The Use of a GRAT (Grantor Retained Annuity Trust)

A GRAT (grantor retained annuity trust) is a technique for transferring property to members of the grantor's family at a reduced transfer tax cost. A grantor creates a GRAT by transferring property to a trust and retaining a "qualified annuity interest" in the property. The trust lasts for a specified period of time that the grantor is expected to outlive(the trust "term"). At the end of the specified term, the trust property passes to the trust's remainder beneficiaries (members of the grantor's family).

GRATs take advantage of special IRS valuation rules which make tax savings possible. The grantor is treated as having made a gift of a remainder interest in the property, the value of which is determined under these special IRS valuation tables. For tax purposes the value of the interest passing to the grantor's family (the gift) is less than the total value of the property at the time the trust is created because the value of the gift is deemed to be (1) the value of the property (2) as reduced by the value of the interest retained by the grantor. The grantor's Applicable Credit against gift and estate taxes (currently $675,000, and increasing in phases to $1,000,000 in the year 2006) can be applied to the reduced gift to avoid or minimize the payment of gift tax on the transfer to the trust. If the trust does not qualify as a GRAT, the special valuation rules would not apply and,as a result, the value of the retained interest would be deemed to be zero, meaning that the grantor would have to pay gift tax (or apply his Applicable Credit) the entire value of the trust property at the time he created the trust.

When the grantor's retained interest terminates, the property remaining in the trust passes to the grantor's beneficiaries free of a gift tax, even if it has appreciated in value since the trust was created. If the grantor survives the trust term, the trust property won't be includable in his estate for estate tax purposes when he dies because he will no longer have any interest in the property. If the grantor dies during the term, part or all of the trust property will be includable in his gross estate. But, he won't be any worse off than he would have been if he hadn't created the trust in the first place.

The Elder Suite

The vast majority of caregiving for the senior population is not provided in nursing homes or assisted living facilities. Most seniors are able to receive care at home with the help of their family. In some cases, this is an alternative. However, in many cases this is simply not an option. Location issues, careers, money and raising families of their own prevent many adult children from caring for elderly parents. However, children do not want their senior parent's safety or comfort to be at risk and many want to participate in caring for their elderly parent. This is a common issue for many families with elderly relatives today.

Balancing the needs of the elderly parent and caregiver child can be difficult. However, one solution can be the addition of an "elder suite" to the caregiver's residence. Basically, an elder suite is approximately 300 square feet of living space that is custom tailored to the special needs of senios and is installed on the caregiver's residence. The elder suite has an open layout for easy accessibility and also has the safety features such as shower seating, oversized doors, non-slip flooring, grab bars and panic buttons.

Paying for the elder suite is often less expensive and more time efficient than the costs and time involved in building an addition to the caregiver's residence. The elder suite provides both the senior and the caregiver's family with the privacy and independence each needs. In addition, the elder suite can be removed and the caregiver's residence can be returned to its original condition when the circumstances of the family change.

There is a cost to install the elder suite and you can either rent or buy the elder suite, depending on your situation. Compared to the rising costs of assisted living facilities and nursing homes, this is an ideal option for many families. It allows the parent to remain at "home" and maintain a sense of independence while allowing the caregiver child to have peace of mind that his or her parent is comfortable and safe.

Divorce and Beneficiary Designations

Generally, we look to state inheritance law (i.e., NYS Estates Powers and Trust Law) to know who are the "distributees" of an estate. Distributees are those individuals who are entitled to inherit estate assets which do not contain beneficiary designations or are not disposed by will.

A recent case* addressed the issue of whether state law controls where a decedent died before changing his beneficiary designation on his 401(k) plan and life insurance policy (Both named his ex-wife.) The U.S. Supreme Court held that federal law controlled this situation. According to federal law, qualified retirement plans are required to pay the benefits to the designated beneficiaries.

The outcome of this case teaches us the importance of reminding our clients who are going through a divorce to change beneficiary designations on all assets, including retirement plans, IRAs, bank accounts and life insurance policies. Accordingly, these clients should also revise their estate planning documents, such as the Last Will and Testament, Health Care Proxy and Power of Attorney.

*Egelhoff S. Ct., March 21, 2001.

