By Drew Grey, CPA, Partner


1. The Current Status Of Federal Estate And Gift Taxes

Under current tax laws, the unified gift and estate tax exemption amount remains at $5,120,000 per person until December 31, 2012, at which time it is scheduled to be reduced to $1,000,000 per person as of January 1, 2013.  The current 2012 35% estate and gift tax rate is scheduled to rise to 55% on January 1, 2013.


2. What Is The Likelihood That Congress Will Change The Estate And Gift Tax Rates And Exemption Amount?

Based upon statements being made by both Republicans and Democrats, it is probable that Congress will pass tax legislation to modify the existing estate and gift tax laws, but that legislation most likely will be enacted after the November election and may not occur until 2013.  President Obama has advocated for enacting a $3,500,000 estate and gift tax exemption and a tax rate of 45.  Since estate and gift taxes are not a large revenue raiser to offset the large federal deficit, it is likely that there will be a political tax compromise in the estate and gift tax area.  A possible scenario is that new estate and gift tax legislation will be enacted in early 2013 and be made retroactive to January 1, 2013.


3. Will There Be A “Claw Back” If The Client Utilizes The Increased $5,120,000 Gift Tax Exemption In 2012?

It is possible that Congress could in the future force a client to pay gift or estate taxes on the higher exemption amount that such client previously utilized, which used exemption was greater than the federal estate tax exemption that is allowable at that client’s death.  For example, if the federal estate tax exemption is only $1,000,000 at the client’s death, but the client in 2012 utilized $5,120,000 of the gift tax exemption by making lifetime gifts, then Congress could require that the $4,120,000 difference be included in that client’s estate (when the client dies) for federal estate tax purposes.  In other words, Congress on a deceased client’s estate tax return could choose not to allow that decedent the benefit of the previously used higher $5,120,000 gift tax exemption, even for those clients who made gifts in 2012.  Currently, Congress has not taken a position on having such a claw back of the estate and gift tax exemption.  Many tax observers predict that Congress for political and fairness purposes would not enact such a draconian claw back of the used gift tax exemption amount.  Even if Congress were to enact such a claw back of the gift tax exemption, the income and appreciation of 2012 gifts still inures to the benefit of the client’s children and grandchildren.


4. The Current Low Interest Rates Provide The Use Of Grantor Retained Annuity Trusts And Sales To Grantor Trusts At Extremely Low Or No Gift Tax.

The September, 2012 interest rate of §7520 for a grantor retained annuity trust (also known as a “GRAT”) is a low 1%.  Thus, if a client contributes assets to a GRAT that generates a yield in excess of this 1% amount then that GRAT will transfer assets gift and estate tax free to the client’s children.  The major disadvantage of a GRAT is that if the grantor parent dies during the GRAT term all the GRAT’s assets come back into that parent’s taxable estate.  Thus, a short term GRAT is often used as a tax planning technique to transfer large amounts of assets to children gift tax free.  Note that because of generation skipping tax laws, GRATs generally are not an effective estate planning method to leave assets to grandchildren.

The current low AFR interest rates encourage the sale of assets to children and grandchildren, and the client’s sale of assets to grantor trusts (also known as “defective income trusts”) for the benefit of younger family members.  For example, the September mid-term AFR interest rate was a low .84%.


5.  Properly Formed And Operated Family Partnerships Continue To Be Validated By The Courts

Taxpayers continue to utilize family limited partnerships (and family limited liability companies) to generate minority and lack of marketability valuation discounts for lifetime gifts, and for assets gifted to their family at death.  Taxpayers that observe the proper formalities of forming and operating a family limited partnership have been successful when those partnerships have been challenged by the Internal Revenue Service.

In Estate of Lockett, T.C. Memo 2012-123, a case lost by the taxpayer, the formalities of forming the partnership were not observed where the parent contributed 100% of the capital.  In fact, the parent was the only partner, which resulted in the Tax Court’s nonrecognition of a valid partnership and the denial of a lack of control and a lack of marketability discount.  The Tax Court pointed out that a limited partnership needs more than one partner.  However, in Estate of Stone, T.C. 2012-48, another 2012 Tax Court decision, the Tax Court found a valid partnership where the decedent had transferred real estate to a family limited partnership and thereafter gifted limited partnership interests to family members.  The Tax Court’s holding in Estate of Stone was based in part upon the fact that there was a business purpose in that real estate was to be managed as one family asset by the limited partnership (rather than being fractionalized).  Importantly, the decedent parent did not utilize the assets of the partnership for the parent’s support, the formalities of transferring the real estate to the partnership were observed, and there was no comingling of the parent’s personal assets with the partnership’s assets.  Similarly, in the 2012 Tax Court decision of Estate of Kelly, T.C. Memo 2012-73, the Tax Court upheld a family limited partnership where the partnership was created for non-tax reasons of insuring equal estate distributions, avoiding potential litigation among family members and achieving effective asset management.  In Estate of Kelly, none of the partnership’s funds were used for the parent’s support, and the formalities of the partnership’s operation were observed.

Where family partnerships are utilized to make annual gifts in an attempt to utilize the $13,000 per year annual exclusion per donee, the gifted limited partnership interests must qualify as a “present interest.”  In Estate of Wimmer, T.C. Memo 2012-157 even though there were restrictions on transferability of the donee’s limited partnership interests, the Tax Court still held that the limited partnership interest qualified as a present interest.  The Tax Court stressed that there was a present interest (thus qualifying for the annual gift tax exclusion) in part because the partnership regularly distributed income to the partners.  In Wimmer, the partnership held publically traded securities that generated earnings each year.  The Wimmer case demonstrates that partnership interests, to qualify for the gift tax annual exclusion, must be analyzed as to any restrictions on transferability of the donee’s interests as well as whether the assets in the partnership are likely to generate current cash flow to the donee partners.  The Wimmer court’s holding was that the taxpayer must prove that the partnership would generate income; that some portion of that income would flow steadily to the donee partner; and that the partnership’s income could be readily ascertained.  An important fact in Wimmer was that the general partners were obligated to distribute partnership income each year to the partners.


The above is not tax advice for any client or matter; it is provided as a topic of general interest to our readers and should not be used for tax planning purposes.  Each client’s situation contains unique facts.


If you are interested in exploring how these rules could benefit you, please contact Drew Grey at (818) 995-0090 or at to receive advice on your specific matter.




September 20, 2012 Posted in Estate Tax Planning, Tax