For Clients, Community, Advisers.  President Obama’s 2013 budget gives us some insight concerning what might happen if he is reelected and his 2013 budget (or any of its broad concepts) are adopted.

• LIFETIME EXCLUSION FROM ESTATE TAX:  The law would essentially revert to that which was in place in 2009.  That is, the current Republican endorsed $5.12 million exemption which is in force in 2012 would become $3,500,000 per individual ($7,000,000 per couple).  The estate tax on amounts over $3,500,000 would be 45% instead of 35%.  Of course, if Congress does nothing before January 1, 2013, the exemption will become $1 million and the rate will be 55%.
• TARGET:  GRANTOR TRUSTS.  For many years, irrevocable grantor trusts have been used as a sophisticated estate planning technique to reduce the size of an individual’s estate while avoiding income tax.   It’s a “have your cake and eat it, too” type of transaction.  These trusts come in all sizes and flavors.  They are often used to pass a business interest to another generation without payment of income and deferral of estate tax.  The administration’s proposal eliminates the key benefits of grantor trust transactions.  These have been around for many years.  They have been an important tool in our toolbox.  The administration seeks to take away this key tool.
• QUALIFIED GRANTOR ANNUITY TRUST:  Sam Walton made the GRAT famous.  He transferred billions of dollars of Wal-Mart stock to his family at very little transfer tax cost.  Describing how a GRAT works is beyond the scope of this brief article.  The proposed legislation prohibits the “zero’d out” GRAT which is the tool that Walton used.  It is an important technique for transferring property that increases in value over a short time to others.  It keeps the growth in value outside the donor’s estate.  The administration has been after this technique since Obama came in to office.
• VALUATION DISCOUNTS.  To value property for gift or estate tax, an appraiser will take into account its marketability and whether or not the interest transferred is that of a majority interest or that of a minority interest.  If the interest or parcel has limited marketability, a marketability discount of 5-25% can be applied.  If a minority interest is transferred (such as a minority interest in a business), a minority interest discount of 5-35% can be applied.  It is not uncommon for us to see combined discounts of 35% to 45%.  Over the years, some taxpayers have become very aggressive.  As a result, the IRS has also become aggressive in challenging discounts.  Here, the administration seeks to cut back the discounts.  However, the 2013 budget does not specify exactly how they seek to do this.

There are a few additional points which are somewhat esoteric and beyond the scope of what I believe clients and advisers want to read in a short article.  The administration also seeks to cut back the use of dynasty trusts and the use of trusts which length exceed the traditional rule against perpetuities.

In 2012, it’s anyone’s guess as what is going to happen in the political area.  As a result no one can predict what, if anything, will be passed and signed when it comes to the estate tax and gift tax.  This area has been a political football since before George Bush left office.  My only prediction is that it will continue to be.  As a result, as lawyers and planners, we need to be proactive on our clients’ behalf.  And our clients need to be diligent in ensuring that their plans are reviewed on a continuing basis and are up-to-date.

For Clients, Advisors and Community

Our society is increasingly mobile.  Many of our clients have multiple residences.  They spent the spring and summer months in the Chicago area but spend the late fall and winter in warmer climates – Florida, Arizona, California, Hawaii and other locations.

In a sometimes desperate chase for increased revenue, Illinois (and other states) have recently passed often significantly increased taxes on income and on estates of decedents.  Many of these states have also passed increased taxes on business and have developed climates unfriendly to business.  I hear often from my Illinois clients that they want to relocate to escape the high taxation in this state and move or retire to states with lower taxes like Florida and Wyoming.  Many are of the belief that you can change your domicile and therefore the jurisdiction in which you are taxed by spending the majority of time and simply getting a drivers’ license and registering to vote in a new state.

It’s not that simple.  Each state has its own rules for determining whether an individual is subject to income or estate tax in a given state.  And, the determination can be different for husband and for wife! 

There are basically two approaches to this question. Illinois and California and a few other states have adopted an approach that states that a resident is one who is in the state for other than a temporary or transitory purpose during the tax year or whose domiciled in the state but absent from the state for a temporary or transitory purpose during the year.

In order to make a determination these states look at various factors which may include the amount of time spent in another states versus the amount of time spent in Illinois; the location of the spouse and children; the location of the principal residence; the state that issued a driver’s license; the state of voter registration; state where professional licenses are; location of banks; location of medical, legal and accounting professionals and state where social ties and/or permanent work assignments.

New York and other states take a different approach.  There are two prongs to the New York test.  The first asks if the individual is domiciled in New York.  Domicile is subject to a “five factors” test.  They are:  home, active business involvement, time, near and dear items and family.  Time is probably the most important element.  But, there is also an alternate “residency” test to be passed as well.  An individual is taxed in New York if he or she maintains a permanent place of abode in New York and spends more than 183 part or full days there during a taxable year.

As one can readily  see, these tests can be very subjective. If you’re planning to flee the jurisdiction to reduce your tax bill, be sure you do it the right way and consult an expert who is familiar with the particular rules involved.