When tax revenues plummeted during the Great Depression, Congress needed a new source of revenue to avoid huge deficits. Partially because it would give them something new to tax, Prohibition was ended and a new excise tax on alcohol helped shore up the sagging budgets on the state and federal levels.

Today, as we climb out of the “Great Recession,” the government is falling behind again. In April the Treasury Department posted an $83 billion deficit, nearly four times larger than April 2009’s and the largest ever for that month. It was also the 19^th consecutive deficit posted, and Uncle Sam is looking for a way to stop that losing streak.

To address the situation, the Obama administration has proposed several changes to the tax code as part of the 2011 budget. Some of these proposed changes directly impact estate and gift tax planning. If the proposals get the approbation of the Congress, they could affect the estate/gift plans of many. If (or until) these tax law changes are approved, readers still have an opportunity to take advantage of some “once-in-a-generation” chances to save money.

Of the proposed estate and gift tax law changes, there are three categories that could have a profound impact on property transfers. The three categories included in President Obama’s proposal include tax basis consistency, valuation discounts, and grantor retained annuity trusts.

- Grantor retained annuity trusts (GRATs) are annuities that have long been popular as a means to transfer large sums of money to a family member tax free. They will remain an option under the president’s proposal, but the minimum term before the beneficiary can receive the corpus will be extended significantly to 10 years. The longer term may make it less likely that the growth benchmark needed for the GRAT (to be an effective wealth transfer vehicle) will be met. Extending the term also makes it more possible that the person establishing the trust could die before the maturity period of the GRAT has been reached.

- The second proposal targets certain restrictions on family controlled entities which might lower the value of a business. If approved, some restrictions (discounts, i.e. lack of control, lack of marketability) will be disregarded for the purposes of valuation assessment in case an ownership stake is transferred by gift or bequest to a family member. If valuation discounts are restricted, transfers of “ownership interest in business entities” will retain their full fair market value. Obviously, the higher the fair market value, the greater the tax paid upon transfer.

- Tax basis, the purchase price of property plus improvements and less depreciation, is used to determine the amount of gain or loss once the property is sold, gifted, or bequeathed. Obama’s proposal seeks to stifle those who would skirt the estate tax by requiring executors of wills to provide both the recipient and the IRS with information on the tax basis of the property inherited.

It’s important to stress that, for now, these are only proposals. Some of these proposals might be enacted as originally drafted, some might be modified as a result of congressional debate, and some might be completely rejected. Nonetheless, it is wise to be familiar with what is currently on the President’s “wish list.”

However, the uncertainty that surrounds them, combined with the certainty of other changes in tax law – next year’s jump in the capital gains tax, for example – means it is more important than ever to have a solid financial and estate plan in place.

This entry was posted on Tuesday, June 1st, 2010 at 10:59 am and is filed under Accounting, Wealth management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.