Currently, the Federal (and North Carolina) estate tax is repealed, as is the Federal generation skipping transfer tax (“GST tax”), which tax is applicable to transfers made to persons more than a generation below the transferor. However, the repeal is “temporary” and the estate and GST taxes are scheduled to be reinstated effective January 1, 2011. 

The repeal resulted from passage of the Economic Growth and Tax Relief Reconciliation Act in 2001 (the “2001 Act”), which includes a sunset provision that automatically reinstates the estate and GST tax as of January 1, 2011 – although at rates in effect in 2001 (55% tax rate and $1,000,000 exemption per person). The impact of reinstatement of the estate tax at 2001 rates is dramatic, considering that in 2009 the maximum rate was 45% and the exemption amount per person was $3,500,000. Thus, in 2009, a married couple could have “sheltered” a combined $7 million in assets from estate (and GST) taxes, whereas in 2011 (if no change to the current law is enacted) the same couple will be able to shelter only $2 million. 

All of these changes are understandably confusing and overwhelming. Additionally, the scheduled reinstatement is wrought with uncertainty as a number of Bills have been introduced in Congress that either would make the repeal permanent or modify the rates and exemption amounts currently scheduled to become effective as of January 1, 2011.

Many taxpayers have implemented significant planning to reduce their exposure to the Federal estate and GST taxes assuming the exemption amounts would be $3.5 million. If the exemption amounts return to $1 million, many taxpayers will face significant estate taxes – for many, the value of their retirement accounts and primary residence exceed $1 million. 

In light of these issues, what should taxpayers consider doing?

• Review current estate planning documents to ensure that these documents accurately reflect your intentions in light of the fluctuation in the estate and GST tax exemptions. While most documents are drafted to take into consideration the then applicable exemption amount, a taxpayer may have executed documents that provided for certain gifts or the funding of trusts assuming that the exemption amount would be $3.5 million. Thus, a comprehensive review of current documents is appropriate and encouraged.
• Evaluate ownership of life insurance policies as the proceeds of a life insurance policy owned by the insured are included in the insured’s gross estate for estate tax purposes. Thus, if a taxpayer anticipates being in a taxable estate situation, transferring ownership of life insurance policies to an irrevocable trust may be an efficient way to preserve the death benefit proceeds for the benefit of family members and otherwise reduce the value of the taxpayer-insured’s gross estate. 
• Determine if a gift program is appropriate to make current transfers of wealth and to take advantage of the annual gift tax exclusion.  Gifts equal to the annual gift tax exclusion amount (currently $13,000) are not taxable and do not use the gift/estate tax exclusion. In addition, more aggressive gifts and transfers may be appropriate for consideration and are discussed in more detail below.

Additionally, taxpayers who have Dynasty-type trusts and other trusts that are exempt from GST tax, and to which they make annual gifts, should be aware that the repeal of the GST tax in 2010 also resulted in the lack of a GST exemption to allocate to such gifts. If you are in this situation, what should you do?

• Consider foregoing a gift in 2010 if a contribution to the trust has not been made in 2010 and does not need to be made. Without a GST exemption to allocate to a gift to an exempt trust, a transfer to such a trust may result in the imposition of a GST tax when a later distribution is made.
• Consider making the contribution to the trust in the form of a loan if a contribution is necessary (for instance, to provide liquidity to fund premium payments on a life insurance policy). This may help avoid future GST tax considerations.
• Consider making a distribution from the trust to the skip person beneficiary. This enables you to take advantage of the opportunity to make a distribution without the imposition of GST tax, if a trust has beneficiaries who are “skip persons” (i.e., persons who occupy a generation below the grantor of the trust) and the trust is not exempt from GST tax.