Tax Law Update
By David A. Handler and Alison E. Lothes
Originally written for WealthManagement.com
Greenbook for fiscal year 2016 released—The Obama administration released its 2016 budget proposals, known as the Greenbook. The following is a summary of the items that are most relevant to estate-planning professionals. Bear in mind, this is more of a “wish list” than anything else, as we’ve seen some of these proposals many times in prior Greenbooks.
Retirement plan Roth restrictions: The Administration proposes that Roth individual retirement accounts be subject to the same required minimum distributions (RMDs) as traditional accounts, applicable to those participants who turn 70½ after Dec. 31, 2014. Contributions after age 70½ would also be prohibited.
Stretch payout: As it did last year, the Administration is proposing that “stretch” payouts over the beneficiary’s life expectancy only be permitted for surviving spouses. Non-spouse beneficiaries designated by participants dying after 2014 would be required to take distributions over five years. There would be exceptions for disabled or chronically ill persons, minor children and beneficiaries who are less than 10 years younger than the participant.
Contribution limit: A new limit would prohibit contributions to IRAs and defined contribution plans if a taxpayer has accumulated retirement benefits in excess of an amount necessary to provide the maximum annuity permitted by the Internal Revenue Code under a defined benefit. Currently, that amount would be $3.4 million for a 62 year old.
60-day rollover: The proposal would allow beneficiaries other than spouses to roll over inherited qualified plans or IRAs into another qualified plan or IRA within 60 days without income tax penalty. Currently, a direct trustee-to-trustee transfer is the only way non-spouse beneficiaries can move an inherited plan without incurring income tax.
RMD exception: Participants and owners would be exempt from taking RMDs if the value of their accounts is less than $100,000, as valued when the taxpayer is age 70½ and at the end of each successive year.
Exclusion overhauls: Attempting to do away with Crummey withdrawal rights, the Administration is proposing a new annual exclusion for gifts of restricted property interests. Each year, a taxpayer would have an exclusion amount of $50,000 for any of the following types of transfers: to trusts, of interests in pass-through entities, of interests subject to sale restrictions and of other interests that the donee can’t easily liquidate. To the extent a taxpayer makes transfers of these types exceeding $50,000, gift tax would be due (or lifetime exemption used).
The Administration seeks to clarify that the health and education exclusion under IRC Section 2611(b) for direct payments of tuition or medical expenses to the education or health care provider should only apply to payments by a donor, and not to distributions from trusts. This restriction is intended to render health and education exclusion trusts ineffective. This plan would further require Section 2611(b) to be amended, as it currently applies to “any transfer which, if made inter vivos by an individual …” (emphasis added), which clearly means the transfer doesn’t need to be made inter vivos by an individual.
Exemptions and more: The Administration proposed again to roll back the current estate, generation-skipping transfer (GST) and gift tax exemptions to 2009 levels ($3.5 million for estate and GST, $1 million for gift), without any adjustments for inflation, going forward. The top tax rate would be 45 percent. However, taxpayers wouldn’t face any penalty for making gifts in prior years when the exemptions were higher (that is, there wouldn’t be a clawback). Portability would still apply, but while the surviving spouse could use the full remaining amount of the deceased spouse’s exemption to shelter his estate at death, he would be restricted to using only the amount of the deceased spouse’s gift tax exemption available on date of death for lifetime gifts (so that a surviving spouse can use the deceased spouse’s remaining gift tax exemption only; she doesn’t have the benefit of using the deceased spouse’s remaining estate tax exemption during life).
Again, the Administration proposes that the GST tax-exempt character of a trust to which exemption has been applied would only last 90 years, after which the GST tax would again apply to the trust. The intent here is to negate the use of dynasty trusts that last 360 years, 1,000 years or indefinitely as tools to forever avoid estate taxes.
The budget proposal also suggests that the estate tax lien period be extended to match the deferral period for estate tax payments related to closely held business interests. The lien is imposed for a period of 10 years after date of death, but an estate may have more than 14 years and nine months to pay estate tax deferred under the rules applicable to closely held business interests. The proposal seeks to increase the period of the lien so that it’s coterminous with the deferral period.
Income tax aspects: The Administration again proposed that the basis of property received by a taxpayer through a gift or inheritance must not exceed the value reported on the gift or estate tax return of the donor. To implement this, the Administration seeks to create a reporting requirement for the donor (or his estate), which would inform the beneficiary of the basis.
The Administration has scaled back its 2014 proposal that property held in a grantor trust for income tax purposes be included in the grantor’s estate for estate tax purposes. The 2015 proposal suggests that property sold to a grantor trust (including appreciation and income), less the consideration paid, will be included in the grantor’s estate and subject to estate tax, or if distributions are made or the trust ceases to be a grantor trust, subject to gift tax. This requirement wouldn’t apply to trusts holding only life insurance, nor to trusts already included in the grantor’s estate for other reasons, such as qualified personal residence trusts or grantor retained annuity trusts (GRATs).
GRATs: Once again, the Administration proposes doing away with zeroed-out and decreasing GRATs. It suggests imposing a requirement that the value of the remainder interest in a GRAT be equal to at least 25 percent of the value of the property transferred to the GRAT or, if greater, $500,000 (but not more than the value of the GRAT in any case). In addition, the budget proposal seeks to impose a minimum 10-year term for GRATs and a maximum term of the life expectancy of the annuitant plus 10 years (to combat “100-year GRATs”).