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IRS Releases Estate Tax Statistics for 2001-2009

I’ve been looking over the data from the IRS Estate Tax Statistics for decedents dying between 2001 and 2009.  The data was collected as part of the annual estate tax study.  A few interesting points about the 2009 statistics:

  • Due to the higher exemption amounts (which increased from $675,000 in 2001 to $3.5 million for 2009 – more on that here), the number estate tax tax returns decreased from over 108,000 in 2001 to under 34,000 in 2009.  In other words, only 34,000 of individuals who died in 2009 had taxable estates when the exemption amount was $3.5 million.  I would be curious to know what the number would drop to if the proposed $5 million exemption amount were enacted.
  • Those estates that were taxable in 2009 had over $194 billion in assets.  The primary assets were stock and real estate, coming in at 30 percent and 22 percent, respectively.  Cash (11%), bonds (13%), pensions and 401(k)s (7%), and miscellaneous other assets (17%) made up the rest.
  • Just under half of the decedents with taxable estates were married and another 38 percent were widowed.  And, not surprisingly, over 97 percent of those who were married claimed a marital deduction.  Only 10 percent of estates of married decedents owed estate tax.  This indicates that most of these folks had done at least some estate planning, and I suspect the majority of them had also used a credit shelter bequest.  This is a strong policy reason for making the unified credit portable (meaning that the second spouse to die could take advantage of any unused portion of the predeceased spouse’s unified credit).
  • Less than half of those filing owed estate taxes!  Again, this indicates that most folks with taxable estates are doing some sort of estate planning, including marital and charitable bequests to avoid taxes at the death of the first spouse.
  • Bad news for us guys.  Almost 58 percent of the decedents with taxable estates were males.  This, combined with the statistics indicating heavy use of the marital deduction, indicates that the men are dying first and leaving the estate to their wives, using the marital deduction to zero out the estate taxes at the first death.
  • Approximately 19 percent of the estates claimed a charitable deduction, for a total of $16 billion in charitable deductions claimed.  But the ultra-rich appear to be the ones making the biggest donations.  Over 58 percent of the donations were made by estates with $20 million or more in gross assets, notwithstanding that these estates represented only 3 percent of filers.

It will be interesting to see how these numbers influence the policy arguments over estate tax repeal or a permanent estate tax fix.

Alliance for Retirement Prosperity: The Anti-AARP?

I think of the AARP as a good organization, one that looks out for the needs of its elderly members and keeps them informed on relevant issues.  As such, I would have thought that the AARP would be one of the most non-controversial advocacy groups in Washington.  But apparently not.

Politico recently reported that a new anti-AARP group is being formed to counteract what it believes is a left-wing agenda of the AARP.  The new group, which is called the Alliance for Retirement Prosperity [update 01/12/12: There used to be a link here, but I took it down because the site had turned into an ad site.  I guess the Alliance didn’t work out], has its cross hairs fixed on repealing President Obama’s recent health care law and reforming Medicare and Medicaid. Its purpose is to provide a “conservative challenge” to the AARP.  With a only about $5 million in funding compared to the AARP’s $1.42 billion (with a “b”) in revenues in 2009 alone, it has its work cut out for it.  But it seems to be off to a fairly decent start.

What intrigues me most about this group is its business model.  The Alliance will be a for-profit endeavor.  Alliance President Larry Hunter, who is also a top Republican advisor, believes the group’s for-profit status will differentiate it from other advocacy groups that have unsuccessfully attempted to compete with the AARP.  Hunter stated:

As a for-profit business, the Alliance will use the market forces of competition among its vendors to deliver a wider array of products and services at better prices to its members.

In contrast, most advocacy groups (like AARP) are non-profit.  I am an advocate for nonprofits and have represented a fair number of them.  But I must admit that at times I don’t see a policy justification for exempting certain activities from taxation.  And I have sometimes wondered if the lack of a profit model contributes to the lackluster performance of some membership-based nonprofits. I expect that most folks will view the stated purposes of the Alliance with it’s for-profit model in mind.  After all, we know that some people could get rich off of this, and we must assume that this is at least one if not the primary purpose of the group’s founders.  But it will be interesting to see the organization can overcome the “taint” of the for-profit motive to achieve its policy objectives.

IRS Clarifies 2010 Basis Rules for Revocable Trusts

New FAQs indicate that property held in a revocable trust should qualify for allocations of basis increase

The IRS has published a webpage on FAQs about the New Tax Rules for Executors for 2010 (Update: the original IRS webpage has been taken down; most of this information is now contained in Publication 559).  While most of these rules are not groundbreaking (Q: Is the estate tax repealed for decedents dying in 2010? A: Yes.), they do provide guidance about how the IRS will apply the 2010 basis rules to property held in revocable trusts.

