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Click the following link to read Part 1 of our article 2010 Tax Act: Estate Planning & Asset Protection. We discuss in Part 1: How does the 2010 tax laws by Obama affect estate planning for 2010, 2011, 2012?
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Many clients who have learned that the Tax Act will only last two years will wait until the end of 2012 to plan. This is not a good idea. Time and economic fluctuations concern the estate-tax laws and have an effect on the ability to meet estate planning objectives. Family loans, GRATs (Grantor Retained Annuity Trusts) and charitable lead annuity trusts (CLATS) are affected by interest rates. Since December the interest rates have risen dramatically and long-term interest rates were 3.53%. For the same types of transactions in January, the interest rates were already at 3.88%. Additional spikes over time will erode the advantages that planning strategies could obtain. When estate planning, time is of the critical. It is suggested that planners urge clients to act as soon as possible to avoid the implications of higher interest rates in the future.
How the new 2010 Obama Tax Laws Affects Estate Planning Strategies
Clients are questioning how this new tax law will change my estate planning steps. There are a few things that planners should tell their clients in this regard:
GRATs (Grantor Retained Annuity Trusts)
GRATs (Grantor Retained Annuity Trusts) will remain a good, potential planning strategy for those with a high net worth. Many financial planners believed that GRATs would be eliminated or restricted, but they were not axed in the new tax law. However, the restriction or elimination of the GRATs (Grantor Retained Annuity Trusts) will in effect after December 2012. High net worth clients who would benefit from GRATs should plan on using them while they can. Financial advisors must also help clients evaluate GRATs and understand what the advantages and disadvantages are of using GRATs in comparison to gifts of installment sales to grantor trusts when considering the five million dollar tax exclusion. If the assets that are inside the GRAT do not surpass the federal interest rate or if the taxpayer should decease while the annuity term is in effect, this estate planning strategy will not be fruitful. With an absolute gift, actual growth will lie outside of the estate and an installment sale to grantor trust will generally surpass a GRAT (Grantor Retained Annuity Trust) since the interest rates that are used are lower. In this case, the estate planning strategy can still be beneficial even if the client were to decease before the load of the installment sale is fully paid back and, opposite to the effects of a GRAT, the GST (generation skipping transfer) can be . Unlike a GRAT, the taxpayer’s exemption can be beneficially exploited.
There are some people who will deduce that a $5 million exclusion will allow them to annul their life insurance that is used to pay for the estate-tax encumbrance. People are advised not to make these deductions. The estate-tax rules are still there and may return in 2013. Financial advsiors should cautiously reevaluate life insurance coverage and take a look at forecasts in order to analyze the actual need for life insurance and to evaluate whether trusts that were originally grantor trusts should be changed to non-grantor. If the client has a life insurance policy that is not in trust, the $5 million exclusion could change insurance planning. Financing or split-dollar insurance could be undone by making a gift to an insurance trust. This trust would not be taxed on account of the new exemption.
For many years, planners have recommended the use of bypass and marital deduction trusts when planning. Many clients should have wills that will include these types of trusts. Planners need to take the time to explain to the client why the new provisions of the law are actually traps for unwary taxpayers. They should not be relied upon and traditional bypass trust planning remains important.
The 2010 Tax Act has changed estate planning completely, but these changes will only last for two years. Some clients who take advantage of this situation could benefit in many ways. Advisors should help all clients understand the changes that have been made and the opportunities that are now available as a result.