The
new Tax Act repeals this QFOBI deduction as of December
31, 2003. Interestingly, that is the same date after
which the estate tax exclusion is increased to $1,500,000.
Some observers comment that this represents "what
one hand giveth, the other hand taketh away."
Conservation
Easement Exclusions Improved. The 2001 Tax Act
expands the land which can qualify as a conservation
easement as any land located in the United States.
This is a significant improvement over the prior definition
which limited such easements to land located within
a certain distance from metropolitan areas, national
parks, wilderness areas, or urban national forests.
This can be a very attractive estate planning benefit.
The
value of a conservation easement may be excluded from
the gross estate subject to certain percentage and
dollar limitations. Generally, the percentage restriction
is 40% of the value of the land, which is further
reduced by two percentage points for each percentage
point by which the value of the easement is less than
30% of the value of the land. The maximum dollar amount
of the exclusion is $400,000 in 2001 and $500,000
in 2002 or thereafter. These changes take effect immediately.
"SWEET
& SOUR"
Qualified
State Tuition Programs Are Sweetened. In our last
newsletter, we discussed Alaska's new Qualified State
Tuition Program authorized by I.R.C. *529. This is
a great way in which to set aside funds for the education
of children or grandchildren. In summary, you may
contribute, gift tax free, $50,000 for a family member*s
tuition and education expenses. You may continue to
make contributions for a beneficiary every five years.
You can invest up to a maximum of $250,000 for each
beneficiary. By doing so, you remove the contributed
funds from your gross estate. Unlike funds contributed
to a child*s or a grandchild*s trust, funds contributed
to the plan grow free of income tax. Alaska has added
asset protection to the above-described benefits.
An account is exempt from a claim by the creditors
of the donor or of a beneficiary. You retain the right
to change the beneficiary among family members, without
penalty. You also retain the right to withdraw the
funds placed in the account, but the earnings portion
of the withdrawn funds will be taxed at your tax rates
and will be subject to a penalty of 10% of the earnings.
The
new 2001 Tax Act has "sweetened" these *529
tuition programs. The law used to be that when amounts
were distributed to a student beneficiary, they were
taxed at the student*s tax rates. Under the new Tax
Act, distributions to the beneficiary which are used
to pay for qualified higher education expenses are
no longer taxable to anyone. This is a tremendous
improvement for I.R.C. *529 tuition programs. The
funds that you contribute for the education of your
children or grandchildren will grow income tax free,
and when distributed for education expenses will be
income tax free! This new tax benefit is effective
beginning in 2002.
Alaska
has chosen the brokerage firm of T. Rowe Price to
manage funds contributed to its I.R.C. *529 tuition
program. You may obtain more information about this
tuition program by going to www.uacollegesavings.com.
IRA
Rollovers to Charities Go Sour. For several years
charities have been lobbying for a new tax provision
which would allow individuals to withdraw amounts
from their IRAs, income tax free, if the amounts were
directly contributed to a charity. This would be an
important improvement compared to the present situation
where often the income resulting from the withdrawal
is not completely offset by the income tax charitable
deduction which the donor receives. The reason for
the present mismatching is that itemized deductions
on your income tax return are subject to certain limitations
as your income grows higher. The Senate version of
the new tax bill included the above IRA rollover provision.
However, the final 2001 tax bill dropped this provision
to satisfy the overall tax cut ceiling.
There is still hope. H.R. 774 is pending in Congress
and is designed to accomplish this IRA charitable
rollover result. Perhaps this change will be enacted
in the near future. It would eliminate the income
tax sting for donors who desire to contribute part
or all of their IRAs to charities during the donors*
lifetimes.
Pension
Changes. The new Tax Act includes more than 50
provisions which are designed to increase retirement
savings and pension coverage. A few highlights are
as follows:
1.
Increased IRA Contributions. Under the new
Act, the contribution limit for IRAs would be increased
to $3,000 for 2002-2004, $4,000 for 2005-2007, and
$1,000 annually in 2006 and thereafter. Individuals
50 and older would be allowed to make catchup contributions
to an IRA of $500 annually through 2005, and $1,000
annually in 2006 and thereafter.
