Changes to the Estate and Gift Tax Rules in the Proposed 2013 Federal Budget

On February 13, the President released his federal budget proposals for the 2013 fiscal year.  The proposed budget includes over 130 large and small proposed tax changes for businesses and individuals, including new incentives to “insource” jobs, higher taxes for upper-income taxpayers, and the extension of key tax breaks.  Below are some of the key estate and gift tax proposals made.

  1. Return to 2009 estate and gift tax exemption and rate. The estate, generation-skipping transfer (GST), and gift tax exemption 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.  These changes would apply for estates of decedents dying, and for transfers made, after December 31, 2012.
  2. Portable estate tax exclusion made permanent. The provisions allowing a surviving spouse to use the deceased spouse’s unused estate and gift tax exclusion (but not the GST tax exemption) , which expires for decedents dying after December 31, 2012, would be made permanent.
  3. Basis consistency and reporting requirement for donated and inherited property. Current law does not explicitly require that the recipient’s basis in inherited property be the same as the value reported for estate tax purposes.  The proposal would require that the basis of property in the hands of the recipient be no greater than the value of that property as determined for estate or gift tax purposes (subject to subsequent adjustments).   A reporting requirement would be imposed on executors and donors to provide the necessary valuation and basis information to both the recipient and IRS.
  4. Toughened rules for valuation discounts. Certain restrictions (“disregarded restrictions”) would be ignored in valuing an interest in a family-controlled entity transferred to a member of the family if, after the transfer, the restriction will lapse or may be removed by the transferor and/or the transferor’s family.  The transferred interest would be valued by substituting for the disregarded restrictions certain assumptions to be specified in regulations that will undoubtedly limit or eliminate a valuation discount in these circumstances.  These rules would apply to transfers after the enactment date of property subject to restrictions created after Oct. 8, 1990 (the effective date of Code Sec. 2704).
  5. Minimum and maximum term for grantor retained annuity trusts (GRATs). A GRAT would be required to have a minimum term of ten years and a maximum term of the life expectancy of the annuitant plus ten years.  Also, the remainder interest would have to have a value greater than zero at the time the interest is created and any decrease in the annuity during the GRAT term would be prohibited.  These rules would apply to GRATs created after the enactment date.
  6. Duration of GST tax exemption limited.  Under the proposal, the GST exemption allocated to a trust would terminate after 90 years.  This rule would apply to trusts created after the enactment date, and to the portion of a preexisting trust attributable to additions to such a trust made after that date.
  7. Coordination of income and transfer tax rules applicable to grantor trusts. The current lack of coordination between the income and transfer tax rules applicable to a grantor trust creates opportunities to structure transactions between the deemed owner and the trust that can result in the transfer of significant wealth by the deemed owner without transfer tax consequences (e.g., installment sales to grantor trusts).  New rules for grantor trusts would prevent this by: (1) including the assets of the trust in the gross estate of the grantor for estate tax purposes, (2) subjecting to gift tax any distribution from the trust to one or more beneficiaries during the grantor’s life, and (3) subjecting to gift tax the remaining trust assets at any time during the grantor’s life he or she ceases to be treated as an owner of the trust for income tax purposes.  These rules would apply for trusts created on or after the enactment date and with regard to any portion of a pre-enactment trust attributable to a contribution made on or after the enactment date.
  8. Extension of estate tax lien on Code Sec. 6166 deferrals. The estate tax lien under Code Sec. 6324(a)(1) would be extended to apply throughout the Code Sec. 6166 deferral period, effective for estates of decedents dying on or after the effective date and for estates of decedents dying before the enactment date as to which the current law Code Sec. 6324(a)(1) lien period had not expired on the effective date.