Client Alerts

Gift and Estate Tax Issues, January 2009

Changes in the Federal Estate Tax Laws

As most of you know, the federal government currently imposes a tax on the privilege of transferring property upon death. There are three exceptions to this tax: (i) an unlimited marital deduction (assuming your surviving spouse is a U.S. citizen); (ii) an unlimited charitable deduction; and (iii) an "applicable credit" against the tax levied on non-spouse, non-charitable transfers.

As of January 1, 2009, this credit will allow you to transfer an amount (called the "applicable exclusion amount" or the "tax exemption amount") up to $3.5 million to any beneficiary without payment of federal estate tax. The federal estate tax is scheduled for repeal in 2010; however, a sunset provision reinstates the federal estate tax in 2011 and beyond with only a $1 million federal applicable exclusion amount to shelter property going to non-spouse, nonscharitable beneficiaries. As many of you already know, President-elect Obama opposes the scheduled repeal of the federal estate tax. If his tax plan is adopted, the federal estate tax exemption will remain $3.5 million and the top federal estate tax rate will remain at 45% in 2010 and beyond.

Accordingly, if you and your spouse have more than $3.5 million in assets, each of you should consider how your assets are titled so that you can each utilize your full federal applicable exclusion amount by passing this sum to your non-spouse, non-charitable beneficiaries (including trusts) without the imposition of a federal estate tax. Please keep in mind that any assets that are held as joint tenants or tenants by the entirety will pass outside of your Will to the joint tenant. Also, assets that have a beneficiary designation (e.g., life insurance and retirement benefits) will pass pursuant to the beneficiary designation and not under your Will and/or Revocable Trust.

New York Estate Tax Exemption

Although the federal applicable exclusion amount will change at the start of the New Year, New York continues to maintain the state death tax laws that were in existence before the changes in federal law. As a result, an estate may be subject to New York State death taxes even if it is exempt from federal estate tax. The current New York State estate tax exemption amount is $1 million. Accordingly, if a New York resident were to die in 2009 and leave $3.5 million in a trust for the benefit of his spouse and children, a New York estate tax of $254,911 would be due. This discrepancy between the federal and New York State estate tax laws creates additional choices in tax planning, particularly for a married couple.

Many states no longer have an estate tax and, as such, changing your primary residence to a different state may be advisable for some clients. For others, a change in the form of ownership of real estate and/or tangible personal property located in other states may reduce state death taxes.

Gift Tax Lifetime Exemption

Unlike the federal estate tax exemption amount (described above), the exemption for lifetime gifts remains frozen at $1 million, even though the estate tax exemption amount has increased.

Any lifetime taxable gifts exceeding a cumulative lifetime total of $1 million (not including annual exclusion gifts) will be subject to federal gift tax, making careful planning of lifetime donative transfers very important.

There is no New York State gift tax.

Gift Tax Annual Exclusion

On January 1, 2009, the federal gift tax annual exclusion (the aggregate amount that you can give to an individual per year without incurring a federal gift tax) increased to $13,000 ($26,000 for a married couple who elect to "split" their gifts on their gift tax returns). This exclusion is available each year and enables you to give up to $13,000 per year to as many different beneficiaries as you desire, without any gift or estate tax consequences.

In addition, on January 1, 2009, the federal gift tax annual exclusion for gifts made by U.S. citizens to their noncitizen spouses increased from $128,000 to $133,000.

Gifts of the annual exclusion amount do not count against the $1 million gift tax exclusion amount (described above), making such gifts an important planning tool for those who are able to make them.

Note that gifts of so-called "future interests," which include most gifts in trust, do not qualify for this exclusion. Careful planning is required to ensure that gifts in trust are eligible for the annual exclusion.

Tuition and Medical Payments

In addition to the federal gift tax exclusion amounts, you may pay tuition and medical expenses (including medical insurance premiums) for any individual in any amount without incurring a gift tax, provided that you make the payments directly to the school or service provider (e.g., you write a check to a doctor).

