Planning Items and Strategies to Consider During Uncertain and Difficult Economic Times

by Dan Pape

Pape, Daniel
(402) 341-3070

Turn on the evening news or open any newspaper and all you hear about is the poor state of the economy. While difficult times are never easy to face, the economic downturn, when combined with recent tax law changes and  potential, adverse tax proposals by the new President, encourage taking consideration of estate and income tax planning opportunities and strategies, sooner than later.

The federal estate tax exemption for those dying in 2009 is $3.5 million (up from $2 million in 2008). As it is on the books right now, the estate tax will disappear in 2010, and then resurrect on January 1, 2011, by taxing estates of more than $1 million at rates as high as 55%. While it is highly unlikely that Congress will actually allow the exemption to become unlimited in 2010, the exact outcome of the estate tax exemption and maximum estate tax rate beginning in 2010 is not entirely clear.

One possible outcome is that the 2009 estate tax exemption level will be made permanent at $3.5 million (indexed for inflation going forward), the estate and gift tax exemptions will be unified and there will be a maximum estate tax rate of 45%. With some luck, Congress will also allow “portability” of the exemption between spouses, thus making it easier for spouses to fully utilize their exemptions without having to separately title assets between them.

The increase in the estate tax exemption is meaningful. In light of it, some may ask “who needs an estate plan when there’s an exemption of $3.5 million – especially when I have lost 40% in my stock portfolio in the last year and the real estate market has collapsed?” While it is true that the vast majority of people will not have to worry about estate taxes if the $3.5 million exemption level is made permanent (the Tax Policy Center estimates that only one-quarter of 1% of all estates would be subject to estate tax under such circumstances), there are still significant end-of-life issues that need to be considered.

For starters, estate plans need to be reviewed to confirm that the higher exemption levels are accounted for under the plan (i.e. by containing formula bypass language that picks up the then-current exemption amount). In addition, many estate plans which are drafted for married couples who have children first provide for the funding of a “family trust” (typically in an amount up to the estate tax exemption), with the balance going to a “marital trust”. Some of these plans then provide for outright distributions to non-spousal beneficiaries on the death of the first spouse. For example, some plans were drafted at a time when the creator’s estate was anticipated to be large enough to properly provide for the surviving spouse (via the marital trust), even after the distributions to the non-spousal beneficiaries were taken into account. With the downturn in the economy, such a plan may no longer fulfill the creator’s intentions because the marital trust may no longer be funded at an adequate level. Any plans containing such provisions should be evaluated and reviewed for possible modifications.

In addition, while most estate plans commonly set up distributions to the next generation “by the head” (i.e. split my assets equally between my children…), some plans require specific bequests to be made to named beneficiaries. One danger of making distributions in this manner is that the values of the assets that are the subject of the bequests may vary widely over time due to circumstances that were not contemplated at the time the plan was drafted. For example, if a husband and wife set up an estate plan that provides for one child to receive an interest in a family-owned bank that the child is active in, while a second child is to receive a family farm (with the values of such assets being roughly equal at the time the plan was drafted), it is possible the bank stock may be more adversely affected by the recession, thus unintentionally leaving one child short on the amount of his or her distribution. Similarly, charitable bequests could have been established to provide for fixed dollar amounts going to a named charity. With the losses that have been realized in individuals’ net worth these days, such a bequest could result in a disproportionate amount of the overall estate now going to charity (as compared to what was intended at the time the plan was originally drafted). Because of the risks presented by specific bequests, any estate plan which contains them should be reviewed to ensure the creator’s intentions will continue to be met.

While an uncertain economy may make it difficult to act, people should be made aware that oftentimes this is one of the best opportunities to transfer wealth with lower estate and income tax consequences. Strategies that benefit from a combined low interest rate and depressed business value environment include (among others) sales to irrevocable grantor trusts, charitable lead trust planning and qualified personal residence trust planning.

A sale to an irrevocable grantor trust (“IGT”) is an estate “freeze” strategy that involves the creation of an irrevocable trust into which the client sells an asset they expect to appreciate over time, in exchange for a promissory note equal to the value of the transferred asset. No gain is recognized for income tax purposes on the sale of the asset into the trust (hence the “grantor” as owner nature of the trust), but the asset is removed from the person’s estate for estate tax purposes, thus “freezing” the value as of the date of the sale. IGT’s are especially attractive in today’s climate in light of: (1) the continued downward pressure on business values due to the economic conditions; and (2) the interest rate on the promissory note being based on the IRS’s “applicable federal rate,” which is near historic lows.

A qualified personal residence trust (“QPRT”) works in a similar manner. A QPRT is an irrevocable trust to which the creator transfers ownership of their residence (or vacation home) for a term of years. During such term, the creator retains the right to use the property; thereafter the property is distributed to the beneficiaries. The transfer to the trust is a taxable gift to the beneficiaries, but the gifted amount is discounted based on the rate set forth in Internal Revenue Code § 7520 and applicable mortality tables. With depressed residential property values, a QPRT is an attractive option for clients to consider. A more detailed article, authored by Jim Wegner of our office, which discussed QPRT strategies is available at the McGrath North website,

For clients with charitable intentions, a charitable lead annuity trust (“CLAT”) is an excellent technique to consider now.  A CLAT is a trust to which the person contributes assets to, with the trust paying a charity a fixed amount for a fixed number of years or for the life of a person.  The assets remaining in the trust at the end of the term return to the heirs.  A CLAT is beneficial because upon the transfer of the assets into the trust, the gift is equal to the difference between the value of the assets and the value of the charity’s interest.  A compelling case can be made for using a CLAT now due to the low interest rates used to determine the value of the charity’s interest, which in turn results in a significantly lower gift for gift tax purposes. Depending on the CLAT’s terms, the taxable gift would be minimal.

Practice Pointers

  1. Recent tax law changes mandate a thorough estate plan review. The impact of the increase in the federal estate tax exemption to $3.5MM, “family” and “marital” trust funding and distribution issues, and issues surrounding special bequests all deserve attention to ensure that the creator’s intentions are fulfilled in their estate plan.
  2. A review of any life insurance policies put in place to pay anticipated estate taxes should be undertaken to determine their need going forward. Alternatively, the proceeds from such policies can be re-directed for non-tax purposes.
  3. The low interest rate environment, in combination with low business valuations and depressed real estate prices caused by the recession, has created substantially favorable wealth transfer opportunities that deserve serious consideration. Specifically, sales to intentionally defective grantor trusts, along with charitable lead annuity trust and qualified personal residence trust planning can result in significant tax savings.
  4. Now is the time to consider outright gifts of assets with depreciated values. Gifting such assets now serves as a means by which to remove the future appreciation from the estate once the economy heats back up.
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