“Green Book” Proposals on Estate and Income Tax

Pending Legislation

President Obama’s Green Book contains proposals for modifying the GRAT rules, eliminating valuation discounts for transfers of interest in many family limited partnerships and limited liability companies, and increasing income tax rates and limiting deductions for high income taxpayers.

Here’s a nice outline prepared by Bob Keebler, CPA of Virchow Krause & Company, LLP in Wisconsin.

        I.      Current Estate Tax Proposals

A.      Grantor Retained Annuity Trust (GRAT)

1.      Overview of technique

                                                a.      GRATs shift wealth to future generations estate and gift tax free to the extent that the growth rate of the transferred asset exceeds the government’s mandatory interest rate (i.e. IRC Section 7520 rate)

i.         The current IRC Section 7520 rate for May 2009 is 2.4%

                                                b.      If the grantor dies during the GRAT term, all (or nearly all) of the trust’s assets are included in the grantor’s taxable estate

i.         Short-term “rolling” GRATs (i.e. GRATs with terms from two to five year) can be used to mitigate this estate inclusion problem

2.      Issue

                                                a.      The Obama Administration sees short-term GRATs as being too effective in avoiding the estate tax

3.      Proposal

                                                a.      Require that a GRAT must have a term that is not less than ten years

i.         Proposal is designed to increase the likelihood of estate inclusion

ii.       Proposal still allows GRATs to be “zeroed-out”

iii.      Proposal will only be effective after the date of enactment (i.e. prospective)

B.     Valuation Discounts

1.      Overview of technique

                                                a.      When closely-held interests are transferred to family members, there is usually a discount associated with the transfer due to certain provisions of the governing document

i.         These discounts can range anywhere from 20% to over 50% depending on: (a) the type of assets involved, (b) the nature of the entity and (c) restrictions

2.      Issue

                                                a.      The IRS and the Obama Administration have seen valuation discounts taken in the past as being abusive in an attempt to underreport tax

3.      Proposal (see example)

                                                a.      Certain restrictive provisions of the governing instrument will be ignored for valuing a transferred interest between members of transferor’s family

i.         The disregard of certain restrictive provisions will increase the value of transferred interest, increasing estate and/or gift tax

ii.       Regulatory authority will be granted (including the ability to create safe-harbors)

iii.      These rules will apply to all entities created after 10/8/1990

      II.      Current Income Tax Proposals

A.      Reinstate the 39.6% tax rate

1.      Will apply to taxpayers currently in the 35% tax bracket

2.      Will take affect on 1/1/2011

B.     Reinstate the 36% tax rate

1.      Will apply to taxpayers currently in the 33% tax bracket

2.      Will apply to married filing jointly taxpayers with taxable income above $250,000 ($200,000 if single)

3.      Will take affect 1/1/2011

C.     Reinstate 3% phase-out of itemized deductions

1.      Will apply to married filing jointly taxpayers whose AGI is above $250,000 ($200,000 if single)

2.      Will take affect 1/1/2011

D.     Reinstate 2% phase-out of personal exemptions

1.      Will apply to married filing jointly taxpayers whose AGI is above $250,000 ($200,000 if single)

2.      Will take affect 1/1/2011

E.     Impose 20% capital gains tax on qualified dividends and long-term capital gains

1.      Will apply to married filing jointly taxpayers whose taxable income is above $250,000 ($200,000 if single)

2.      Reduced capital gain tax rate on five-year long-term capital gains would be eliminated

3.      Will take affect 1/1/2011

    III.      Action Steps

A.      Establish a series of GRATs today to lock-in future growth at historically low rates

B.     Transfer closely-held business assets to junior family members today to “freeze” estate tax value of assets at all-time low values

C.     Explore sale of highly-appreciated assets to lock in 15% capital gains tax rate

D.     Explore the possibility of converting to a Roth IRA

E.     Explore exercising Non-Qualified Stock Options (NQSOs) before increase in tax rates



Valuation Discount Example




Closely-held business*




Other assets




Gross estate




Less: Exemption




Taxable estate




Estate tax @ 45%




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