In This Issue

• President Bush's Agenda For Tax Relief Includes Estate Tax Repeal
• Changes in Your Health Care Planning Options
• GRAT-itude
• Recently Passed Ohio Legislation Proves to be Taxpayer Friendly
• IRS Issues Simplified Rules for Qualified Retirement Plans

President Bush's Agenda For Tax Relief Includes Estate Tax Repeal

By Erika L. Haupt

On February 8, President Bush submitted an Executive Summary to Congress outlining his agenda for tax relief. Included in the agenda is an elimination of the "death tax." Although the details of the elimination are not included in the agenda, based on his tax plan as submitted during the 2000 campaign, President Bush proposes an estate tax repeal, including the gift tax and the generation-skipping transfer tax, over a period of years.

One proposal is a gradual reduction of the highest marginal estate tax rate of 55% over seven years with a complete elimination in 2009. Another proposal would phase out the estate, gift and generation-skipping transfer taxes over five years.

A further proposal would reduce all transfer tax brackets, which is the functional equivalent of increasing the applicable credit amount. Currently, the applicable credit amount, the amount that a you may pass during lifetime or at death free from federal gift or estate tax, is $675,000 and is scheduled to increase to $1 million by 2006. Some believe, including prominent Democrats, that a simple way to reform transfer taxes is to increase the credit amount immediately to $3 or $5 million. If raised to $5 million, a couple could shield $10 million from gift or estate tax with the use of standard A-B trusts.

Likely to be included in repeal is an elimination or partial elimination of the §1014 step up in income tax basis for assets inherited from a decedent. Currently, assets you inherit receive an income tax basis equal to the fair market value of the assets as of the decedent's date of death. If the step up in basis is eliminated, the basis in the decedent's hands will carry over to you when you inherit assets from the decedent's estate. Any gain on the sale of inherited assets will be calculated using the decedent's basis.

GOP congressional leaders and economic advisers to President Bush recently indicated that a compromise could include a repeal of the current estate tax but with a new capital gains tax liability on assets inherited from estates above a minimum amount of $1 or $2 million. All assets below the minimum would receive a step up in basis. The decedent's basis would carry over to the remaining assets, and capital gains tax would be due on the entire appreciation if and when the heirs sold those assets. The reason for the elimination of basis step up and resulting capital gains tax is budget concerns.

Although both Republicans and Democrats agree that transfer tax reform is necessary, there should be interesting debates about the scope of repeal before a final bill is sent to the White House. With the immediate focus of the Bush administration on the stimulation of the economy and across-the-board marginal income tax rate cuts, the estate tax repeal is beginning to be pushed further down the tax to-do list. Interest groups such as insurance and charitable lobbies are at work, as well.

The "price tag" of transfer tax repeal will include federal and state revenue loss and the consequences of unrestricted asset shifting. For instance, as a result of the state death tax credit associated with federal estate tax, New Hampshire will lose 4.5% of its revenue with a total repeal. New York and Florida will lose 2.5%. To make up for lost revenue, states may implement or increase inheritance taxes. Furthermore, if there is no tax consequence to transferring assets to family members, domestic trusts or foreign trusts, there will be greater opportunities to shift assets in order to minimize state or federal income taxes.

The details of transfer tax reform and possible estate tax repeal should become clearer over the next several months, and we will keep you updated on changes that will affect your plans. Whatever the end result, new and innovative estate and income tax techniques will certainly develop and a carefully considered wealth transfer plan will remain an important aspect of your overall estate plan.

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Changes in Your Health Care Planning Options

By Michele Selig Worobiec

You may already have a living will or durable power of attorney included as part of your estate plan. The living will affirms your decision that artificial nutrition, hydration and respiration should be discontinued (or not initiated) in the case of a "terminal condition" as defined within the document. It also allows you to make that same designation in the event of a "permanent unconscious state."

