Last night, the House passed the compromise tax legislation negotiated between President Obama and the Senate Republicans (the “Act”). President Obama is expected to sign the Act into law promptly. Although the Act includes a number of provisions that our clients will find of interest, we would like to bring to your immediate attention a few of the more significant features of the Act that bear upon year-end transfer tax planning.
Taxable gifts
Under the Act, the Federal gift tax rate for 2010 through 2012 is 35%. In addition, the Federal gift tax exemption will increase in 2011 from $1 million to $5 million. The increase in the Federal gift tax exemption will be for 2011 and 2012 only (with the 2012 exemption indexed for inflation). While in certain situations paying a gift tax can result in an overall tax benefit, most clients who are considering making taxable gifts this year to take advantage of the 35% gift tax rate will want to wait until 2011, when a larger Federal gift tax exemption will be available.
Generation-skipping transfers
The Act provides that transfers to grandchildren made prior to January 1, 2011 will escape Federal generation-skipping transfer (“GST”) tax entirely. For 2011 and 2012, the Federal GST tax rate will be 35% and the Federal GST tax exemption will be $5 million (with the 2012 exemption indexed for inflation).
Prior to the end of 2010, clients who have not yet used their $1 million Federal gift tax exemption or who are willing to pay the 35% Federal gift tax (and, in some states, a state gift tax) may wish to make gifts to grandchildren (or other skip persons), either outright or in trust. The amount transferred to grandchildren would “skip” the child generation and would avoid Federal and state estate and GST taxes that might otherwise be imposed on a child’s death, representing a significant potential tax savings.
The Act also permits distributions prior to year end from trusts that are neither exempt nor grandfathered from the Federal GST tax without the imposition of a Federal GST tax. Again, such distributions could result in significant tax savings.
Grantor retained annuity trusts
The Act does not contain the requirement that GRATs have a minimum 10-year term. Thus, it will still be possible to establish short-term GRATs. Nonetheless, because the benchmark rate for this month is only 1.8%, clients may still wish to establish GRATs prior to year end.
