Summary of Estate, Gift and GST Tax Proposals in the President's FY 2016 Budget From Treasury's 'Greenbook'

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By Deborah M. Beers, Esq.

Buchanan Ingersoll & Rooney, Washington, DC

The following is a brief summary of the estate, gift and generation-skipping transfer tax proposals, and related provisions, in the President's FY 2016 Budget. The descriptions below are not intended to be exhaustive, and many nuances of their operation are omitted, or remain to be fleshed out in regulations. Further, since it is highly unlikely that any considerable number of these proposals will become law in the current Congress, they are at present of mainly academic interest.

A. Estate and Gift Tax Changes.

1. Capital Gains on Gift and at Death. The proposal would increase the highest long-term capital gains and qualified dividend tax rate from 20% to 24.2%. The 3.8% net investment income tax would continue to apply as under current law. Thus, the maximum total capital gains and dividend tax rate, including net investment income tax, would thus rise to 28%.

Under the proposal, the donor or deceased owner of an appreciated asset would realize a capital gain at the time the asset is given or bequeathed to another. The tax imposed on gains deemed realized at death would be deductible on the estate tax return of the decedent's estate (if any). Gifts or bequests to a spouse or to charity would carry the basis of the donor or decedent.

The proposal would exempt any gain on all tangible personal property such as household furnishings and personal effects (excluding collectibles). The proposal also would allow a $100,000 per-person exclusion of other capital gains recognized by reason of death that would be indexed for inflation after 2016, and would be portable to the decedent's surviving spouse under the same rules that apply to portability for estate and gift tax purposes (making the exclusion effectively $200,000 per couple). Other exemptions and rules, to be fleshed out in regulations, would apply.

2. Require Consistency in Value for Transfer and Income Tax Purposes. Effective for transfers after the date of enactment, the basis of property received by reason of death under §1014 must equal the value of that property as reported for estate tax purposes. The basis of property received by gift during the life of the donor must equal the donor's basis determined under §1015 as reported for gift tax purposes. The basis of property acquired from a decedent to whose estate §1022 (to which the estate tax did not apply) is applicable is the basis of that property, including any additional basis allocated by the executor, as reported on the Form 8939 that the executor filed.

3. Restore 2009 Estate, Gift and GST Parameters . Effective for gifts made and estates of decedents dying after December 31, 2015, the top tax rate would be 45% and the exclusion amount would be $3.5 million for estate and GST taxes, and $1 million for gift taxes. There would be no indexing for inflation. The proposal would confirm that, in computing gift and estate tax liabilities, no estate or gift tax would be incurred by reason of decreases in the applicable exclusion amount with respect to a prior gift that was excluded from tax at the time of the transfer ("clawback"). Finally, the unused estate and gift tax exclusion of a decedent electing portability and dying on or after the effective date of the proposal would be available to the decedent's surviving spouse in full on the surviving spouse's death, but would be limited during the surviving spouse's life to the amount of remaining exemption the decedent could have applied to his or her gifts made in the year of his or her death.

4. GRATs and Other Grantor Trusts.  GRATS. This proposal would require, in effect, some downside risk in the use of GRATs (particularly "zeroed out" GRATs) by imposing the requirement that a GRAT have a minimum term of 10 years and a maximum term of the life expectancy of the annuitant plus 10 years. The proposal also would include a requirement that the remainder interest have a minimum value equal to the greater of 25% of the value of the assets contributed to the GRAT or $500,000 (but not more than the value of the assets contributed). In addition, the proposal would prohibit any decrease in the annuity during the GRAT term, and would also prohibit any tax-free exchange of assets between the grantor and the GRAT – i.e., the exercise of a power of substitution.

Other Grantor Trusts. The President's Budget proposes, that, to the extent that the income tax rules treat a grantor of a trust as an owner of the trust's assets for income tax purposes, and the grantor engages in a nontaxable sale or exchange (presumably including a "swap" of assets pursuant to the exercise of a power of substitution) with the trust:

  •  The portion of the trust assets received in that transaction, and all retained and reinvested income, gain and appreciation thereon (exclusive of consideration received), would be included in the gross estate of that grantor for estate tax purposes;
  •  Any distribution from the trust to one or more beneficiaries during the grantor's life would be subject to gift tax; and
  •  The remaining trust assets would be subject to gift tax at any time during the grantor's life if the grantor ceases to be treated as an owner of the trust for income tax purposes.

The transfer tax imposed by this proposal would be payable from the trust. Exceptions are provided for certain types of trusts and transfers.

5. Limit Duration of Generation-Skipping Transfer (GST) Tax Exemption. The Budget proposal would provide that, with few exceptions, on the 90th anniversary of the creation of a trust, the GST exclusion allocated to the trust would terminate. Specifically, this would be achieved by increasing the inclusion ratio of the trust (as defined in section 2642) to one, thereby rendering no part of the trust exempt from GST tax. An express grant of regulatory authority would be included to facilitate the implementation and administration of this provision.

This proposal would apply to trusts created after enactment, and to the portion of a pre-existing trust attributable to additions to such a trust made after that date (subject to rules substantially similar to the grandfather rules currently in effect for additions to trusts created prior to the effective date of the GST tax).

6. Extend the Lien on Estate Tax Deferrals Provided Under Section 6166. Section 6166 allows the deferral of estate tax on certain closely held business interests for up to 14 years from the (unextended) due date of the estate tax payment (up to 15 years and three months from date of death). However, the estate tax lien on §6166 assets under §6324(a)(1) expires approximately five years before the due date of the final payment of the deferred estate tax under §6166.