2. Increased
401(k) Limits. Annual elective deferral limits
for 401(k) and 457 plans, and 403(b) annuities would
be raised from $10,500 to $11,000 in 2002 and then
increase in $1,000 increments to reach $15,000 for
2006 and thereafter. Additional catchup contributions
to such plans (available for individuals 50 and older)
would begin at $1,000 for 2002 and increase by $1,000
annually to reach $5,000 in 2006.
3. Additional
Increased Limits. Annual contribution limits with
respect to each plan participant in a defined contribution
plan were increased from $35,000 or 25% if compensation
to $40,000 or 100% of compensation. The annual benefit
limit under a defined benefit plan was increased from
$140,000 to $160,000.
Other
Tax Act Changes. Our discussion above has focused
upon only the transfer tax changes and several income
tax and pension tax changes which are of primary interest
for your estate planning. The Tax Act contains numerous
other changes relating to income tax rate cuts, marriage
penalty relief, individual tax credit changes, educational
benefits involving IRAs, deductions and interest,
and miscellaneous other provisions. These subjects
are beyond the scope of this newsletter. However,
our web site contains links so that you may find a
full discussion of the new Tax Act on the Internet.
The
Entire 2001 Tax Act "Sunsets" on December
31, 2010. When this new Act was passed by the
Senate, there were not enough votes for it to avoid
the application of the "Byrd Rule" contained
in the 1974 Budget Act. What that means is that to
pass, the tax cut package had to "sunset"
after ten years. The bottom line is that the above-described
changes and the estate tax repeal in 2010 will only
be effective until December 31, 2010. At that time,
all of these changes will "sunset," that
is, will terminate. The Federal Gift, Estate and GST
tax laws will then go back to what they were in 2001.
This has been named the "Cinderella" provision.
Probable
Congressional Reconsideration of All of These Changes.
The above-described "sunsetting" of the
new Act on December 31, 2010 will very probably cause
Congress to reconsider the Tax Act. When this occurs,
other changes or adjustments may be made to the tax
law. This will depend upon the political situation
in Congress and the Executive Branch, and other factors
such as our national economic situation, and the needs
of programs such as social security and health care.
WHAT PLANNING SHOULD YOU DO?
The
new Tax Act, which is the result of unusual political
and national financial circumstances, has produced
mixed blessings. On the positive side, the Act presents
the promise of significant reduction and even repeal
of the estate and GST taxes. On the negative side,
the Act presents increased planning complexity. We
now, in effect, have four tax regimes: the existing
2001 law; the phase-in law from 2002 until 2009; repeal
in 2010; and sunset in 2011.
The complexity of four tax regimes is further complicated
by the uncertainty of eight Congresses and new presidential
administrations prior to 2010. In addition to the
uncertainty of the law, we have the uncertainty of
our longevity. Perhaps this is best illustrated by
the "gallows" humor now circulating that
under the new Tax Act we should plan to die in 2010.
At present, that is the only year under the new Act
when the estate tax will be repealed.
So,
what should you do?
Initially,
it is important to place this subject in perspective.
The new Tax Act only focuses upon one aspect of estate
planning: reduction of transfer taxes. Whatever the
size of your family's estate, tax reduction is only
one planning goal and may not be the most important.
Most clients are primarily concerned with their dispositive
plan. Where will the assets go after the first spouse's
death, and then when both spouses die? How will these
assets be protected, managed, and ultimately distributed
for the benefit of the children, grandchildren, and
other beneficiaries and charities? Who are the key
people who will manage this process? How will assets
be invested? How will beneficiaries with special needs
be taken care of?
Next,
it is important to emphasize that we are at an early
stage of analyzing the tax reduction planning that
will be appropriate under this new Act. With that
in mind, here is a list of general tax planning observations
that national estate planning experts have been discussing.
Five
Year Plan. Our rule of thumb has always been that
you should plan for the next five years. Then re-evaluate
your situation and planning. This concept continues
to be appropriate in view of uncertainties created
by this new Tax Act.
