At McGuireWoods, Belcher tells clients that if they are contemplating using these discounts to transfer assets they should do it quickly, on the grounds that this particular proposal could easily be tucked into a final estate tax reform bill. “By using a family limited partnership or LLC, parents may transfer wealth at an average discount of 40 percent to their beneficiaries,” Belcher says. “Such valuation discounts definitely may not be available next year.”

Based on the IRS’s recent history of aggressively pursuing taxpayers over this issue, Congress may well enact this proposal to bolster the efforts of their IRS colleagues. Mel Warshaw, a wealth advisor with JP Morgan Private Bank in Boston, observes that the IRS has been spending a great deal of money litigating cases involving valuation discounts. Although, for the most part, the IRS has won only when the record-keeping was flawed or there was outright abuse, eliminating the discounts would greatly reduce its litigation load.

THE DYNASTY’S DOMICILE The following states allow dynasty trusts to exist in perpetuity: Alaska Arizona Colorado Delaware District of Columbia Idaho Illinois Maine Maryland Missouri Nebraska New Hampshire New Jersey Ohio Rhode Island South Dakota Virginia Wisconsin Wyoming and Utah allow a dynasty trust to last 1,000 years, Florida allows 360 years and Washington allows 150 years.

However, Marilyn Calister, a managing director with Wealth and Tax Advisory Services in New York, believes that Congress will not be the final arbiter of the discount controversy. She expects that, with the large number of legal cases pending, the valuation issue is more likely to be resolved by the courts.

Endangered Trusts
The committee also seems intent on obliterating both dynasty and Crummey trusts. Removing them from the arsenal of asset transfer techniques would raise tax revenue by $500 million to $1 billion over 10 years, according to JCT estimates. These proposals seem a bit more politically motivated than fiscally revolutionary, however, in light of the $300 billion to $400 billion tax gap. Thus the rumors of the imminent death of these popular strategies are most likely exaggerated.

Dynasty Trusts. These trusts enable assets to pass from generation to generation free of gift, estate or generation-skipping transfer taxes. The JCT plan would impose an estate tax or transfer tax on a family’s assets every two generations, practically ensuring that a perpetual dynasty trust will not achieve tax savings beyond one generation.

Yet the life cycle of a trust has been a matter left to state rather than federal law. Seventeen states and the District of Columbia have eliminated rules against perpetuities or are allowing grantors to extend the life of a trust so that it can last under the rule against perpetuities. (See box, above.) The proposal to limit the exemption on dynasty trusts would face opposition from the states, the banking industry and representatives of closely held businesses.

Crummey Trusts. Named for D. Clifford Crummey, who won a 1968 case establishing the legality of this type of trust, a Crummey trust enables a wealth holder to make multiple gifts to multiple beneficiaries, with each gift qualifying for the annual $11,000 gift and estate tax exclusion. Beneficiaries waive the right to withdraw the funds, allowing the gifts to become trust assets, typically used to pay the premium on a life insurance policy held by the trust. Most people set up the trusts with their children and grandchildren as the beneficiaries of the insurance policy.

But in order to maximize the benefits of the gift exclusion, some have been granting powers to extended family members, raising eyebrows on the joint committee. This enables the wealth holder to gift much larger sums into the trust each year and remove the assets from the estate. The JCT seems unclear as to whether it wants to eliminate or reduce this perceived abuse. The proposal presents three options, only the first of which seems workable.

• Option 1 would limit who could be a recipient by requiring that the holder of a Crummey power be a direct beneficiary of the trust.

• Option 2 would defeat the purpose of the trust altogether by giving the holder, who may or may not be an ultimate beneficiary of the trust, a lifetime right to withdraw the gift.

• Option 3 would require no prior agreement that the gift recipient will not withdraw funds from the trust.

“Even if the estate tax were to be repealed, people would still seek relief from gift taxes on lifetime transfers, and this would tighten things up,” says Charles D. Fox IV, a partner in the Chicago office of Schiff Hardin. “But in reality, most people already draft trusts in accordance with Option 1.”

Thomas P. Cavanaugh, an estate and trust attorney with Cox, Hodgman & Giarmarco in Troy, Mich., agrees that even if the number of Crummey beneficiaries were limited, that would merely detour planning. He notes that trust grantors already use a tactic if they have a shortage of potential beneficiaries for gifts that qualify for the $11,000 per person per year gift tax exemption. “In that event,” he says, “Mom and Dad lend money to the Crummey trust to fund the premium.”

Furthermore, Congress would have to face down a powerful Crummey beneficiary: the insurance lobby, which helped quash a similar proposal to do away with Crummey trusts a decade ago.

Gayle Ronan, a former private banker, writes about wealth management. ronan1@comcast.net

Illustration by Ken Orvidas.

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