2009: FLPs, GRATs and Crummey Trusts, Will There Be Watershed Estate and Gift Tax Legislation?
February 9, 2009

As we start 2009 all eyes seem are on the lifetime estate tax exemption (currently 3.5 Million Dollars per person) and the annual donee gift tax exemption (currently $13,000 per person). But there are some very intriguing proposals being discussed in the Congressional tax committees that could seriously curtail the use of some commonly utilized estate planning techniques. There is also speculation that the rules will be made retroactive to the beginning of 2009. The gun sights are trained on three and they are as follows.

(1) Family limited partnerships and family LLCs (collectively as used herein “FLPs”), the Internal Revenue Service (“IRS”) absolutely hates them. It suspects FLP use gives rise to abusive gift and estate tax discounting techniques. For some years now the IRS has attempted to cut the effectiveness of FLPs by challenging the discounts taken by moneyed family members for the transfer of minority and non-controlling interests directly to other family members or into trusts for other family members. Lawyers have been clever; but, the IRS has been picking the weakest situations to make its point and it has been somewhat successful. Particularly galling to the IRS is a discount for the transfer of FLP interests where the FLP is invested almost exclusively in cash or marketable securities. The IRS worked with Congress to introduce legislation to significantly curtail the use of discounting and would like to totally destroy FLP usefulness by application of family attribution rules. Application of the family attribution rules seems far-fetched. Adult children tend to have adverse pecuniary interests from their siblings and many families are dysfunctional. Rep. Earl Pomeroy (D-ND) introduced H.R. 436 which proposed the concept of “actively traded” as a requirement for applying a lack of control discount. Our best word of advice is, whatever the underlying assets of the FLP, have a bona fide business purpose and run it like a business. If you would like more details or a checklist for business operations, simply give us a call or email us.

(2) Grantor Retained Annuity Trusts (“GRATs”) are also on the short list. Rumor has it that the gentleman who wrote the original GRAT regulations publically stated that he regretted what he considered a fundamental flaw in the regulations. That “flaw” allows a grantor to effectively “zero-out” a the gift of a remainder interest for gift and estate tax purposes. The IRS doesn't like “zero-ed out” GRATs. To curtail the concept of “zeroing-out” the remainder interest in a gift, the IRS has suggested that there be at least a 10% remainder gift interest at the creation of the GRAT in order for it to be considered qualified. The rules suggested are somewhat similar to those currently applicable to charitable remainder annuity trusts. Although these rule changes will not eliminate the use of GRATs, they will certainly curtail its effectiveness. It is expected that the IRS will also want to apply the 10% remainder rule to qualified personal residence trusts (“QPRTs), which are GRATs funded with a personal residence.

(3) Crummey Trusts are the third potential victim. With an estate tax exclusion of 3.5 Million Dollars, the IRS sees the use of Crummey withdraw powers to create a present interest gift and utilize the annual donee exemption as excessive. These powers treat certain transfers into trust as completed gifts of present interests if the trust beneficiary is provided a period of time (typically 30 days) during which to demand the property transferred in trust. Successful use will shelter $13,000 per donee annually from gift tax. As background to the IRS frustration, in 1991, the U.S. Tax Court decided the Christofani case. In Christofani, the taxpayer attempted to utilize over 20 Crummey withdrawal powers. The IRS lost this case. Chief among the arguments it presented was that remote contingent beneficiaries (grandchildren) should not be considered as present interest beneficiaries (a technical term of art in gift tax). The Court stated that the present interest could be held by anyone who was given the power to withdrawal; it was the power to withdraw and not the perceived likelihood that it would or would not be exercised that was important. Since the Christofani loss, the IRS has been restricting the circumstances under which Crummey withdraw powers may be exercised and looking for a sympathetic ear and for the opportunity to legislatively overturn the Crummey decision. The IRS thought it has that ear when in 1998 the Clinton administration included a provision in its budget that effectively eliminated the use of Crummey powers. But the Clintons were also the beneficiaries of a Crummey trust. That one was designed for the payment of legal fees. So the matter was dropped. With the current make-up of Congress and the Executive branches and given the economic difficulties facing the country, the time may be right for a statutory change. There is a proposal before the Joint Tax Writing Committee (Jan. 21, 2009) to amend Chapter 12 of the Internal Revenue Code to repeal the use of Crummey powers. If you believe the Committee, by “eliminating the use of complicated trusts and the application of a rule that rarely is used, the proposal would simplify tax planning for many individuals.” Frankly, the Crummey trust is frequently used and not particularly complicated. If Crummey powers are legislatively nullified, a portion of a gift into trust will no longer be a present interest and will therefore count against one's lifetime gift tax exclusion. Stated differently, a donor will no longer be able to rely on the $13,000 annual per donee exclusion for a gift into trust.

In closing, proposed changes are simply, proposals. If the proposals are made permanent, there will be new alternatives to explore. Estate planning and wealth transfer solutions will still be efficient and effective. The application of some techniques will be statutory in nature and others simply organic to the financial climate around us at the time.

If you have questions, please contact:
Charles B. Jones, Esquire

CJones@TandLLaw.com
(410) 752-2468