Good
News: Existing Tax Planning Techniques Untouched.
There is always the danger that when Congress brings
us a new tax benefit, it will take an existing one
away. For example, see the discussion of the qualified
family owned business interest deduction, above. The
good news is that, for the most part, such tradeoffs
did not occur in the transfer tax area. For example,
the Treasury Department has been lobbying Congress
to eliminate valuation discounts for transfers of
passive assets between family members. Similarly,
Treasury has been trying to eliminate qualified personal
residence trusts and annual exclusion gifting to trusts.
None of these endangered techniques were eliminated
by the new Tax Act. Almost all of our other tax reduction
techniques remain intact.
Continue
Planning. The phase-in of benefits, possible repeal,
and potential sunsetting are a long way off. You do
not want to abandon or forego valuable planning techniques
only to find out that political gridlock or national
economic changes result in some or all of the transfer
tax benefits not occurring.
Interim
Life Insurance. If you are doing initial estate
planning or re-doing your planning and the estate
tax applicable credit is more than your family's total
net worth (including life insurance), then you may
decide not to include tax reduction planning. If you
are between $675,000 and a future estate tax applicable
credit amount, you may want to purchase term life
insurance to cover the period between now and when
the credit amount phases-in.
Review
Dispositive Plans. Some plans depend upon the
estate tax applicable credit amount. For example,
plans which distribute that amount to children of
a first marriage, and the remaining assets to a second
spouse. As the credit amount increases, or is eliminated
by repeal, the plan changes. Is this what you want?
Take
Advantage of New Gift Tax Credit. For gift tax
purposes, beginning in 2002 the applicable credit
is $1,000,000. Even if you have already used your
present credit ($675,000), you now have $325,000 more.
In medium and large estates, both spouses should consider
gifting this amount to trusts. Future growth will
be excluded from your estates. The gifts may be leveraged
by taking advantage of the valuation discount offered
by family LLCs. The trust may be perpetual for the
benefit of your children and further descendants.
Alaska self-settled trusts allow you to be discretionary
beneficiaries.
Avoid
Paying Gift Tax. Under existing law, it is advantageous
to pay gift tax rather than estate tax. However, if
the estate tax is repealed, there will be no advantage
in the prior payment of gift tax. When significant
gifting is appropriate, we can help with planning
"safety nets" which minimize the risk that
such gifts will produce out-of-pocket gift tax liability.
Perpetual
Trusts. If the estate tax ultimately is repealed,
experts are recommending that perpetual trusts be
used to protect assets against subsequently enacted
estate or inheritance taxes.
Use
Community Property Trusts. Alaska's optional community
property act is designed to take advantage of the
full adjustment of basis at the death of the first
spouse to die. This will minimize the capital gain
tax when a surviving spouse sells assets. This special
community property benefit is not affected by the
new Tax Act. Beginning in 2010, the proposed carryover
basis will limit the adjustment of basis to a maximum
of 4.3 million dollars. Our clients often use joint
revocable trusts to take advantage of this income
tax benefit.
We
Will Keep You Informed. The tax laws have always
been a "moving target." We will keep you
informed of new transfer tax developments and changes.
As new planning techniques develop, we will be discussing
them in future newsletters and on our web page.
NEW
ALASKA ESTATE PLANNING LEGISLATION |
Alaska
Enacts Amendments to Alaska Community Property Act.
In 1998, Alaska enacted an optional community property
system for its residents, and for non-residents who
desire to use such a system. Couples may elect to
have some or all of their property characterized as
community property. Residents accomplish this election
by entering into a community property agreement or
executing a community property trust. Non-residents
may elect to have some or all of their property characterized
as Alaska community property by executing a community
property trust, which has at least one trustee who
is an Alaska individual or an Alaska bank or trust
company.
The
Alaska optional community property act provides the
non-tax benefits of sharing and equality of ownership.
In addition, several significant tax benefits are
provided. At the death of the first spouse to die,
both halves of the community property receive an adjustment
in basis. As a result, if the surviving spouse sells
community property, capital gain is minimized. Second,
after the death of the first spouse, the ability to
use non-pro rata funding of the bypass and marital
share often provides advantageous income tax and property
ownership benefits.