The lapse of the estate tax for 2010 was accompanied by a new set of basis rules that replaced the taxpayer-friendly “stepped-up” basis rules with a modified carryover basis regime.  Generally, for the estates of decedents who die in 2010, the basis of assets acquired from the decedent is the lesser of the decedent’s adjusted basis (carryover basis) or the fair market value of the property on the date of the decedent’s death.

There are two “coupons” that taxpayers can apply to reduce the harsh consequences of the new carryover basis system.  First, the executor can allocate up to $1.3 million (increased by unused losses and loss carryovers) to increase the basis of assets left to anyone.  Second, the executor can allocate an additional $3 million to increase the basis of assets passing to a surviving spouse, either outright or in a Qualified Terminable Interest Property (“QTIP”) trust.

The 2010 basis rules, which are found in IRC § 1022, apply to property “treated as owned” by the decedent and “acquired from the decedent.”  There has been some discussion about whether property owned by a revocable trust would qualify.  Two views have emerged.  The more conservative view is that since IRC §  1022 deals with what is or isn’t owned by the decedent for purposes of basis allocation and does not mention revocable trusts, revocable trusts do not qualify for the basis increase.  In other words, because IRC § 1022 does not reference the grantor trust rules, property owned by a grantor trust is not “treated as owned” by the decedent and is therefore ineligible for basis increase.

The other view, which I hold, is that property owned by a grantor trust under the rules of IRC §§ 671-678 are treated as wholly-owned by the grantor and therefore should qualify for the basis increase based on the plain language of the rules themselves.  The IRS appears to agree, although with some timidity.  The FAQs state:

All of the decedent’s property was held by a revocable (or living) trust.  Can the basis of that property be increased as well?
Probably yes. The decedent is treated as owning property transferred by the decedent during life to a qualified revocable trust (as defined in section 645(b)(1)).

While this language falls short of binding guidance on the issue, it should give taxpayers some comfort that property held in a revocable trust will be eligible for basis step-up under IRC § 1022.

Making Good Use of GRATs in 2010

With the scheduled reinstatement of the Federal estate tax less than 4 months away, many taxpayers are taking advantage of the current low-interest-rate environment to use estate freezing techniques.  Estate freezing strategies are designed to limit future estate tax value of an asset to its current value (“freeze” the value) and allow future growth to pass to the taxpayer’s beneficiaries free of gift or estate tax.

Estate freezing techniques are usually used to supplement and enhance a solid gifting strategy.  Although there is no estate tax in 2010, there is still a gift tax of 35 percent.  Taxpayers are allowed to make annual exclusion gifts of up to $13,000 per done (doubled to $26,000 for married couples) without incurring gift tax.  But gifts in excess of the annual exclusion will chip away at the taxpayer’s $1 million lifetime exclusion.

Grantor-retained annuity trusts (GRATs) are popular estate freezing techniques.  GRATs are irrevocable trusts in which the grantor retains an interest that is a “qualified” interest under the Internal Revenue Code.  The grantor transfers property into the trust, which provides that the grantor will receive a fixed annuity on at least an annual basis for a number of years.  At the end of the trust term, whatever is left in the trust after the annuity has been fully paid will go to the remainder beneficiaries.  The “gift” is the theoretical value of the remainder, which is calculated using a statutory interest rate known as the 7520 rate.

GRATs are appealing in a low-interest rate environment because the 7520 rate is correspondingly low.  The value of the grantor’s retained interest is “frozen” at the value of the contribution plus the 7520 rate.  If the assets in the trust out-perform the 7520 interest rate (2.4 percent for September), the excess will be transferred to the remainder beneficiaries free of gift tax when the trust term ends.

The most aggressive GRAT strategy—and one which may soon be limited—is the “zeroed-out” GRAT.  By manipulating the amount of the retained annuity and the term of the trust, it is possible to set the GRAT up so that the value of the retained interest is technically worth nothing.  If the assets outperform the 7520 rate, all of the assets remaining in the trust at termination will pass to the remainder beneficiaries free of gift or estate tax. If the asset does not out-perform the 7520 rate, the assets are simply returned to the grantor at the end of the trust term and the grantor is in no worse position than if the trust had not been established.  Because zeroed-out GRATs have little downside and can yield big tax savings, they have become increasingly popular in recent years.