Gift Splitting

It is a common practice for financial advisors, accountants and attorneys to recommend that their clients gift the "annual exemption" each year as part of the clients' estate, gift and income tax planning. The following is a summary of the rules regarding "gift-splitting" which is an important part of utilizing the annual exemptions.

Generally, each individual is permitted to gift $10,000.00 to any number of donees during a tax year without the requirement of filing a gift tax return and, at the same time, without utilizing the applicable exclusion amount. If a gift from a married individual exceeds $10,000.00 to any one donee, you may consider gift-splitting with their spouse. That is, if the nondonor spouse agrees, the gift can be deemed to have been made from both husband and wife; thereby utilizing the $10,000.00 exemption per spouse, for a combined $20,000.00 gift per donee.

The following are the requirements for gift splitting: Gift-splitting can only be elected between spouses. Gift-splitting is not permitted if the couple is divorced and either of them remarries during the year; the spouses must both be U.S. citizens or residents; and the nondonor spouse must consent to the gift-splitting.

A split gift is recorded on the donor's gift tax return. If only one of the spouses makes gifts during the calendar year, then the nondonor spouse simply consents by signing the donor spouse's gift tax return and will not need to file their own gift tax return (unless the total gifts to the donee exceeds $20,000.00 for the year or any gift constitutes a future interest).

Note that a nondonor spouse may revoke the splitting of gifts on or before the April 15th following the year of the gift. In addition, the gift-splitting election applies to all of the gifts made during the year. As a result, the nondonor spouse cannot elect to split some gifts but not other gifts.

As the end of the year approaches, it is important to advise clients on the basic rules of gift-splitting and the gift tax return requirements so that the gift tax exemptions are not jeopardized.

Proper Beneficiary Designations

We have been discussing the importance of proper beneficiary designations in wills and living trusts. Generally, the most frequent type of designation seen is, assuming no surviving spouse, "to my children, in equal shares, per stirpes." This means that a distribution will be made to the surviving family members when a beneficiary dies before the testator or settlor of a trust. But what about beneficiary designations for non-probate assets such as life insurance, annuities, 401K's and IRA's? The answer is that equal attention must be paid to the beneficiary selection for these types of assets as with wills and trusts. The per stirpes designation on a financial institution's or insurance company's beneficiary designation form is acceptable. Some issues to be aware of include: per stirpes (for example, "to my son, A, per stirpes") may not avoid the appointment of a guardian by a court if a minor does inherit as a contingent or designated beneficiary of a non-probate asset. A simple solution: "To my son, A, per stirpes, but in the event such issue who inherit shall be minor (s) then said minor's beneficiary share shall be paid to a custodian under the Uniform Transfers to Minors Act until the maximum age permitted by law and thereafter directly to the beneficiary. The custodian, if none, shall be designated by the executor or administrator of my estate." If there is no per stirpes or per capita designation on a beneficiary designation form, the proceeds of the policy or retirement account will be payable to the testator's estate, and be distributed according to the terms of his or her will, or by intestacy, if no will exists. This may create unintended results and unintended beneficiaries. If a trust is named the beneficiary of a IRA, and the testator later revokes the trust, care must be taken to change the beneficiary designation form, as well. It is also recommended that a beneficiary designation form be completed in duplicate, with one copy returned to the owner of the account or policy. This avoids the potential problem of a misplaced or lost designation form by a financial institution.

Reviewing the Tax Relief Act of 2001

On May 26th Congress approved The Economic Growth and Tax Relief Reconciliation Act of 2001, the biggest tax cut in a generation. The bill, which provides for a tax cut of $1.35 trillion in the next decade, passed the House by a vote of 240 to 154, and passed the Senate by a vote of 58 to 33.

The new legislation makes 441 tax-law changes, according to the Wall Street Journaland will require CCH Inc. (a leading publisher of tax information) "to update more than 14,368 pages in its 23 core federal tax...looseleaf materials." This issue of THE ADVANTAGE and succeeding issues will focus on and highlight some of the changes in the Estate and Gift Tax Laws and the Generation Skipping Transfer (GST) Tax Law.

