• Changes to the Federal Estate Tax Effective January 2009 Combined with the Current Political and Economic Climate Create a Unique Opportunity to Review and Enhance Your Estate Plan before Year End
  • October 15, 2008
  • Law Firm: Blank Rome LLP - Philadelphia Office
  • Regardless of your net worth, a review of your estate plan is warranted before year end, for several reasons. First, the estate tax exemption is scheduled to increase to $3.5 million on January 1, 2009, while the gift tax exemption will remain fixed at $1 million. Second, political and economic realities make it more likely than ever that the Federal estate tax will be made permanent after 2009. Finally, the low interest rate environment, along with depressed asset values, provide potentially significant opportunities to transfer future appreciation to your children and/or grandchildren in a tax efficient manner.

    To Repeal or Not To Repeal – That is the Question

    The enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) provided for a series of increases in the Federal estate tax exemption amount from $1 million in 2002 to $1.5 million in 2004 to $2 million in 2006 to $3.5 million in 2009. EGTRRA also reduced the maximum Federal estate tax rate from as high as 60% to 45%. As a result, many clients’ estates are no longer subject to the Federal estate tax, but those estates that continue to be taxed face potentially significant tax liabilities.

    As the law currently stands, the Federal estate tax is completely repealed in 2010 and then is reinstated with an estate tax exemption of $1 million and a maximum tax rate of 55% in 2011. During this entire time, including the year of estate tax repeal, the lifetime gift tax exemption remains at $1 million.

    Will we ever see a full repeal of the estate tax? For the past year or so, most experts have speculated that the estate tax will not be permanently repealed. Even before the recent melt-down in the financial services industry, spiraling budget deficits have made it more likely than ever that the Federal estate tax is here to stay.

    Although the presidential candidates’ proposals differ on the estate tax exemption amount and the estate tax rate, both John McCain and Barack Obama appear to be in favor of retaining the estate tax. Therefore, it is likely that new legislation will be introduced prior to 2010 that will make the estate tax permanent. Mr. McCain has stated that he is in favor of a $5 million exemption and a 15% estate tax rate, while Mr. Obama supports a $3.5 million exemption and a 45% rate, in essence, freezing the amounts that will go into effect in 2009 under current law. Of course, the final resolution of the estate tax issue will depend on the results of the presidential election and the control of the houses of Congress.

    Looking Ahead to 2009 – What Should You Do?

    The changes that take effect in 2009 and the possibility that the estate tax will continue beyond 2009 create unique planning opportunities. These changes will impact most individuals regardless of the magnitude of their net worth. The $1.5 million increase in the estate tax exemption to $3.5 million in 2009 will mean that fewer clients’ estates will be subject to the estate tax and their current plans may become obsolete. On the other hand, it is important that those individuals whose estates continue to be subject to the estate tax consider, and possibly implement, one or more gift planning techniques that could substantially reduce their overall tax exposure. The annual gift tax exclusion amount will increase in 2009 from $12,000 to $13,000, providing a small planning benefit to all clients regardless of net worth.

    Married Couples With Net Worth Above $7 Million; Single Individuals With Net Worth Above $3.5 Million

    There are a myriad of planning opportunities available to our wealthiest clients. Clients with a net worth above $7 million (for most married couples) and $3.5 million for single individuals will continue to be subject to the Federal estate tax. However, the lifetime gift tax exemption is not expected to be increased above $1 million, making it more important than ever that wealthy clients fully leverage their exemption through lifetime gifting techniques. The current low interest rate environment, along with depressed asset values, makes many of these techniques even more effective than ever.

    Gifting techniques that leverage the lifetime exemption should continue to be considered, and in appropriate situations, implemented. These include intra-family loans, grantor-retained annuity trusts (“GRATs”), installment sales to intentionally defective grantor trusts (“IDGTs”) and charitable lead annuity trusts (“CLATs”). (Each of these techniques are more fully discussed in our Private Client Group Alert entitled “Historically Low Interest Rates Create Unique Estate Planning Opportunities,” which may be found at our website www.blankrome.com under Resources, Publications, Service - Trusts & Estates).

    With an intra-family loan, the transferor lends money to the transferee (which may be an individual, trust or business entity), documented by a promissory note bearing interest at the very low applicable federal rate (“AFR”). The borrower can use this loan to pay down higher-rate debt or make investments which are anticipated to achieve a rate of return higher than the AFR. Any returns in excess of the AFR will be retained by the borrower free of gift or estate tax. As of October 2008, these interest rates range from 2.19% to 4.32%, depending on the length of the loan.

