Estate Planning Could Be Affected By Administration’s Budget Proposals

On Wednesday, April 10, the Obama Administration proposed ambitious spending and revenue changes, as it released its proposed budget for fiscal year 2014 (October 1, 2013-September 30, 2014). As in past years, a number of proposed tax changes affecting estate planning are described in the Treasury Department's "General Explanations of the Administration's Fiscal Year 2014 Revenue Proposals" (popularly called "the Greenbook"), including a return to the 45 percent transfer tax rate and $3.5 million exemption of 2009. Even though the congressional reception and ultimate outcome are in doubt and nothing will happen soon in any event, the proposals should be kept in mind when considering estate planning actions and may affect the shape and timing of those actions in some cases.

Grantor Trust Proposal Clarified and Narrowed, but Still Tough

Background: Use of Grantor Trusts

A "grantor trust" is treated as "owned" by the grantor (creator) of the trust during the grantor's lifetime or some shorter period. As a result, after the grantor makes a gift to an irrevocable grantor trust, with the grantor's descendants, for example, as beneficiaries, the income tax on that trust's income must be paid by the grantor, even though the income belongs to the trust and its beneficiaries. That permits the grantor to make income tax payments that benefit the trust and its beneficiaries without treating those payments as additional gifts.

Grantor trust treatment also permits transactions between the trust and the grantor without income tax, including sales without capital gain and payment of interest without creating taxable income. That feature has supported the popular and effective estate planning technique of an installment sale to a grantor trust, in which assets are sold to the trust for a promissory note with lenient terms (especially at today's low interest rates), often with a small "down payment." The future appreciation in the value of those assets in excess of the modest interest rate escapes gift and estate tax. The trust can also last for multiple generations and be made exempt from the generation-skipping transfer (GST) tax by allocation of the grantor's GST exemption. That feature of grantor trusts also permits fine-tuning or updating the assets of the trust by the grantor's exchange of assets with the trust, again without capital gain or gift treatment.

Administration Proposal: Focus on Installment Sales to Grantor Trusts

In last year's Greenbook, for the first time, the Administration proposed changes to the estate and gift taxation of grantor trusts treated as owned by the grantor for income tax purposes. As written, those proposals appeared designed to treat all such grantor trusts as fully subject to estate tax when the grantor dies, or to gift tax if grantor trust status ceases during the grantor's life. Observers...