As of September 2000, the Ohio State Bar Association approved a revised living will form to give you the opportunity to use your living will as a means of communicating a DNR (Do Not Resuscitate) order for the same two health conditions. This decision indicates that you do not wish to have CPR performed in the event you stop breathing or your heart fails. For the purpose of the living will, CPR includes the use of chest compressions, drugs and electric shock to restore heart function or insertion of airway tubes to restore breathing functions.

The Ohio legislature provides for additional ways that you can identify your DNR status, such as an identification card, necklace or bracelet. These items must be approved by the department of health and meet some additional statutory requirements. The alternate forms of identification help to notify physicians, emergency medical service personnel and health care facilities who do not have knowledge of, or immediate access to, your living will of your desire to have CPR withheld.

In addition to the health care decisions made in the living will, you may also sign a durable power of attorney for health care. This document designates an individual to make health care decisions on your behalf in the event you are unable to make those decisions for yourself. Although the durable power of attorney for health care was also revised in September 2000, it is essentially the same form as originally approved by the Ohio State Bar Association in 1991.

We would be glad to assist you with making these important decisions and incorporate them into your current estate plan.

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GRAT-itude

By Edward C. Hertenstein

We love GRATs (grantor retained annuity trusts). Although they have many uses, here we are just focusing on "marketable stock GRATs." They are a terrific "heads I win, tails I tie" tax play. And the Tax Court in Walton v. Commissioner, 115 T.C. No. 41 (December 22, 2000), just made them a lot better.

The goal is to transfer, gift and estate tax free, marketable stock to your children (or to a trust for your children —you can even be the trustee). The $10,000 annual gift tax exclusion is not used here, so you can continue that gifting as well.

Here's how they work: You transfer, say, $1 million of marketable stocks to a 2-year GRAT paying you an annuity of about $550,000 per year for the 2 years. Obviously, if the stocks don't appreciate or even decline, the GRAT can't make the full payments. But that's a "tie": if you had done nothing, the stocks would have gone down anyway. Lots of folks were reminded in 2000 that stocks can go down. That could make now a great time to consider GRATs.

If, however, the stocks do appreciate, there may be stock value remaining after you receive back your annuity payments. That remaining stock passes to your children gift and estate tax free. This is the "win." In our example, if the stocks paid a dividend of 2% and increased 20% per year, more than $270,000 would pass to the children free of any gift tax (more than $470,000 if increased 30% per year; nearly $700,000 at 40% per year). What fun these GRATs have been during the last 5 years or so of the bull markets!

Because GRATs are "heads I win, tails I tie," volatility of the markets actually is a significant tax advantage. But we want to caution that tax planning should not dictate investment strategy.

The other "tie" (in the tax sense) is that you could die before the end of the 2-year period. No tax downside.

Under the IRS method of calculating the up-front gift (relying on its regulations), the taxable gift would be about $5,000 (for our $1 million GRAT above) if you were 50 when you set up the GRAT (about $12,000 if 60, $27,000 if 70, and about $62,000 if 80). Thus, as the "ante" increased with age, we were looking for other techniques for older folks.

Look no more. The Tax Court in Walton struck down the IRS method, holding that the IRS regulation "is an unreasonable interpretation and an invalid extension" of the tax law. Pretty strong language. We love it.

Result: We can now do GRATs, under the Tax Court's decision in Walton, that have zero taxable gifts. So, in our example above, the $1 million GRAT creates no taxable gift at all.

In a sense, the opportunity is a "use it or lose it" much like the annual exclusion. Think about it: Any time there are market gains, without GRATs, you have foregone an opportunity to make tax free gifts. This is a strategy that can be implemented over and over. Many clients stay "fully invested" in GRATs (by directing annuity payments from one GRAT to new GRATs) on the belief that in the long run equity investments will out pace IRS interest rates (the February 2001 rate is 6.2%).

With planning techniques like GRATs, who needs to wait for "death tax" repeal? (More on that in upcoming issues.) And with strategies that don't involve paying gift tax, why wait for the politicians? Our experience is that we don't get what is advertised anyway.

