the survivor.  Portability is available even if the first spouse or registered civil partner died before October 9, 2007.  Portability generally applies based upon the percentage of the nil rate band that the first decedent did not use.  For example, if the first decedent died when the nil rate band was £300,000, and used £150,000 (or 50%) of it, and the second decedent dies when the nil rate band is £325,000, the increase in the nil rate band is £162,500 (50% of the £325,000 nil rate band at the second death).  Also, in the United Kingdom, it is the executors or personal representatives of the second decedent who can transfer the unused nil rate band.  Unused nil rate bands from more than one predeceased spouse or registered civil partner can be transferred, up to one full nil rate band.

The portability provisions of TRUIRJCA expire at the end of 2012.  Unless portability is extended or made permanent, it will be of limited application.

Given the complexity of ending portability (whether to continue it for the surviving spouse where the first spouse died in 2011 or 2012), and the absence of any substantial opposition to portability, it seems likely that it will be extended or made permanent.

Even if portability is made permanent, clients should nevertheless consider using a credit shelter trust.  Portability applies only to estate and gift tax, not to GST tax.  The DSUEA is not indexed for inflation.  Assets in a credit shelter trust are better protected against the surviving spouse’s potential creditors, including future spouses.  On the other hand, by leaving assets to the spouse outright, a second basis step-up will be available at the spouse’s death.

One way to get some degree of creditor protection without losing the basis step-up at the spouse’s death is to provide for the spouse in a QTIP trust.  While the spouse must be entitled to all of the income from a QTIP trust, the spouse need not be entitled to principal. If the estate is too small to require the filing of a Federal estate tax return, it is not possible to make a QTIP election for Federal estate tax purposes.

If the estate is large enough to require the filing of a Federal estate tax return, it is possible to make a QTIP election for all of a trust if it is necessary to make a QTIP election for a portion of the trust to eliminate the Federal estate tax.  If it is not necessary to make a QTIP election for any portion of the trust to eliminate the Federal estate tax, the Internal Revenue Service will treat the QTIP election as null and void at the request of surviving spouse, or the executors of the surviving spouse’s estate.  Some people have suggested that the Internal Revenue Service (or, perhaps more importantly, decoupled states seeking estate tax at the first spouse’s death) might not treat the QTIP election as null and void on its own absent application by the surviving spouse or the executors of the surviving spouse’s estate.

One possible solution is the Clayton trust.  In a Clayton trust, property is held in a QTIP trust to the extent the executors elect QTIP, and in a credit shelter trust to the extent the executors do not elect QTIP.  This enables the decision to be postponed until after the client’s death.

Consistency in Valuation

Executors should keep in mind that if this proposal is enacted, the estate tax value will be binding for income tax purposes.

Valuation Discounts

The Administration proposes to disregard certain restrictions.  However, it is interesting to note that the Administration’s proposals do not include the elimination of valuation discounts for cash and marketable securities in family limited partnerships or family limited liability companies.

Grantor Retained Annuity Trusts

There have been various proposals to limit GRATs, including the Administration’s proposal to require a 10-year minimum term, as well as proposals to require a 10% minimum value for the remainder interest.  While none of these limitations has yet been enacted, clients may wish to consider creating GRATs now, to take advantage of existing law.

Limit Duration of GST Exemption

When the current version of the GST tax was enacted in 1986, most states had either the common law rule against perpetuities (lives in being plus 21 years), or a similar rule.  Soon thereafter, many states adopted the Uniform Statutory Rule Against Perpetuities, which permitted for a 90-year rule.

In 1990, the National Conference of Commissioners on Uniform State Laws reported that “Nearly all trusts (or other property arrangements) will terminate by their own terms long before the 90-year permissible vesting period expires.” Despite this comment, approximately one-half of the states have either repealed their rule against perpetuities or lengthened the permissible perpetuities period, in some cases to as long as 1,000 years.

By allocating GST exemption to a trust that can continue for many generations, or forever, a substantial amount of wealth can be placed out of the reach of the transfer tax system for a very long time, or forever. Since this proposal only applies to trusts created after enactment, or additions made to existing trusts after enactment, clients may wish to consider making transfers in trust now, and allocating GST exemption to them, so as to take advantage of current law.

Reduce Value of Itemized Deductions

If the value of itemized deductions is limited to 28%, this will reduce the benefit of itemized deductions for taxpayers in higher brackets. One would anticipate that charities would be concerned about this possible change.

The Administration proposes to make this provisions effective beginning in 2012. If this proposal is enacted, clients may wish to consider accelerating income tax deductions from 2012 to 2011 to the extent they can do so without adverse AMT consequences.

CONCLUDING OBSERVATION: Practitioners should monitor possible changes in the tax law.

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Bruce Steiner

CITE AS:

LISI Estate Planning Newsletter #1791 (March 17, 2011) at http://www.leimbergservices.com   Copyright 2011 Leimberg Information Services, Inc. (LISI).  Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission.

CITES: 

General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals (Dept. of the Treasury, Feb. 2011); Estate of Spencer v. Commissioner, 43 F.3d 226 (6th Cir. 1995), rev’g. T.C. Memo 1992-579; Robertson v. Commissioner, 15 F.3d 779 (8th Cir. 1994), rev’g. 98 T.C. 678 (1992); Estate of Clayton v. Commissioner, 976 F.2d 1486 (5th Cir. 1992), rev’g. 97 T.C. 327 (1991); Estate of Willis E. Clack, 106 T.C. 131 (1996), acq., 1996-2 Cum. Bull. 1; Rev. Proc. 2001-38, 2001-1 C.B. 1335; National Conference of Commissioners on Uniform State Laws, “Uniform Statutory Rule Against Perpetuities With 1990 Amendments” at 14, http://www.law.upenn.edu/bll/archives/ulc/fnact99/1990s/usrap90.pdf (last visited Feb. 27, 2011); http://www.hmrc.gov.uk (last visited Feb. 27, 2011)