The Minnesota Investor: New rules could change estate payouts

THE MINNESOTA INVESTOR

GENE WALDEN

Congress is pushing through some big changes in estate taxation laws that could have an impact on the level of tax-free distributions you can pass on to your heirs.

"In the universe of estate planning, what is going on about us is truly the equivalent of the Big Bang theory," explains Roy M. Adams, an attorney and professor emeritus of estate planning and taxation at Northwestern University School of Law.

Adams was in the Twin Cities last week to discuss the new laws at an estate planning workshop sponsored by Securian Trust Co. and the Salvation Army. He said Congress must act soon to rework an earlier law that is set to eliminate all inheritance taxes for 2010.

"Next year it would be a free ride," says Adams. Under the existing law, beneficiaries would pay no taxes regardless of the size of the inheritance next year. But in 2011, the tax-exempt amount would drop to $1 million and heirs would pay about a 55 percent tax rate on any inheritance in excess of $1 million. Adams says he expects Congress to pass a revised tax law next month.

"It needs to be done then because if it comes any later the government Bureau of the Budget wouldn't be able to get the new rules printed and distributed in time for 2010."

Under the proposals, the exemption level would be $3.5 million per spouse -- before or after your death. Under the current law, you and your spouse can each give away $13,000 per year to your heirs tax-free. In addition, you and your spouse can make additional tax-exempt contributions of up to a total of $1 million each to your heirs.

Under the new plan, you and your spouse would each be able to make gifts of up to $3.5 million each -- for a total of $7 million. You can pay out all or part of the $3.5 million while you're alive. If you don't give the full amount away while you're alive, the balance of that $3.5 million would go to your heirs tax-free after you die. Any inheritance beyond the $3.5 million per spouse would be subject to a federal tax rate of 45 percent, plus state tax.

Changes in GRAT Trust rules

"There are currently a number of trusts that allow families to essentially beat the system and give away more to their children without taxes," says Adams. Under the new tax proposal, some of the rules governing those trusts would be changed.

Currently some wealthy families use a "grantor-retained annuity trust" (GRAT) to pass on much of the appreciation of a particular asset to their heirs tax-free.

With a GRAT, a family can put thousands or millions of dollars into the trust, which is set up as an annuity that pays the donor an annual payment for a fixed period of time. At the end of the period, any remaining value of the trust is passed on to the beneficiary as a tax-free gift.

In determining taxes for the trust, the government assumes the trust is growing at a rate set by the IRS, which is currently about 5 percent. But if the trust is earning more than the set rate, then the heirs may get a tax benefit when the assets are distributed.

"On a $1 million investment, the government assumes you're earning $50,000 a year based on its set rate, but if the investment is paying 10 percent, your kids would receive $100,000, but it would be taxed as though they're receiving $50,000," said Adams.

However, if the parent dies during the term of the trust, the money reverts to his or her estate and is subject to the estate tax. To minimize the chances of that happening, estate planners have been setting up GRATs with terms as short as two years.

Under the new proposal, GRATs would be required to be set up with at least a 10-year term.

Adams said Congress is also expected to repeal a rule that allows families to pass on assets with a tax discount through family partnerships.

Gene Walden lives in the Twin Cities and is the author of more than 20 books about business and investing. Send questions to gwalden100@comcast.net.