On December 16, 2010, Congress passed a bill that, in addition to preventing an anticipated rise in income tax rates, will amend the estate, gift and GST tax rules in 2011 and 2012, the effects of which are discussed in the following bulletin.

2010 is drawing to a close after a year of instability and uncertainty in the area of estate, gift and generation-skipping transfer (“GST”) taxation. Last night, Congress passed a bill (which the President will sign today) that, in addition to preventing an anticipated rise in income tax rates, will amend the estate, gift and GST tax rules in 2011 and 2012, as follows:

• Provide a lifetime exemption from gift tax during this two-year period, for gifts of up to $5 million, unified with a $5 million estate tax exemption, as well as a separate $5 million exemption from GST tax.
• Lower the estate, gift and GST tax rates to 35%.

The new law will retain a 35% gift tax rate and a 0% GST tax through the end of 2010. As a result, you will be able to make transfers to grandchildren and more remote descendants through the end of December 2010 at a cost of only 35% (sheltered to the extent of your and your spouse’s remaining $1 million gift tax exemptions), as opposed to the combined 110% rate that would have been payable on a similar transfer in 2009 or the combined 82% rate that will exist in 2011 and 2012 (sheltered to the extent of your and your spouse’s $5 million gift and GST exemptions). In addition, property currently in trusts for the primary benefit of your children may be transferable at no tax cost to grandchildren and more remote descendants, or to a trust for their benefit.

To take advantage of this unique moment in the law, transfers must be made before the end of this year either directly to grandchildren (and/or more remote descendants) or to a trust for their sole benefit. (It is not necessary for you actually to have living grandchildren at this time to fund such a trust, although the trust may require different terms in that situation.) Due to the limited time available before the end of the year, we suggest a two-step process for anyone interested in making such transfers to a trust:

1. Make gifts to a trust that has the following terms:

• For ease of signing, Hume R. Steyer or David E. Stutzman could be the initial Trustee with the power to appoint his successor.
• The Trustee would have the discretion to make distributions to your grandchildren and/or more remote descendants.
• During any period when no grandchildren and/or more remote descendants are living, the trust property could be paid to charity in the Trustee’s discretion (though this becomes more complicated if there are no living grandchildren at the time the trust is created).
• For trusts created when there are living grandchildren, after ten years the Trustee would have the authority to add your children as beneficiaries in his discretion.
• The trust would be a “grantor trust,” making you responsible for the income tax otherwise owed by the trust. Your payment of the income taxes would effectively allow you to make a tax free addition to the trust each year. (Grantor trust status could be switched off; and taxes in respect of capital gains could be reimbursed to the Settlor without terminating grantor trust status.)
• The trust would permit the Trustee to distribute the trust property to a new trust for one or more of the existing trust beneficiaries but with new terms (this process is known as “decanting”).

2. After the New Year, we will work with you to evaluate whether you wish to transition to a different Trustee, and/or whether the Trustee should decant to a trust with different dispositive provisions.

By using the above two-step process, you can ensure that you take advantage of this narrow window to achieve a remarkable tax outcome, while maintaining flexibility to customize the terms of the trust at a later date.

Gifts to this type of trust in 2010 will not be permanently exempt from GST tax, although distributions from the trust to your grandchildren will never be subjected to GST tax. Distributions to members of more remote generations, however, will attract GST tax at the time of distribution, and the trust itself will be subject to GST tax at the death of the last of your grandchildren. Because gifts to these trusts are not permanently exempt from GST tax, the proposed transaction may only be appropriate for individuals intending to transfer amounts in excess of $5 million ($10 million for a married couple) to their grandchildren. For smaller gifts, it may make more sense for you to wait until next year, at which time you could gift up to $5 million ($10 million for a married couple) to a trust for grandchildren and/or more remote descendants that would be permanently exempt from GST tax.

We will shortly be sending out a detailed bulletin regarding the other provisions in the newly-enacted law.

If you have any questions regarding this Bulletin or would like to express your interest in making year-end transfers to grandchildren or more remote descendants, please contact Hume Steyer (212-574-1555) or David Stutzman (212-574-1219) of our Trusts and Estates practice group.