Foreign Gifts

Recent changes have been made to the IRS reporting requirements for "foreign gifts" received by U.S. persons. Recipients of any gifts or bequests received on or after June 17, 2008 from a "covered expatriate" must pay a transfer tax on any amount exceeding the gift tax annual exclusion. All such gifts are aggregated for purposes of calculating the transfer tax. In addition, as of January 1, 2009, if you receive "foreign gifts" from nonresident alien individuals or foreign estates, you are required to report such gifts if the aggregate amount exceeds $100,000 during the tax year.

Generation Skipping Transfer Tax

Similar to the federal estate tax exemption amount, the federal generation skipping transfer ("GST") tax exemption amount has increased to $3.5 million. The GST tax is scheduled to be repealed in 2010 and then reinstated in 2011 with a $1 million tax exemption amount in the absence of new legislation. Generally, the GST tax applies to property transferred (from a trust, by gift, or upon death) to individuals at least two generations below the transferor (or the individual who created the trust) or to a trust from which such an individual will benefit. The GST tax exemption amount is automatically applied to certain types of transfers unless the transferor officially opts out of the automatic allocation.

Transferring Wealth to Younger Generations

Despite the difficult economic climate, if you feel that you have sufficient assets, it might be a good time to do some estate planning. There are ways in which you can take advantage of today's low interest rates and the depressed value of assets that are likely to rebound in the coming years (e.g., real estate and stocks). If you are interested in more complex estate planning strategies, please contact me to discuss the use of intra-family loans, intentionally defective grantor trusts, or grantor retained annuity trusts ("GRATs"). You may be able to reduce the transfer tax costs or preserve your exclusion amounts if assets you transfer now increase in value later.

College Savings

If you have young children or grandchildren, you may want to consider a 529 plan to assist you in putting aside money to pay for college. There are a variety of savings plans and pre-paid tuition plans which may be appropriate for you. Each of these plans offers significant tax savings and tax planning opportunities. For more information, I recommend looking at; it provides a great deal of general information about the different types of plans, as well as details and comparisons for specific ones.

Kiddie Tax

The Small Business and Work Opportunity Tax Act of 2007 has sought to reduce the benefits of intra-family transfers by broadening the "kiddie tax." In the past, individuals in high-income brackets could reduce the amount of tax due on appreciated property by transferring such assets to family members who were in low-income brackets or below the taxable income threshold. Under this new Act, the net unearned income of a child under the age of 18 will be taxed to the child at the parents' highest marginal tax rate. In addition, a child between the ages of 19 and 23 will be subject to the "kiddie tax" if (1) the child's earned income is less than one-half of the child's support, (2) either parent of the child is alive at the end of the tax year, and (3) the child does not file a joint tax return for the tax year.

Charitable Gifts

Transfers to qualified charities, whether during lifetime or upon death, are generally exempt from transfer taxes and do not affect the availability of the gift tax exclusion amount or the estate tax exemption amount.

In addition to reducing the value of your estate for estate tax purposes, charitable giving during life may provide you with an income tax deduction. The benefits are even greater when appreciated assets are given to a charity. Because the charity does not pay income tax, no capital gains tax will be owed upon the sale of the assets by the charity.

IRAs and Qualified Plans

Many employee benefits, including 401k plans, IRAs, SEPs and other individualized plans, profit sharing plans and money purchase pension plans, have post-death payment features that should be reviewed in the context of your estate planning. Such assets often suffer greater tax erosion than other assets because they are subject to both estate tax and income tax. Careful planning may minimize the tax impact on such assets. You should review the beneficiary designations on such plans to make sure that they are in accord with your wishes and your estate plan.