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Recently Passed Ohio Legislation Proves to be Taxpayer Friendly

By Scot C. Crow

Substitute Senate Bill 108 (the "Bill") as recently passed by the 123rd Ohio General Assembly results in some significant taxpayer friendly changes to the Ohio estate tax.

1. Filing Requirements and Credit Increase

   Prior to enactment of the Bill, an Ohio estate tax return was required to be filed by every decedent whose total estate (both probate and nonprobate) exceeded $25,000. This amount was the equivalent of an estate tax credit of $500. With the passage of the Bill, the credits and filing thresholds increased as follows:

   1. For dates of death on or after January 1, 2001, but prior to January 1, 2002, the estate tax credit is increased to $6,600. Thus, no estate tax return will be required to be filed if the decedent's total estate is $200,000 or less.

   2. For dates of death on or after January 1, 2002, the estate tax credit is increased to $13,900. For dates of death in 2002 and after, no estate tax return will be required to be filed if the decedent's total estate is $338,000 or less.

      The effect of the credit increases is to eliminate filings for 63% of all estates for those dates of death occurring in 2001 and 78% for those dates of death occurring in 2002.

2. Qualified Family Owned Business Exemption

   In addition to the estate tax credit increases, the Bill also enacted Ohio Revised Code §5731.20, which permits a deduction for qualifying family owned business interests. The maximum deduction is $675,000. To qualify for the election and receive the deduction the estate must meet the following general requirements:

   1. the decedent must have been a U.S. citizen and/or resident;

   2. the executor must make the election on the Ohio estate tax return;

   3. the value of the business must exceed 50% of the adjusted gross estate;

   4. the decedent or members of the decedent's family must have materially participated in the business for at least 5 of the 8 years prior to the decedent's death;

   5. the business must qualify as an active trade or business (the deduction is not available for portion of business consisting of passive assets);

   6. the business must pass to qualified heirs who will materially participate in the business for 10 years after the decedent's death; and

   7. the heirs must sign a written agreement consenting to an Ohio recapture tax for 10 years.

3. Future of Ohio Estate Tax

   Lastly, Section 3 of the Bill directs the establishment of a Joint Committee on Estate and Death Taxes to report to the Governor no later than December 31, 2001 on a proposal to phase out Ohio's estate tax by 2006. The proposal is to establish a "pick-up" tax and bring Ohio in form with the majority of states that have already enacted and been operating under a "pick-up" tax system.

   Under a "pick-up" or sponge tax system, the state, itself, does not impose an inheritance tax. However, if an estate receives a credit on its federal estate tax return for state inheritance taxes paid, the amount of the credit generally must be paid to the state in which the decedent resided at his or her death.

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IRS Issues Simplified Rules for Qualified Retirement Plans

By Erika L. Haupt

On January 12, 2001, the Treasury Department released a new set of rules that radically simplify how to calculate required minimum distributions from a qualified retirement plan after you turn 70 ½ and how to determine a plan's designated beneficiaries. The new rules permit most plan participants to withdraw money more slowly during their lives and allow for flexibility in planning after death.

The rules provide the following basic changes:

1. Uniform Table to Determine Distributions

   Under the old rules, the "designated beneficiary" of a plan was determined as of the year following the year that a participant turned 70 ½ (the "required beginning date"). If the designated beneficiary was a charity, the participant could only take distributions based on his or her life expectancy because the charity was deemed to have a life expectancy of zero. If a spouse was the designated beneficiary, the participant could use the joint life expectancy of the participant and his or her spouse but was faced with the decision whether to recalculate the participant's life expectancy, the spouse's life expectancy or both.

   Under the new rules, the schedule for minimum distributions during a participant's life is the same for almost everyone. With one exception, to calculate the minimum distribution for a year, the participant takes his or her age during that year, looks to a single life expectancy schedule for that age and divides the balance of the plan at the end of the previous year by that life expectancy. The exception arises if the only beneficiary of the plan is the participant's spouse who is more than 10 years younger than the participant. In that case, the minimum distribution is based on the joint life expectancy of the participant and the spouse.

