PDF:  Tax News & Comment — March 2010

I.    Introduction

Many taxpayers wish to transfer assets to their children during their lifetimes rather than at their death. Therefore, lifetime transfer planning remains important for reasons wholly independent from the fate of the estate tax. While the $1 million lifetime gift tax exclusion amount is a hindrance to large gratuitous transfers, gifts of interests in discounted family entities, installment sales to grantor trusts, and transfers to annuity trusts can significantly leverage the $1 million gift tax exclusion amount.

The gift tax annual exclusion amount for 2010 remains at $13,000. Much wealth can be transferred without gift or estate tax consequences by prudent use of annual exclusion gifts, either outright or in trusts providing Crummey powers. It is unlikely that new IRC §2511(c) would operate to invalidate annual exclusion gifts made under IRC §2503 to non-grantor trusts.

The federal gift tax rate (New York has no gift tax) for gifts made in 2010 and thereafter is 35 percent, down from 45 percent. Although the 35 percent rate is not scheduled to increase in 2011, Congress has historically imposed the same rate of tax on both gifts and estates. Since the 35 percent gift tax rate may prove only temporary, large gifts of $1 million or more made in 2010 may be considerably less expensive than the same gifts would be in 2011.

II.  Valuation Discount Legislation?

Although the IRS has been successful in challenging gift and estate valuation discounts with arguments premised on IRC §2036, IRC §2704(b)(2) has rarely aided the IRS in litigation in the twenty years since its enactment.  President Obama may seek to curtail valuation discounts by means of new legislation. This creates a “window of opportunity” for gift tax planning with valuation discounts in 2010. This prospect, in combination with the historically low gift tax rates now in effect, makes transfer planning in 2010 particularly attractive.

Treasury’s 2010 budget proposal includes a provision that would expand the scope of IRC §2704(b).  Pursuant to its statutory authority to promulgate regulations with respect to restrictions that have the effect of reducing the value of a transferred interest for tax purposes, but without reducing the value of the interest to transferees, the IRS may move independently of Congress.  Although any proposed regulations are subject to public comment and may not be released in final form 18 months, under IRC §7805(b)(2), the final regulations issued within that time can be made be retroactive to the date of enactment.

Section 2704(b)(2) ignores in valuing an interest in a closely held entity any “applicable restriction” on liquidation that would lapse or could be removed after the transfer. Restrictions in governing agreements, if not ignored, increase estate and gift tax discounts. Under the proposal, a new category of “disregarded restrictions” would be ignored under §2704(b). Disregarded restrictions would include limitations on the owner’s right to liquidate the interest if the limitations are more restrictive than a standard identified in the regulations, even if they are no more restrictive than those imposed by state law.  Most states have enacted statutes which take advantage of the “no more restrictive than state law” language in §2704(b).  This has made it possible for estate planners to avoid the application of the statute.

If new regulations are promulgated restricting the ability of taxpayers to claim valuation discounts when making gifts of interests in family entities, there may be a trend to capitalize on discounts available for undivided interests in real estate.  Thus, if co-tenants by the entirety possess rights under state law to partition property, the IRS may recognize discounts in the range of 15 percent to 30 percent. See Estate of Barge v. Com’r, T.C. Memo 1997-188 (26% discount recognized for undivided interest in timber). Estate of Stone, 103 AFTR2d 2009-1379 (9th Cir. 2009) allowed only a 5 percent discount for an undivided 50% interest in an art collection.

Since New York imposes estate tax, but not gift tax, large gifts of cash or unappreciated assets by a person gravely ill can save considerable New York estate taxes.  While gifts of appreciated assets will also result in New York estate tax savings, such gifts will forfeit the basis step up that would otherwise occur at death.

III.  Gifts Under Power of Attorney

A power of attorney is invaluable should the principal later become incapacitated, since the appointment of a legal guardian  requires court proceedings. Although gravely ill persons rarely have the capacity to make large gifts, another avenue for such gifts opened on September 1, 2009.  Effective 9/1/09, NY General Obligations Law §5-1501, which governs the content and execution of powers of attorney, was revised and amended. Under revised law, a power of attorney must be signed, dated and acknowledged not only by the principal, but also by the agent. A power of attorney is now durable (i.e., not affected by later incapacity) unless it specifically provides otherwise.

A new Statutory Major Gifts Rider (SMGR), if executed  simultaneously with the power of attorney, authorizes an agent to make legally binding major gifts on behalf of the principal. The SMGR must be executed with the same formalities governing the execution of a Will. The SMGR may also authorize the agent to “create, amend, revoke, or terminate an inter vivos trust.”

Under §5-1504, acceptance of the statutory “short form” POA by banks and other third parties is now mandatory. A third party may not refuse to honor the power or SMGR without reasonable cause. The statute provides that it is unreasonable for a third party or bank to require its own form, or to object to the form because of the lapse of time between execution and acknowledgment. The statute requires that the agent, a fiduciary, observe a “prudent person standard of care,” and imposes liability for breaches of fiduciary duty.