Charitable IRA Gift Distributions

In its Emergency Economic Stabilization Act of 2008, Congress revived the charitable IRA gift rollover provisions that expired at the end of 2007. The provisions now extend through December 31, 2009. This new legislation allows individuals who are 70 1/2 years of age or older to make tax-free distributions directly from their IRAs to "qualified charities." This is particularly helpful for individuals who have been unable to fully benefit from charitable deductions in the past or who are confronted with mandatory IRA withdrawals. If you qualify, you can exclude up to $100,000 from your gross income and count the charitable gift towards your annual minimum required distribution; however, it is important to remember that you will not be able to take a charitable income tax deduction for this distribution. The key provisions of this Act are as follows:

Required Minimum Distribution Rules Suspended for 2009 for IRAs and other Defined Contribution Plans

Pursuant to the Worker, Retiree, and Employer Recovery Act of 2008, enacted by President Bush on December 23, 2008, the required minimum distribution rules for IRAs and other contribution plans are suspended for the 2009 tax year. Accordingly, owners and beneficiaries of IRAs and other contribution plans have the flexibility of choosing whether or not to take distributions from their retirement accounts in 2009. This is particularly helpful in light of the reduced value of assets in retirement and contribution plans. You should contact your plan administrator if you have any questions regarding the required minimum distributions for your retirement plan or account.

Life Insurance

If you are planning to purchase life insurance, we should have a conversation before you purchase a policy to see whether a life insurance trust would be appropriate for you. You should also review any existing insurance policies to determine the appropriateness of a transfer of such policies to a life insurance trust and to ensure that the beneficiary designations of such policies comport with the dispositive provisions of your estate plan.

If you have a life insurance trust please ensure that your Trustee is complying with the formality of notifying the trust beneficiaries of their withdrawal rights each time a contribution is made to the trust. In addition, please make sure that you have named your insurance trust as the owner and beneficiary of any life insurance policies that you wish to transfer to the trust.

Pay On Death Accounts

A Pay on Death ("POD") account is a useful tool to avoid the probate of some assets and to efficiently transfer them at your death. A POD account is very easy to establish. You simply give your bank the name of the person or people you wish to receive the funds in the account upon your death. You may change the beneficiary or withdraw some or all of the funds at any time. Until your death, the beneficiary has absolutely no right to access any funds in the account. Upon your death, the beneficiary must show the bank a death certificate and appropriate personal identification to claim the funds.

A POD account may be particularly useful for you if you wish to transfer funds quickly upon your death to someone to whom you do not wish to give access to the funds during your lifetime.

Additional Information Regarding Your Estate Plan

Personal Records

Estate planning encompasses much more than the preparation of Wills and trusts to dispose of your property according to your wishes. To assure the orderly transfer of property as you have planned, it will be helpful for your survivors to have as much information as possible from you about your assets. To avoid confusion and to ensure that nothing is overlooked, I recommend preparing a list of all of your bank and investment accounts, life insurance policies, and other assets, along with account numbers and contact names and phone numbers for each.

In addition, increased use of investment software and online banking, investing, and bill-paying services are creating a new challenge to survivors. With fewer (or no) paper records evidencing some accounts, your executor could fail to recover some assets. To supplement the list recommended above, you may want to keep a list of all electronic accounts and all passwords required to gain access to them.

Once compiled, these lists should be periodically updated and kept in a safe place with your original will and/or trust documents.

Non-Financial Planning

Executing your estate planning documents and making the many decisions that accompany that process are very important steps to ensuring the smooth transfer of your assets according to your wishes after your death. Also very important, however, is ensuring that your personal wishes are respected regarding non-financial matters as well. If you have not already done so, you may wish to prepare a letter for your loved ones detailing your wishes regarding funeral and burial arrangements and any religious or other issues you would like to be acknowledged at the time. It is best to provide this information to loved ones in a letter, rather than in your will, because funeral arrangements are frequently made prior to reading a will.

Keeping Your Estate Plan Current

In addition to the tax law changes highlighted above, changes in your assets, your family situation, or your business relationships may necessitate changes in your estate plan.

You may wish to review your estate plan if any of the following events occur:

Filing Trust and Estate Income Tax Returns

Currently, you can request an automatic extension for filing trust and estate Federal income tax returns. However, please note that the period of this automatic extension has been reduced from six months to five months for all trust and estate Federal income tax returns due on or after January 1, 2009.

This material is intended for informational purposes only and does not purport to be legal advice.

To comply with certain U.S. Treasury regulations, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this memorandum, including attachments, is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.