The President Barack Obama administration has taken aim at five estate and retirement planning strategies, says John McManus, founding attorney with McManus & Associates in New York City and New Providence, N.J.
Some of the people who are using these strategies as they approach retirement have lots of money to manage. But those using these approaches also include small-business owners and farmers eager to pass their enterprises on to their children without burdening them with a huge tax bill, McManus says.
Here are simplified summaries of what the government proposes to do to collect more taxes from money passed down via estates and the like. You decide whether the proposals are fair.
Lower the estate tax exemption. The proposal on the table would limit the estate tax exemption to $3.5 million. Anything above that would be taxed at a rate of 45 percent. Currently, estates are exempted from taxes up to $5 million, and anything higher is taxed at 35 percent.
Retool intentionally defective grantor trusts. Today, a family can put a business or other property in a trust and give their offspring pieces of the trust. The offspring have no control over the trust and no right to sell what's in it. The value of the gifts are discounted for tax purposes because the gifts are "defective" since the recipients don't have a say in their management. Under the government's proposal, the tax discount would be reduced or disappear.
Tax grantor retained annuity trusts, or GRAT. Families use a GRAT to avoid the cap on gift taxes. Mom and Dad put money in a trust and lend it to their children. The kids keep whatever the trust earns in excess of the interest on the loan, which they pay back to Mom and Dad. Because interest is paid, the IRS sees this transaction as a loan and not a gift. The Obama administration wants to put new limits on GRATs.
Limiting generation-skipping transfer tax exemptions to 90 years. The children have done so well that they don't need Pop's money, so it is put in trust for the grandchildren, who under certain circumstances can receive it tax-free after their own parents die. Proposed changes would limit the tax-free time period to 90 years, which doesn't seem all that long considering current lifespans.
Taxing grantor trusts when Dad still manages the money. Under the proposal, if Dad has continued to buy and sell the investments held in certain trusts, the money would be considered a part of his estate and subject to taxes when he dies.
McManus says he believes that taxing estates at 45 percent is unfair and counterproductive. "We are proposing to penalize hardworking people who aren't making millions. Having to pay a punitive amount in taxes takes away the motivation to start up a business."