Beginning in 2002 and through 2009, the Estate and Gift Tax rates will be reduced. At the same time, the Unified Credit Exemption amount for Estate Tax purposes and the GST Tax Exemption amount will be significantly increased. In 2002, the Unified Credit Exemption amount for lifetime gifts will be increased to $1 million and will remain at that level. The Estate Tax and GST Tax are repealed in 2010, but only for one year. In that same year, assets would begin to be inherited at their purchase price rather than market value (carryover basis), so heirs could inherit old capital gains-tax liabilities - making bookkeeping potentially burdensome.

Commentators have noted some curiosities in this legislation. For instance, according to an Op-Ed piece humorously entitled Bad Heir Day in The New York Times (May 30th), the postponing of the repeal of the Estate Tax until 2010 left the "books insufficiently cooked," so Congress- added a 'sunset' clause, officially causing the whole bill to expire, and tax rates to bounce back to 2000 levels, at the beginning of 2011. So in the law as now written, heirs to great wealth face the following situation: If your ailing mother passes away on Dec. 30, 2010, you inherit her estate tax-free. But if she makes it to Jan. 1, 2011, half the estate will be taxed away. That creates some interesting incentives. Maybe they should have called it the Throw Momma From the Train Act of 2001.

Contrary to the somewhat cynical views espoused by some of these critics, it will not be necessary for our clients or their heirs to resort to criminal activity in order to benefit greatly from the new tax laws. With proper estate planning, the reduction in Estate and Gift Tax rates and the dramatic increases in the Unified Credit Exemption will allow much greater wealth to pass from one generation to the next, with far less tax erosion than was the case under prior law. More detials of the tax legislation, and some resulting planning opportunities, will be the subjects of ensuing articles.

Reviewing the Tax Relief Act of 2001 - Part 2

As we have noted in the previous newsletter, under the 2001 Tax Act (that President Bush has now signed into law), the amount exempt from estate taxes and the rate of tax on larger sums are slowly reduced beginning next year until 2010. At that time the estate tax (but not the gift tax) is repealed for one year. The new law then "sunsets", meaning the law existing prior to the 2001 Act will be reinstated effective January 1, 2011. Thus, (a) in 2009 only estates in excess of $3.5 million will be subject to estate tax, at a top federal rate of 45%; (b) in 2010 there will be no estate tax: and (c) in 2011 we revert to estate tax on estates exceeding $1 million, at a top rate of 55%.

According to an article in The New York Times (June 14, 2001), these: roller-coaster changes can turn an estate plan drafted under the old law to eliminate estate taxes into a financial disaster. ...Six prominent estate tax lawyers agreed in interviews [June 13th] that the repeal would probably not take place, but they all said individuals must have wills that take into account a range of possibilities, including all of the changes planned over the next 10 years, the possibility of permanent repeal and the prospect that repeal will never take place. ...Those who...have a will and estate plan drafted under the old laws need to ...have it reviewed and in many cases rewritten. ...Without revisions, these experts said yesterday, widows may be left with far less than they expected, children and grandchildren may be stuck with huge tax bills that could have been avoided and litigation over who receives tax-favored assets may erupt, even in families whose members have worked together to build and preserve their wealth.

The above-quoted article may be somewhat alarmist, particularly in light of some interesting statistics the same newspaper published in a different article on April 8th this year: while 17% of Americans in a recent Gallup survey think they will owe estate taxes, only a much smaller perentage in fact do. "And nearly half the estate tax is paid by the 3000 or so people who each year leave taxable estates of moer than $5 million." While The New York Times doesn't specifically say so, the negative implication of this latter statistic is that somewhat more than half the estate tax is paid by people who leave less than $5 million (though we don't have statistics to verify that inference).

We believe that clients are advised to continue to make "annual exclusion" gifts and take other steps to reduce estate tax where there is risk that they may die before repeal with an estate larger than $1 million. We also agree with the experts quoted by The Times above that it is sensible for clients to have their wills and other estate planning documents reviewed. Many clients may benefit from having their "optimum marital deduction" will updated to avoid the anomaly of having all or most of their estate diverted to the "Bypass" trust (a/k/a "Credit Shelter" trust). Further, since the gift tax exemption increases to $1 million per person in 2002, leveraged gifts via GRATs and Family Limited Partnerships will take on added importance in the "reform" period.