Many fear that we may be nearing the end of the era of the GRAT as an estate-planning tool.  President Obama’s 2011 budget projects almost $3 billion in savings from restricting the use of GRATs, and the Joint Committee on Taxation believes that restrictions on GRATs could raise almost $4.5 billion over 10 years.

In the current political environment, some believe that Democrats will curb the use of GRATs in order to raise revenue for other tax breaks or for spending.  And we have seen recent proposals to do just that.  For example, the Small Business Tax Relief Act of 2010 proposed by Rep. Sander M. Levin (D-MI) on July 30, 2010, would require 10-year minimum term for GRATs (compared with the current 2-year term).  Since all of the GRATs assets are included in the grantor’s estate if he or she dies within the term, extending the term from 2 to 10 years would make it much more likely that the full value of the GRAT will be subject to estate tax.  This increased “mortality risk” could curb the use of GRATs for gift tax savings.  Other bills have proposed to limit the use of zeroed-out GRATs.

If the proposals to curb the use of GRATs are ultimately successful, changes would probably not be effective until the date the proposals are signed into law.  Many taxpayers are seizing the current opportunity to take advantage of the low 7520 rate and establish GRATs before the law changes.  Others are shifting assets from existing GRATs into new ones with lower interest rates.  Those who are concerned with the reinstatement of the estate tax in 2011 should consider incorporating GRATs into their estate planning strategy.

Effect of 2010 Basis Rules on Timing of Asset Sales

Most discussion about the 2010 tax laws has focused on the repeal of the estate tax for 2010 and guesses about what Congress might do in 2011.  But although 2010 modified carry-over basis regime has received less coverage, fiduciaries should be aware of how it could affect the sale of assets of individuals who died in 2010.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) replaced the historic full basis step-up system with a modified carryover regime.  Under prior law, all appreciation in property that was left to someone at death disappeared.  The recipient took a basis that was equal to the value of the asset at the date of death.  Under the new Section 1022, the recipient of property inherited from a decedent will generally take a basis that is equal to the decedent’s basis in the property.  All built-in appreciation will follow the assets into the hands of the recipients.

The new Section 1022 does provide relief from the general carryover basis rule.  The estate is allowed a general $1.3 million basis adjustment for property passing to anyone and an additional $3 million basis adjustment for property passing to a surviving spouse.  These adjustments function like coupons that the personal representative can apply toward the appreciation in selected assets.  With these coupons, anyone can shelter up to $1.3 million of appreciation from taxation and spouse’s can shelter an additional $3 million.

But what if the taxpayer has more appreciation than is covered by the coupons?  Suppose, for example, that Sally inherits land worth $3 million from her grandfather in 2010, and that her grandfather inherited the land from his mother in the early 1940s.  However her grandfather’s basis is determined (and this is a real challenge in 2010), the property will likely have more than $1.3 million of appreciation.  If Sally sells the property immediately, in 2010, it is likely that most of the proceeds from the sale would be taxable.

This result may be avoidable.  EGTRRA provides that, after 2011, the estate tax laws will apply as if EGTRRA had never been enacted.  What would be the result of a sale of inherited property EGTRRA had never been enacted?  The property would get a full basis step up.  This gives Sally an argument—although it may be a stretch—that the appreciation in the property is not taxable if she waits until 2011 to sell it.  If this argument is successful, deferring sale of the property until 2011 could result in a substantial tax savings.

This puts fiduciaries, including trustees, in a precarious situation.  Fiduciaries usually sell assets to meet cash needs as soon as the needs are determined, thereby minimizing investment risk due to market volatility.  But now the fiduciary has a dilemma: If the fiduciary waits until 2011 to sell the asset, the appreciation in the property may escape taxation, but this will expose the fiduciary to investment risk due to market volatility between now and 2011.

So what should the prudent fiduciary do?  Sell now and take the risk of losing the possibility of full basis step-up, or sell later and take investment risk due to market volatility?  While there may be no easy solution, a few guidelines can be helpful. If the fiduciary needs cash but only owns highly appreciated assets, the fiduciary should consider obtaining a loan to meet imminent cash needs and deferring assets sales until things settle down in 2011.  If this exposes the fiduciary to too much investment risk, the fiduciary should consider acquiring a derivative security to hedge the risk.  If, on the other hand, there is enough 2010 basis allocation to shelter the appreciation, the fiduciary should consider selling assets immediately to raise the cash.  In either event, fiduciaries are well-advised to document everything, including the analysis that led to the decision.