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Johnston Allison & Hord Attorneys
Johnston Allison & Hord Attorneys
Johnston Allison & Hord Attorneys
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Johnston, Allison & Hord
1065 East Morehead Street
Charlotte, NC 28204
704.332.1181    Fax: 704.376.1628
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Legislative Update-2010 Tax Act

In January of this year, we sent letters to our estate planning clients and many of our planning colleagues explaining the unique situation presented by the 2001 Economic Growth and Tax Relief Reconciliation Act’s (“2001 Tax Act”) one-year repeal of the federal estate tax and generation-skipping transfer (“GST”) tax in 2010. In that letter, we encouraged our clients to review their existing estate planning documents to ensure that their intentions would be met should death occur during the repeal year (2010). We also explained how the same 2001 Tax Act will “sunset” (in other words, expire) on January 1, 2011. In the absence of intervening legislation, this sunset will trigger return of the federal estate tax exemptions and rates as they existed before the 2001 Tax Act (i.e., $1,000,000 estate tax exemption and a top federal rate of 55%).

From the time the 2001 Tax Act was enacted until virtually the end of 2009, most attorneys, accountants, and financial planners expected Congress to act responsibly by permanently extending or repealing the 2001 Tax Act before the one-year repeal and sunset provisions took effect. Congressional action is necessary to create certainty upon which planning professionals and taxpayers may rely. At the time of our letter in January, most tax professionals still predicted that Congress would quickly enact a oneyear “patch” to deal with the uncertainty surrounding the repeal and provide additional time to permanently address the federal estate and GST tax. However, estate tax legislation has not been a top priority in either the House or the Senate thus far in 2010.

Legislative Action


In a dramatically partisan vote on December 3, 2009, the House of Representatives passed H.R. 4154 to permanently extend the 2009 federal estate and GST tax systems. H.R. 4154 never made it to the Senate floor for consideration. This attempt was not the first time that the House had passed legislation either extending the 2009 rates and exemptions or introducing new rates and exemptions more favorable to taxpayers. Historically, the Senate has been the barrier for any legislation to get out of Congress. As more time passes in 2010, many professionals are beginning to believe that 60 Senators will never agree on a single approach, and that 2010 will pass without significant tax legislation. Although 51 votes constitutes a majority in the Senate, 60 votes are required if the legislation impacts the budget beyond a ten year window (the so-called “Byrd Rule”). As a result, any permanent legislation generating decreased revenues as compared to the pre-2001 federal estate and GST tax systems may require 60 votes in the Senate.

The “PAY-GO” law passed by the Senate on January 28, 2010, and designed in part to prevent any tax changes from adding to the federal deficit, further complicates the matter. Unless legislation falls within the PAY-GO law’s two-year exception for the extension of 519109 V1 the 2009 transfer tax and alternative minimum tax systems, the legislation will require 60 votes in the Senate. In practical terms, the PAY-GO law mandates that any estate tax legislation providing for an exemption above $1 million and a top rate below 55% for longer than a two-year period will require 60 votes in the Senate.

For the reasons discussed above, the primary focus for new tax legislation has been on the Senate. Earlier this summer, Senate Finance Committee ranking minority member Chuck Grassley (R-Iowa) publically blamed Senate majority leader Harry Reid (D-Nev)for the current uncertainty in the estate tax system. Senator Grassley criticized Senator Reid’s lack of leadership and clear direction about his position on estate taxes, and further postured that the Senate Finance Committee would propose legislation only if the Committee were assured by Senator Reid that a bill passed out of Committee would be considered on the Senate floor. The following month, Senate Finance Committee members Blanche Lincoln (D-Ark) and Jon Kyl (R-Ariz) offered a joint proposal to phase in a permanent estate tax rate of 35% and raise the individual exemption to $5 million, indexed for inflation. Under the Lincoln-Kyl proposal, assets would be transferred on a stepped-up basis; however, the proposal also allows an alternative election for estates of persons dying in 2010 to pay no estate tax and transfer assets on a modified carryover basis. This proposal is significant not only because it is a joint proposal coming out of the Senate Finance Committee, but also because it is one of the first to acknowledge the potential backlash against retroactive legislation capturing transfers that already have occurred in 2010. Partially because of this proposal and partially because we now are approaching the end of 2010, attorneys, accountants, and financial planners are busy advising their clients about the potential planning opportunities present in 2010. Those that follow are some of the most significant planning opportunities.

