December 13, 2005

As the end of the year quickly approaches, there are many changes to the federal and state income, estate, gift and generation-skipping transfer tax laws that may have a direct impact on you. Therefore, now may be a good time to engage in year-end planning and review of your estate plan, with special consideration to the following:

Annual Exclusion Gifts

For 2005, individuals can make an unlimited number of gifts of up to $11,000 per recipient, per year. If not made by December 31, 2005, the 2005 annual exclusions will be lost. For 2006, the amount of the annual exclusion will rise to $12,000 per recipient.
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Tuition and Medical Gifts

Additional unlimited gifts can still be made by paying tuition costs or medical expenses directly to the provider.
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Estate Tax Exemption

The amount that an individual may pass free of federal estate taxes will increase to $2 million next year and $3.5 million in 2009, becoming unlimited in 2010. However, in 2011 it will decrease to $1 million. Although President Bush continues to push for permanent repeal of the death taxes, there has been talk on Capitol Hill of a compromise that would raise the amount an individual can pass free of estate taxes to somewhere between $5 million and $8 million. This potential compromise may also lower the estate tax rate to the current capital gains tax rate of 15%. We are hopeful that legislation will be enacted in 2006, one way or the other, to provide certainty in the transfer tax laws and allow for proper planning.
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Lifetime Gift Exemption

Although an individual can currently pass $1.5 million free of estate tax upon death, the same amount cannot be given away during lifetime without incurring a gift tax. The lifetime gift exemption remains at $1 million (in excess of the annual exclusion, tuition and medical gifts).
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Estate and Gift Tax Rates

Under current law, the top estate and gift tax rate will decrease to 46% in 2006. It is also scheduled to decrease to 45% for 2007-2009 and 0% in 2010, rising to 55% in 2011.
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Generation-Skipping Transfer Tax Exemption

In order to ensure a death tax at each successive generational level, a generation-skipping transfer tax is imposed on transfers to grandchildren or more remote descendants at the top estate tax rate. However, the same amount that can pass free of estate tax ($2 million as of 2006) can pass generation-skipping tax free to grandchildren and more remote descendants.
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State Estate Taxes

The federal government no longer shares the estate tax with the states. To the extent that a decedent is subject to estate tax in his or her state of residence, the federal government now allows for a deduction. Illinois residents may incur state estate taxes at a top rate of 16% (which, after the federal deduction, results in a marginal rate of approximately 8.5%). Note: Several states, including Arizona, California, Florida and Nevada, currently have no estate tax.
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Charitable Donations

The Katrina Emergency Tax Relief Act of 2005 (KETRA) allows some taxpayers to claim bigger charitable deductions than in the past by temporarily removing the charitable deduction limitations for cash gifts to "public charities," even if they have no connection with Hurricane Katrina. However, the restrictions are only removed for contributions made between August 28, 2005 and December 31, 2005. If KETRA's tax-saving provisions apply to your circumstances, you may want to consider accelerating your charitable donations from 2006 to 2005.

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Family Limited Partnerships

Many clients have utilized Family Limited Partnerships ("FLPs") for various planning benefits. Through 2005, the IRS has continued to attack the effectiveness of FLPs, particularly the transfer tax valuation reduction benefits. In some cases, the IRS has been successful in having the FLP ignored for estate and gift tax purposes, which makes the valuation discounts and the accompanying tax savings unavailable. The upshot of these cases appears to be that while FLPs remain effective estate planning tools, they must be entered into for bona fide non-tax purposes, the integrity of which is respected both in their creation and in their ongoing administration.

Anyone who is considering a Family Limited Partnership should remember these important points:

  • Assets must be retitled into the name of the FLP;

  • You should retain sufficient assets outside the FLP to live on (and to pay estimated estate taxes) without recourse to FLP assets;

  • You should not transfer personal use assets to the FLP (e.g., a residence or an automobile);

  • All distributions from the FLP should be made in proportion to the partnership percentages and should be determined based on partnership decisions, not on the needs of any one partner;

  • You should not treat the assets of the FLP as your own but run it like any other business with outside owners.

In addition, the IRS continues to attack FLPs at death based upon retention of certain control by the decedent. If the decedent created/transferred the bulk of the assets to the FLP and retained the power to control the timing of cash flows to the partners (including liquidation), the IRS has argued (successfully in one Tax Court case) that the FLP assets can be included in the decedent's estate. This issue does not arise in the gift context.
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Effective January 1, 2006, Illinois has a new Disposition of Remains Act. Previously, an individual ("principal") could designate an agent, through a health care power of attorney, to make medical decisions, including disposition of remains at death. The new act provides additional requirements for designating a disposition of remains agent. If no designation is executed, the act specifies who can make the decision for you (your executor, spouse, children, parents, next of kin or any other person willing to assume legal and financial responsibility). If you have specific desires regarding disposition of your remains and/or if you want to designate a particular individual to act on your behalf in that regard, you should consider executing a Disposition of Remains Agent Designation.
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For More Information

These and other changes in state and federal laws can have significant financial consequences to you and your family. We recommend that you speak to your Much Shelist attorney or contact Gregg M. Simon or Gregory B. Mann of our Wealth Transfer & Succession Planning group to determine appropriate strategies that meet your objectives and address your circumstances.

Circular 230 Notice. To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.