Alaska's
community property system was patterned after the
Uniform Marital Property Act (UMPA), originally drafted
in 1983. This Uniform Act provides a good overall
structure, but has some ambiguities, and there have
been significant tax developments since it was originally
drafted. Amendments contained in House Bill 181, enacted
by the Alaska Legislature this year, are designed
to solve some of the issues and supplement gaps presented
by the UMPA draft.
1. Increased
Asset Protection. The first amendment changes
the portion of the community property which is subject
to the claims of a creditor of only one of the spouses.
If the spouses held their property jointly, but not
as community property, then a creditor of only one
spouse could only reach the assets of that spouse.
Under the UMPA draft, an obligation incurred by a
spouse during marriage is presumed to be incurred
"in the interest of the marriage or the family."
All of the community property is liable for such an
obligation. This enlargement of the property exposed
to the liability of only one spouse has caused some
couples to hesitate to use this community property
system. In House Bill 181, the Alaska Legislature
has amended the law to provide that the creditor of
only one spouse may only reach the separate property
of that spouse and that debtor spouse's one-half of
the community property.
2. Transfers
of Property to a Community Property Trust By Beneficiary
Designation. This new provision allows property
such as life insurance and IRAs to be transferred
to a community property trust (thereby characterizing
this property as community property) by designating
the trust as the beneficiary of such property. This
amendment will assist couples using joint revocable
trusts, and non-residents using Alaska community property
trusts, in characterizing such assets as community
property.
3. Life
Insurance. This amendment focuses upon the use
of community property funds for the payment of premiums
on life insurance policies. A.S. 34.77.120(b)(5) is
amended to create a presumption that the use of community
property funds to purchase a life insurance policy
for the benefit of certain family members, or a trust
for those members, is presumed to be made with the
consent of the other spouse. The existing statute
creates such a presumption if the beneficiary is the
parent or child of either spouse. The amendment expands
this category to ancestors or descendants of either
spouse, or a trust for the benefit of such persons.
A
new subsection (7) is added to A.S. 34.77.120(b).
The purpose of this provision is to protect the spouses
from undesired and unexpected federal estate tax consequences.
Assume that one of the spouses forms an irrevocable
life insurance trust and contributes funds to the
trust so that the trustee may purchase a life insurance
policy on such spouse's life. Typically such a trust
will be for the benefit of the surviving spouse, and
then the family's children. If the funds contributed
to the trust came from a community property source,
the IRS may argue that if the surviving spouse is
a beneficiary of the trust, then pursuant to Internal
Revenue Code Section 2036 the trust will be partially
included in the surviving spouse's gross estate for
federal estate tax purposes. To avoid this undesirable
consequence, the amendment creates a presumption that
any funds contributed to such a trust were first converted
to the separate property of the insured spouse. The
testimony of the spouse whose life is not insured
is sufficient to rebut either of the presumptions
described above.
4. Division
of Community Property at Death. This amendment
clarifies that on the death of a spouse, one-half
of the community property reflects the share of the
decedent and the other one-half reflects the share
of the surviving spouse. Further, the Alaska Legislature
has adopted the aggregate form of ownership of community
property. Therefore, upon the death of a spouse, a
distribution of community property in kind may be
made on the basis of a non-pro rata division of the
aggregate value of the community property.
The
goal of this amendment is to allow for flexibility
in the division of assets after the death of the first
spouse. For example, a couple's assets may consist
of a large qualified plan or IRA account plus an approximately
equal amount of other assets. Assume that all of the
assets are community property and the spouse who acquired
the retirement assets dies first. A non-pro rata division
of the community property on an aggregate basis would
allow the retirement assets to be transferred to the
surviving spouse, as his or her one-half of the community
property, and the other assets to be used to fund
the bypass trust created by the deceased spouse's
will. Such a non-pro rata division would maximize
both income tax and estate tax planning benefits.
These community property amendments became effective
as of May 8, 2001.