Planning Opportunities


Generation-Skipping Transfers. The most notable aspect of the current 2010 federal tax law is the absence of the GST tax. While the absence of the federal estate tax does not present a “planning opportunity,” the lack of any GST tax may. For the first time in more than 30 years, grantors (or in some instances trustees) may transfer assets more than one generation down without incurring the double tax normally imposed by the GST tax. While some risk remains that the GST tax may be retroactively reinstated, it may be possible to structure a transfer so that its completion is dependent upon the ability of the asset to pass to succeeding generations without the imposition of a GST tax (even if the GST tax is retroactively reinstated to a date preceding the transfer). For this reason, clients who wish to consider transferring assets to grandchildren or great-grandchildren to avoid the tax that would be imposed on those assets in their children’s estates should consider this as an opportunity we may never see again. Similarly, there may be an opportunity to make transfers out of irrevocable or testamentary trusts that currently are not GST exempt. The potential impact of tax savings in these transfers can be significant and should not be overlooked.

Net Gifts. Although the federal gift tax still applies to transfers in 2010, the maximum gift tax rate is 35% (as opposed to a 45% top rate in 2009 and a 55% top rate that may apply beginning in 2011). Because the gift tax is tax exclusive (meaning that there is no additional tax on the amount of gift tax paid), whereas the estate tax is tax inclusive (meaning that the estate tax is calculated on the entire estate, including any assets used to pay estate tax), making taxable gifts most always beats paying estate taxes. In addition, it may be possible to reduce gift taxes paid by making “net gifts” where the donee bears the responsibility of paying the tax, thereby reducing the value of the gift (effectively creating a 27% tax rate). In short, taxable gifts often make sense for clients facing a substantial likelihood of paying estate tax at death, especially in 2010 when gift tax rates are relatively low.

GRATs. Independent from the unique tax law situation presented in 2010, we have frequently recommended that clients use Grantor Retained Annuity Trusts (“GRATs”) to transfer wealth to their children. Under a GRAT, the grantor transfers assets to a trust and retains the right to receive an annuity from those assets for a fixed term of years, following which the remainder of the trust passes to designated beneficiaries (normally the grantor’s children). The higher the value of the annuity retained by the grantor, the lower the amount of gift tax on the transfer of the assets remaining in the trust at the end of the term. The value of the annuity is calculated by using the applicable federal rates, which are set by the IRS on a monthly basis and based on the Treasury yields for similar maturity from the previous month. Because Treasury yields are at an all time low, so too are the applicable federal rates. Therefore, the IRS assumes a very low appreciation when calculating the value of the annuity. It is possible to structure a GRAT so that at the time it is funded, the remainder interest mathematically equals zero (or an amount less than $1). Therefore, any appreciation above the applicable federal rate will pass to the remainder beneficiaries without any gift tax. While this strategy is particularly attractive when interest rates are low and asset or property values are depressed, there is a greater sense of urgency for clients to consider GRATs before Congress passes additional estate tax legislation. The House in at least two bills has included a measure requiring a ten-year minimum term for GRATs, a provision estimated to raise $5.3 billion of additional revenue over ten years. Because there will be pressure to “pay for” any relief provided in any forthcoming estate tax legislation, it seems likely that final estate tax legislation may include this or a similar restriction on the future use of GRATs.



Clients and their advisors are in a unique position given the unlikely possibility of additional tax legislation before the end of this year. While the uncertainty forces all of us to plan with less than complete information, it also may present several opportunities that we will not see again. The Trusts and Estates Group at Johnston, Allison & Hord has invested considerable effort reviewing potential solutions and opportunities for our clients. As expressed in our January letter, we strongly recommend that our clients have their estate planning documents reviewed to ensure that they accurately reflect their current intentions in light of the special circumstances in 2010. Additionally, we encourage our clients to consider taking advantage of the planning opportunities discussed in this letter (and others as may be appropriate) to transfer wealth in the most efficient manner. If you would like such a review of your current plan or if you would like to discuss potential opportunities that may apply to you, please contact one of the attorneys in the Trusts and Estates Group.