   Because there is a single table for determining minimum distributions based on the life expectancy of the participant and someone who is 10 years younger than the participant, there is no longer a drawback in naming a charity as a plan beneficiary. Furthermore, a participant can change the beneficiary after turning 70 ½ without requiring a change in the calculation of minimum distributions.

2. Longer Period to Take Distributions After the Participant Dies

   Under the old rules, if the participant died after 70 ½, minimum distributions for beneficiaries were based on (1) the life expectancy of the oldest beneficiary named on the required beginning date, (2) the participant's remaining life expectancy and (3) the recalculation methods chosen by the participant.

   Now, minimum distributions after the participant dies are based on the life expectancy of the oldest beneficiary of the plan on December 31 of the year following the participant's death. An exception still allows the surviving spouse to roll over the plan benefits to his or her IRA and name new beneficiaries, thus deferring payouts even longer.

   The new rules allow a participant to change a beneficiary at any time and withdrawals after the participant's death can be based on the most recently named beneficiary's life expectancy. For example, if a participant names his or spouse as beneficiary and the spouse dies before the participant, the participant may name a child as beneficiary. After the participant dies, the child can take payouts over the child's life expectancy.

   The new rules also allow a participant to name a number of contingent beneficiaries to permit post-mortem planning. For example, if a spouse is named as primary beneficiary and a child is named as a contingent beneficiary, the spouse may disclaim his or her interest allowing the interest (or a portion of it) to be paid to the child. The interest passing to the child could be withdrawn over the child's life expectancy.

   In addition, a beneficiary could be "cashed out" of a plan prior to December 31 of the year following the participant's death to allow for longer distributions to other beneficiaries. For instance, if a charity is named as beneficiary of ½ of the plan and a child is named as beneficiary of the remaining ½, the charity could be paid its share prior to December 31. Doing so eliminates the charity's zero life expectancy from determining how quickly the child can take out his or her share of the plan.

3. Delayed Distributions Even with Zero Life Expectancy Beneficiaries

   Previously, when a participant died after 70 ½ and a charity, the participant's estate or a trust that did not satisfy certain requirements was named as a beneficiary of the plan, the plan would be distributed either over the participant's remaining life expectancy or within a year after the participant's death. The quicker payout would occur if the participant had elected to recalculate his or her life expectancy causing a zero life expectancy when the participant died.

   Under the new rules, if a charity, the participant's estate or a trust that does not satisfy certain requirements is the beneficiary of the plan on December 31 following the participant's death, distributions may still be spread out over the participant's life expectancy.

   Also under the old rules, if a participant died before 70 ½ with a charity, the estate or a non-complying trust as a beneficiary of the plan, the benefits had to be paid out over the 5 years following the participant's death. Now, the "5-year rule" only applies if the charity, estate or non-complying trust is still a beneficiary as of December 31 of the year following the participant's death. This creates the opportunity —with proper lifetime contingent beneficiary designations —to avoid the 5-year payout requirement altogether.

4. Tracking Distributions

   The old rules did not have a mechanism for tracking whether participants were taking the required minimum distributions. The new rules require the sponsors and custodians of qualified retirement plans to report to the IRS and the participant the amount of the required minimum distribution taken each year. This will alert the IRS of those participants not taking enough from their plans, thereby allowing the IRS to assess the 50% excise tax on the additional amount that should have been withdrawn. Due to a lack of a proper tracking system under the old rules, the excise tax was rarely imposed.

5. Planning Under the New Rules

   A public hearing on the new rules is scheduled for June 1, 2001, and the IRS is expected to issue final regulations by the end of this year. Participants can use the new rules for calculating required distributions for 2001. Given the various planning options the new rules provide, participants should reconsider the choices they have made or will make with regard to beneficiary designations.

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