The State of the Federal Estate Tax: What Does it Mean to You and Your Clients? Lew Dymond, Esq.

1. The State of the Federal Estate Tax: What Does it Mean to You and Your Clients? Lew Dymond, Esq.

2. Oh My! What a Mess! • Assumed Congress would do something before 2010? • Most current plans do not address planning for no federal estate tax and §1022 • Your clients are not alone

3. Good News! • The current state of the law creates the greatest estate planning marketing opportunity in at least 10 years.

4. Where are we and how did we get here? • Taxpayer Relief Act of 1997 • Prior to EGTRRA 2001 we were in the middle of the phase in of the Taxpayer Relief Act of 1997 • Changed name from Unified Credit to Applicable Exclusion Amount • Increase Unified Credit from $600,000 in 1997 to $1M for 2006 and thereafter; Graduated rates up to 55% • GST Exemption $1M with inflation adjustment; flat rate 55% (maximum estate tax rate) • QFOBI – up to $675,000 but coordinated with the amount of the unified credit (applicable exclusion amount) - $1.3M limit • State death tax credit – most state death taxes were “coupled”

5. Where are we and how did we get here? • Economic Growth and Tax Relief Reconciliation Act of 2001 (2002 – 2009) • “Phase out” of the federal estate tax • Immediate increase of unified credit to $1M • Immediate reduction of maximum rate to 50% • Staged increases in unified credit to $3.5M for 2009 • Annual 1% decrease in maximum rate to 45% by 2007 • $1M of unified credit could be applied to lifetime gifts • GST Exemption equal to the unified credit and maximum estate tax rate

6. EGTRRA – Year 2010 • Estate Tax Repealed – Section 2210 • Chapter 11 (Estate Tax) does not apply to the estates of decedents dying after 12/31/2009 • Property remaining in QDROs will not be included in surviving spouse’s estate. Tax on distributions continue through 2010 • GSTT Repealed – Section 2664 • Chapter 13 (Tax on Generation Skipping Transfers) does not apply to generation-skipping transfers after 12/31/2009

7. EGTRRA – Year 2010 • Section 1022 – Treatment of property acquired from a decedent dying after 12/31/2009 • 1022(a) – In general • Carry over basis • Treated same way as property transferred by gift. • Basis is the lesser of decedent’s adjusted basis or fair market value on date of death • 1022(b) – Basis increase for certain property • $1.3M of basis increase. $60K for non-resident non-citizens • No restrictions on who can receive • Must be “acquired from a decedent” – won’t apply to QTIP property or Section 2041 power of appointment property

8. EGTRRA – Year 2010 • Section 1022 – Treatment of property acquired from a decedent dying after 12/31/2009 • 1022(c) –Additional $3M basis increase for “qualified spousal property.” • Outright transfers to spouse or QTIP. • Spouse has a “qualified income interest” • All income on at least an annual basis • No person has a power to appoint to any person other than spouse • Apparently doesn’t apply to general appointment trusts or even survivor’s trust on a joint RLT • Different coupons; different rules

9. EGTRRA – Year 2010 • Section 1022 – Treatment of property acquired from a decedent dying after 12/31/2009 • $1.3M, $60K and $3M are adjusted for inflation • Basis increase not available for gifts received by decedent within 3 years of death • Exception for gifts received from spouse unless spouse received by gift within 3 years of decedent’s death • Section 6018 – Returns relating to large transfers at death – • required for transfers on death exceeding $1.3M. • Allocated by decedent’s executor.

10. EGTRRA – After 2010 • Section 901 of EGTRRA – Sunset Provisions • Provisions of EGTRRA do not apply to: • Taxable, plan or limitation years after 12/31/2010 • Estates of decedents dying, gifts made or generation-skipping transfers, after 12/31/2010 • Application of Internal Revenue Code after 12/31/2010 • shall be applied and administered to years, estates, gifts and transfers as if provisions and amendments to EGTRRA had never been enacted

11. Years 2011 and Beyond • Law prior to EGTRRA 2001 • $1M applicable exclusion amount (Unified Credit); Graduated rates from 41% to 55% applies to estates and lifetime gifts • GST Exemption $1M with inflation adjustment ($1.3M); flat rate 55% (maximum estate tax rate) • QFOBI • State death tax credit restored – economic good news for a number of states

12. GSTT and Trusts Created Under EGTRRA? • Taxable distributions and terminations • §2641 – product of maximum federal estate tax rate and the inclusion ratio • What is the inclusion ratio of trusts created in 2010? • §2642 – 1 minus the applicable fraction; applicable fraction numerator = GST exemption allocated to the trustdenominator = amount of transfer (1-0=1) • Creates risks for gifting strategies in 2010 • Trusts created between 2004 and 2009? • Sunset – IRC applied as if EGTRRA never enacted • EGTRRA GST exemption larger than $1M pre-EGTRRA

13. What will Congress Do Now? • Extend 2009 EGTRRA – Retroactively • HR 4154 – Passed in the House on 12/3/2009 by vote of 225 - 200 • Probably what most practitioners, Democratic congressmen and the Service believe will happen • Extend 2009 EGTRRA – Prospectively • Longer Congress takes the more likely any change will be prospective only; avoid uncertainty of constitutional challenge; Political unpopular action to apply a tax retroactively • Extend 2009 EGTRRA for two years

14. What will Congress Do Now? • Extensive Estate Tax Reform • Use opportunity to address extensive, meaningful estate tax reform. • Short Term GRATS – minimum 10 year term • Discounts on non-operating businesses • Legislative overrule of Crummey • Higher applicable exclusion amount (Unified Credit) • Lower federal estate tax rates (20% - 35%) • Portability • Involve major political differences, not likely to happen quickly and therefore not likely to be retroactive.