    With a GRAT, the grantor transfers assets into a trust for a term of years. During the term of the trust, the grantor receives an annuity payment, at least annually, of either a fixed dollar amount or a fixed percentage of the fair market value of the property placed into the trust. The interest rate used to calculate the annuity payment is the favorably low AFR. At the end of the trust term, any remaining principal is distributed to the trust beneficiaries. Gift leverage is obtained because the reportable value of the gift is equal to the fair market value of the property placed into the trust, less the present value of the annuity payments that the grantor will receive from the GRAT. In most cases, GRATs are designed to result in a gift tax value of nearly $0.

    Similar to a GRAT, with an IDGT assets are sold by the grantor to a trust in return for an installment note that bears interest at the AFR. The note may provide for installment payments over a period of time or may provide for annual interest-only payments with a balloon payment of principal at the end of the term. Any income and appreciation on the trust assets that exceeds the payments required to satisfy the note will belong to the trust beneficiaries free of estate or gift tax at the end of the trust term. Gift leverage is obtained to the extent that the asset sold to the IDGT appreciates at a rate greater than the AFR. Further, for federal income tax purposes, the grantor pays no tax on his or her gain from the sale of assets to the trust and is responsible for paying income tax on the future income earned by the trust, a benefit to the trust beneficiaries which is not treated as an additional gift by the grantor.

    A CLAT provides for the payment of a fixed dollar amount to one or more charitable beneficiaries for a specified period of time, at least annually, regardless of the income generated by the CLAT. At the end of the term, the remaining assets of the trust pass to or in trust for individual beneficiaries. The trust may be established for a term of years or based on the life or lives of individuals living at the time of trust creation. Gift leverage is obtained because the reportable value of the gift at the creation of the CLAT is the fair market value of the assets placed in the trust less the present value of the annuity.

    Married Couples With Net Worth Between $3.5 Million and $7 Million

    Clients at the other end of the financial spectrum should also review their estate plans as a result of the anticipated changes to the Federal estate tax system, although for different reasons. First, estate plans should be reviewed to determine whether they have become obsolete as a result of increases in the estate tax exemption from $600,000 in 1997 to $3.5 million in 2009.

    Most married couples have Wills that contain a “formula” clause providing that upon the death of the first spouse, an amount equal to the estate tax exemption then in effect will be placed in a trust for the benefit of the surviving spouse (the “Credit Trust”) or will pass to or in trust for the benefit of the children, with the remainder of the estate passing outright to the surviving spouse. The intended goal is for the Credit Trust to be funded with the minimum amount necessary to reduce the Federal estate tax to $0 at the first spouse’s death, providing the surviving spouse with unfettered control over the remaining assets, and minimizing the amount of estate tax due at the surviving spouse’s death. With an estate tax exemption amount of $3.5 million in 2009, a “formula” clause may cause all or substantially all of a more modest estate to pass to the Credit Trust, with little or nothing passing directly to the surviving spouse. Failure to review and revise “formula” clauses can result in an over-funded Credit Trust, even though the surviving spouse’s estate may be subject to little or no Federal estate tax. Similarly, a “formula” clause leaving the exemption amount to the children, and little or nothing to the surviving spouse, could have unintended, potentially disastrous consequences. Several estate planning techniques can be employed to address this problem, including “capping” the Credit Trust, adding disclaimer provisions to the estate plan and/or retitling of assets as between the husband, wife, and joint ownership.

    Second, estate plans of clients who may no longer be subject to estate tax after 2009 may nonetheless need to be revised for non-tax reasons. In recent years, more and more of our clients are interested in utilizing trusts, limited partnerships, limited liability companies, corporations and other vehicles as part of their estate plans as a means of protecting their assets from creditors. In an increasingly litigious society, “Asset Protection Planning” through the use of trusts and other protected entities is an effective way to protect beneficiaries not only from themselves, but their creditors, whether arising from a failed business, a failed marriage, or otherwise.


    The estate planning “landscape” is rapidly changing. Political and economic realities are presenting a myriad of opportunities to shift significant wealth in a tax efficient manner. Even if you may no longer be subject to estate tax after 2009, it is important that you review and possibly update your plan to make certain that it has not been rendered obsolete by changes in the law. There are also non-tax reasons for reviewing your estate plan, most importantly, asset protection.