Select Task Force Issues Extensive Report on Transfer Tax Reform

Nearly four years have passed since the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), and the significant problems it created for estate planners and their clients. Recognizing these problems, the Real Property, Probate and Trust Law and Taxation Sections, of the American Bar Association, joined by the American Bankers Association, the American Institute of Certified Public Accountants, the American College of Tax Counsel and the American College of Trust and Estate Counsel, created a Task Force on Federal Wealth Transfer Taxes that was comprised of 32 highly experienced trust and estate attorneys, accountants, trust officers and professors. Its mission was to provide the Joint Committee on Taxation, the House Ways and Means Committee and the Senate Finance Committee with a detailed report examining various options that Congress might consider and noting potential issues and possible solutions that could arise under each scenario. I was privileged to be a member of the Task Force and would like to share a few highlights with you.

Part One of the report discusses the concerns and problems that arose because of the very long phaseout period for imposition of estate and generation-skipping transfer (GST) taxes in 2010, followed by their reinstatement in 2011. Under EGTRRA, the repeal of the estate and GST tax was not accompanied by a repeal of the gift tax, so the second part of the report deals with the issues arising because of this retention, which was ostensibly done in order to protect the income tax system. Perhaps the most complex portion of the report is found in Part Three, which deals with the various problems that arise under “modified carryover basis,” which is scheduled to be imposed upon the repeal of the estate and GST tax.

Finally, Part Four deals not with EGTRRA, but with the current transfer tax system. If Congress ultimately concludes that permanent repeal is not appropriate, this part of the report discusses various issues that arise under the current laws, and suggests alternatives that Congress may wish to consider to simplify the system and eliminate certain areas of tension and complexity that presently exist. If Congress concludes that those suggestions are not sufficient to modify the current system, then Appendix A evaluates various alternatives to our current system, as well as to the estate and GST tax repeal, and implementation of modified carryover basis. It examines an accessions tax (a tax on the beneficiary’s cumulative lifetime receipts of gifts), an income inclusion system (whereby gifts or inheritances would be considered taxable income) or a death realization system (otherwise known as a capital gains on death).

Obviously, it is impossible to highlight all of the major points of a report that exceeds 200 pages, but several issues will hopefully make their mark with the tax-writing committees in Congress. The first is that the extended phaseout of repeal has created havoc with taxpayers and their advisors and Congress should do what it can to shorten this area of uncertainty. If permanent repeal is achieved, the report also suggests that there must be other alternatives to a retention of the gift tax in order to preserve the income tax, for it makes no logical sense to retain the entire transfer tax system for a gift tax that will seldom be incurred, and its retention may also impede legitimate transfers of family businesses.

Among the more interesting aspects of the suggested revisions of the current system involve possible changes in what is required in order to make an annual exclusion gift and the possibility of simplifying estate planning by allowing for the portability of the unified credit between spouses. There also is an intriguing discussion about ways in which the entire structure of the system could be made easier, by doing away with the so-called “string provisions” of IRC §§ 2036 and 2038, and instituting an elective gift situation; under that approach, if a transfer were made during lifetime, the donor could decide whether it was to be a gift or not. If it were a gift, then the asset would be out of the donor’s estate, but if the election were not made, then the entire value of the property would be included in the estate at death.

Perhaps the most controversial aspect of the report is the section on valuation. It is not a surprise to anyone involved in estate planning that this is an area of significant conflict with the government, and the report discusses various alternatives by which issues of valuation could be minimized.

Of course, as with all aspects of the report, what makes theoretical sense to a group sitting around discussing what the law should be may lose out in the ultimate political battles that will occur, particularly when faced with the hard reality of trying to achieve a balanced budget. In any event, the report has been transmitted to the respective tax staffs well in advance of any proposed legislation, and it is hoped that the historic aspect of having so many professional organizations involved in a collaborative effort will at least cause the Committees to consider these issues before enacting whatever ultimately comes out of the tax proposals before the new Congress.