15. What will Congress Do Now? • Nothing – let 2010 and Sunset play out • Politics makes strange bedfellows and strange results • Republicans – “kill the golden goose” • Democrats – significant source of funds for major political priorities • Committee on Taxation 2005 estimates; $290B for 2011 – 2015; $1T for decade of 2011 – 2020 (includes interest on debt reduction • States – economic boost when very much needed • Corrective legislation • Grandfathering of GST exemption for trusts created under EGTRRA; Repeal of Section 1022 retroactively

16. Solutions to Dealwith Uncertainty • The law hasn’t changed for the last 8 years; it just failed to change. • Documents relying on formula dividing into Marital and Non-Marital shares referring to federal estate tax or QTIP allocations may have different results depending on how worded and how interpreted. • Even if all were designed to achieve same result - maximum reduction of estate tax • Subject to ambiguity • Service may not be bound by a state court determination

17. Solutions to Dealwith Uncertainty • The law hasn’t changed for the last 8 years; it just failed to change. • If a client’s documents don’t directly deal with possibility of no federal estate tax and §1022, may need to be amended or restated

18. Solutions to Dealwith Uncertainty • “If there is no federal estate and §1022 is in effect . . .” • All to the Marital Share, with spousal disclaimer funding the Non-Marital Share • Marital Share must be a QTIP or outright • Simple solution; maximum benefit to spouse; still provides flexibility of a “second look” at time death of first to die • Lose flexibility of granting spouse a limited testamentary power of appointment in the CST

19. Solutions to Dealwith Uncertainty • “If there is no federal estate and §1022 is in effect . . .” • The WealthCounsel Back-and-Forth Approach • Allocate to the Non-Marital Share sufficient assets to use the $1.3M §1022(b) step-up in basis • Allocate to the Marital Share sufficient assets to use the $3M §1022(c) step-up in basis (QTIP or outright) • Allocate balance to Non-Marital Share • Maximizes amount going to Non-Marital Share and makes use of spousal $3M step-up in basis

20. Solutions to Dealwith Uncertainty • Other Considerations • Absent change in IRC, • if Marital Share allocated to QTIP should not be included in surviving spouse’s estate §2044 – no marital deduction taken • GSTT inclusion ratio of CST = “1” • Possible legislation that could affect planning • Possible retroactive repeal of §1022 • Complete or partial grandfathering for GSTT purposes • Include QTIP property elected for §1022(c) step-up in the estate of the surviving spouse

21. Solutions to Dealwith Uncertainty • Planning team must determine client’s fact-based objectives as to Marital and Non-Marital division • Design the plan based on best guess as to permanent estate tax law ($1M - $3.5M Unified Credit and GST Exemption) • Then determine if need to specifically address possibility of no federal estate tax and Section 1022 basis adjustment

22. Solutions to Dealwith Uncertainty • All to Marital Share – outright or QTIP (one-lung QTIP) • All to Marital Share – outright or QTIP, with disclaimer funding of Marital Share • May not need to specifically address no federal estate tax and Section 1022 • If Marital Share is to general appointment trust or even to Survivor’s Trust in a joint trust?

23. Solutions to Dealwith Uncertainty • If Marital Share is to general appointment trust or even to Survivor’s Trust in a joint trust • Property may not qualify for §1022 basis adjustment

24. Solutions to Deal withState Death Tax • If the state allows a QTIP election separate from the federal QTIP election • Allocating the Marital Share to a QTIP provides great flexibility • Insure that the Marital Share is large enough to reduce both federal and state death taxes to lowest possible amount; • Elect QTIP treatment for federal purposes only to extent necessary for federal estate tax purposes; if no federal estate tax nothing is elected for QTIP treatment for federal purposes • Make a separate QTIP election for the amount necessary to eliminate state death taxes

25. Solutions to DealState Death Tax • If the state doesn’t allow a QTIP election separate from the federal QTIP election • Two QTIPs • QTIP One – large enough to reduce federal estate taxes to lowest possible amount • QTIP Two – additional amount necessary to reduce state death taxes to lowest possible amount. • Both QTIP One and Two elected for QTIP treatment both federal and state • Rely on Rev. Proc. 2001-38 to have the federal QTIP election for QTIP Two considered void upon death of surviving spouse

26. Other Solutions to Deal with Uncertainty • Consider including a provision allowing distributions from trust to a beneficiary for purpose of allowing a Section 1022 basis adjustment on death of the beneficiary

27. Other Solutions to Deal with Uncertainty • Consider a flexible (hybrid) testamentary power of appointment granting a general power of appointment to any share subject to GSTT and a limited power of appointment to any share not subject to GSTT

28. Other Solutions to Deal with Uncertainty • Decanting provisions • Expanded use of Trust Protectors • Grant the Trust Protector (or an Independent Trustee) the authority to grant a beneficiary a general testamentary power of appointment over property • Grant the Trust Protector broad amendment powers to deal with estate and income tax uncertainties

29. What Should You Do? • The current state of the law creates the greatest marketing opportunity in at least 10 years. • Great opportunity to review existing estate plans and approach them with the “if we only knew then what we know now, hindsight.”

30. What Should You Do? • Advise your clients of the issues involved • They have been reading about it • They want to hear from you • General Client letter • Client only / Public workshop • Get them into your office and review their estate plan in light of the current situation • In a large number of cases there will be a good reason to restate their plan

31. What Should You Do? • Advise clients that if Congress acts differently than you expect, they may need to restate their plans again • History has shown that Congress does not always do what we expect. • Clients should be made aware of this fact. • It’s not your fault.