Major Tax Changes – Administration’s Proposed Tax on Dynasty Trusts

Dear Friends, Colleagues, and Clients,

This week, the Obama Administration released its report detailing the myriad of changes coming to the tax laws, many of which are slated to take effect by the end of this year. This announcement should come as no surprise to our Client Alert recipients, as we have been warning of this coming tidal wave of change for the past two years.

Under the guise of the fair and equal treatment of millionaires and billionaires, the Obama Administration is proposing to substantially alter many key areas of the tax code, with many changes poised to prevent affluent taxpayers from utilizing several of the traditional wealth transfer planning structures.

This Client Alert is not intended to be a complete review of the changes (subsequent Client Alerts will cover these), but it will highlight the important changes that will certainly diminish the wealth transfer opportunities presently available.

One of the Obama Administration’s 2013 Revenue Proposals would limit the duration of the generation-skipping transfer (“GST”) tax exemption. The GST tax is imposed on transfers that skip a generation, for example, transfers from a grandparent to a grandchild. Upon the transferor’s death, to the extent distributions are made from the trust to the transferor’s grandchildren or other skipped persons, the GST tax will be payable on the value of the transfer at the highest estate tax bracket applicable in that year. Under current law, a person has a lifetime GST tax exemption ($5,120,000 in 2012) that can be allocated to all gifts in trust.

This is important because many states have repealed or limited the application of the Rule Against Perpetuities, so that trusts may continue forever (Florida allows trusts to last for up to 360 years). These trusts, commonly referred to as Dynasty Trusts, are a popular estate planning technique. By placing assets in a Dynasty Trust and allocating the GST exemption to those gifts, the assets can be held in trust without being subject to any further gift, estate, or GST taxes from generation to generation. However, the new Revenue Proposals would tax a trust on the value of all of its assets at the proposed new 45% estate tax rate every 90 years.

Fortunately, a trust created before the enactment of the new law will be forever exempt from the new GST tax. The proposed change to limit the GST tax exemption, coupled with the Obama Administration’s additional proposal to reduce the GST tax and gift tax exemptions back to their 2009 level of $1,000,000 (as compared to the $5,120,000 available this year) creates a sense of urgency for anyone thinking of making a gift in trust during the remainder of 2012. Such gifts must be made prior to the enactment of the proposed legislation, which may occur by the end of this year.

In summary, such trusts formed and funded after the implementation of the tax change would be taxed every 90 years. On the other hand, a trust created and funded before the enactment of the new law will be forever exempt from the new GST tax. Therefore, we recommend that you consider making a gift in trust, even if it is of a small amount, as soon as possible to take advantage of having a trust that is exempt from the proposed 90 year tax on Dynasty Trusts. Most importantly, once a GST tax exempt Dynasty Trust is in place, it can be used as a platform for future estate planning without having to worry about exposing the trust to an estate tax every 90 years.

Furthermore, with the Obama Administration’s proposal to limit the gift tax and GST tax exemptions to $1,000,000, anyone considering gifts in trust in excess of $1,000,000 should also take advantage of this limited opportunity available for the remainder of 2012.

If you have any questions regarding this Alert and need assistance in implementing your gift, please contact Susan Jerome, Director of Client Services, to schedule a no charge consultation.

Immediately following this Client Alert will be another one summarizing additional important and impactful suggested tax law changes under the Obama Administration’s Revenue Proposals.

Jeffrey M. Verdon, Esq.

Jeffrey M. Verdon Law Group, LLP

Posted in Client Alert.