The proposal would extend the estate tax lien under §6324(a)(1) throughout the section 6166 deferral period, effective for the estates of all decedents dying on or after the effective date, as well as for all estates of decedents dying before the date of enactment as to which the §6324(a)(1) lien has not expired on the effective date.

7. Modify GST Treatment of Health and Education Exclusion Trusts ("HEETs"). A HEET provides for the medical expenses and tuition of multiple generations of descendants without, in theory, ever attracting a gift, estate, or generation-skipping transfer tax. The proposal would provide that the exclusion from the definition of a GST under §2611(b)(1) applies only to a payment by a donor directly to the provider of medical care or to the school in payment of tuition and not to trust distributions, even if for those same purposes. This proposal would apply to trusts created after the introduction of the bill proposing this change, and to transfers after that date made to pre-existing trusts.

8. Simplify Annual Exclusion for Gifts. The proposal would eliminate the present interest requirement for gifts that qualify for the gift tax annual exclusion. Instead, the proposal would define a new category of transfers (without regard to the existence of any withdrawal or put rights), and would impose an annual limit of $50,000 (indexed for inflation after 2016) per donor on the donor's transfers of property within this new category that will qualify for the gift tax annual exclusion. This new $50,000 per-donor limit would not provide an exclusion in addition to the annual per-donee exclusion; rather, it would be a further limit on those amounts that otherwise would qualify for the annual per-donee exclusion. Thus, a donor's transfers in the new category in a single year in excess of a total amount of $50,000 would be taxable, even if the total gifts to each individual donee did not exceed $14,000. The new category would include transfers in trust (other than to a trust described in §2642(c)(2)), transfers of interests in passthrough entities, transfers of interests subject to a prohibition on sale, and other transfers of property that, without regard to withdrawal, put, or other such rights in the donee, cannot immediately be liquidated by the donee.

9. Clarify/Expand Definition of "Executor." To empower an authorized party to act on behalf of the decedent in all matters relating to the decedent's tax liabilities (whether arising before, upon, or after death), the proposal would expressly make the tax code's definition of executor applicable for all tax purposes, and authorize such executor to do anything on behalf of the decedent in connection with the decedent's pre-death tax liabilities or obligations that the decedent could have done if still living. In addition, the proposal would grant regulatory authority to adopt rules to resolve conflicts among multiple executors authorized by this provision.

10. Modifications to Valuation Discounts . This proposal, a perennial favorite in recent years, appears to be missing from the FY 2016 budget.

B. Retirement Plan Changes.

1. Cap of Retirement Plan Contributions.  The proposed budget proposes to cap tax-deferred saving in 401(k) and Individual Retirement Accounts at about $3.4 million, which is the amount calculated to generate an annuity of approximately $200,000 in income annually when annuitized.

2. Automatic IRAs. Employers in business for at least two years that have more than 10 employees would be required to offer an automatic IRA option to employees, under which regular contributions would be made to an IRA on a payroll-deduction basis. If the employer sponsored a qualified retirement plan, SEP, or SIMPLE for its employees, it would not be required to provide an automatic IRA option for its employees. Employees could opt out if they choose.

3. Eliminate Stretch IRAs .  Under the proposal, non-spouse beneficiaries of retirement plans and IRAs would generally be required to take distributions over no more than five years. Exceptions would be provided for "eligible beneficiaries," including any beneficiary who, as of the date of death, is disabled, a chronically ill individual, an individual who is not more than 10 years younger than the participant or IRA owner, or a child who has not reached the age of majority. For these beneficiaries, distributions would be allowed over the life or life expectancy of the beneficiary beginning in the year following the year of the death of the participant or owner. However, in the case of a child, the account would need to be distributed no later than five years after the date on which the child reaches the age of majority.

4. Simplification.  The Administration proposes two changes that could significantly simplify the administration of retirement plans for many individuals and plan sponsors. The first would exempt an individual from the tax code's required minimum distributions if the aggregate value of a person's individual retirement account and tax-favored individual retirement plan account does not exceed $100,000 on the date it is measured for distribution purposes.

A second proposed change would harmonize the treatment of Roth IRAs and designated Roth accounts in employee plans by generally treating Roth IRAs in the same manner as all other tax-favored retirement accounts, i.e., requiring distributions to begin shortly after age 70 1/2, without regard to whether amounts are held in designated Roth accounts or in Roth IRAs. In addition, individuals would not be permitted to make additional contributions to Roth IRAs after they reach age 70 1/2.

Finally, the proposal would expand the options that are available to a surviving non-spouse beneficiary under a tax-favored employer retirement plan or IRA for moving inherited plan or IRA assets to a non-spousal inherited IRA by allowing 60-day rollovers of such assets.

C. Modify Transfer for Value Rules.

The President proposes to require additional reporting by buyers of life insurance contracts with a death benefit equal to or exceeding $500,000. Buyers of such policies would be required to report the purchase price, the buyer's and seller's TINs, and the issuer and policy number to the IRS, to the insurance company that issued the policy, and to the seller, both upon purchase and upon the payment of any policy benefits to the buyer.

The proposal also would modify the transfer-for-value rule by eliminating the exception that currently applies if the buyer is a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is a shareholder or officer. Exceptions for a transfer to the insured, or to a partnership or a corporation of which the insured is a 20% owner would continue to apply, as would other exceptions (such as the carryover basis exception).

D. Other.

The Greenbook also contains miscellaneous tax cuts for middle-income families (while proposing the adoption of the "Buffett rule" imposing a minimum – 30% - tax on income over $1 million) and small businesses. It would also simplify the two-tier excise tax imposed on the investment income of private foundations by changing the tax to a single-tier 1.35% tax.

For more information, in the Tax Management Portfolios, see Streng, 800 T.M., Estate Planning,  and in Tax Practice Series, see ¶6350, Estate Planning.