Last year’s tax bill included a variety of provisions that for the most part make it easier to work with the allocation of the exemption for generation-skipping tax purposes. Everyone has an exemption worth $1,100,000 in 2002 (adjusted for in-flation) to shelter gifts and estate transfers to grandchildren and other beneficiaries more than one generation younger than the grantor (referred to as “skip persons” in the generation-skipping tax law). One change in the law provides for the automatic allocation of this exemption to “indirect skips,” typically transfers through a trust, where grandchildren or other second generation beneficiaries may receive benefits under the trust. However, there are some trusts where it is unlikely that such remote beneficiaries will actually benefit. For example, they might receive assets only in the unlikely event of a child predeceasing his parent so that assets pass to grandchildren. With respect to trusts that might, but are unlikely to, result in eventual generation-skipping transfers, you can opt out of the “deemed allocation” of GST exemption by filing a 2001 gift tax return with an appropriate attachment. Trusts where this is likely to be appropriate include, among others, irrevocable life insurance trusts. Many such trusts are funded with less than $10,000 in cash each year to cover premi-ums, and no gift tax returns are normally filed. In order to avoid the deemed allocation of generation-skipping exemption to such trusts, however, it may be necessary to file a gift tax return this year. If you have an irrevocable trust of any kind and would like us to review it to determine whether you should file a gift tax return this year, please get in touch with us before the end of March, as such returns (unless extended) are due in mid-April.

Time to Review Split-Dollar Arrangements

If you are a party to a so-called split-dollar life insurance arrangement entered into before January 28, 2002, you ought to review with us and/or your insurance advisor the impact of IRS Notice 2002-8 on that arrangement. An important aspect of this Notice is a special “grandfathering” provision applicable to pre-January 28 arrangements which allows a period of almost two years (expiring January 1, 2004) to decide whether to (1) terminate the arrangement without adverse income tax consequences or (2) convert the arrangement to a loan transaction from the employer to the employee without recog-nizing any “equity” then existing in the insurance contract as taxable income to the employee. In effect, the IRS is pro-viding taxpayers with a grace period of almost two years to figure out what to do about existing split-dollar arrangements in light of the new rules likely to be applicable when new Regulations are promulgated later this year or early next year. Notice 2002-8 provides us with a “preview” of the new approaches likely to be reflected in those Regulations. It is im-portant that you not make any “substantial modification” to your existing split-dollar life insurance arrangement without careful planning, as such modifications could inadvertently lead to loss of grandfathering as set forth in the Notice. The grace period should allow adequate time for thinking through your options and arriving at thoughtful and informed deci-sions. If we can assist you in this process, please let us know.

Many individuals who work with us are well aware of the significant changes in the estate tax structure implemented within the past year. However, even those who understand all the changes still find it difficult to answer this key ques-tion: is my estate plan current? Quite often, a periodic review yields no significant change to an existing plan; but occa-sionally, very substantial changes may be warranted due to changed circumstances.

There are many factors which need to be considered to properly address whether a plan is current. Generally speaking, any plan that is more than five years old should be reviewed by the creator of the plan (the “settlor”) and his or her pro-fessional advisors to make certain it is still suitable. Have there been any changes in family circumstance (marital status, financial status, additions to the family) that could make the plan less suitable than it should be? Is the relative distribution of asset ownership the same as it was when the plan was developed? It is important for couples with taxable estates to have sufficient property in each spouse’s separate ownership to take full advantage of the tax planning contained in the documents. Typically each spouse should have more than the applicable exemption amount in his or her separate name. That amount is currently $1 million, increasing to $1.5 million in 2004, and then $2 million in 2006.

It is also important to review the extent to which recent changes in the law may impact the flow of funds in an estate plan. There are several general observations which have broad application in this regard. First, for couples whose total com-bined estates are likely to be under the applicable exemption amount on the death of the survivor, a plan that was previ-ously complex due to the smaller exemptions can now be changed to a much simpler plan. This simplification could sig-nificantly reduce the amount of complexity faced by the survivor on the death of the first to die and create no negative tax consequences.

Another change that may need to be analyzed on an individual basis is whether the amount that will be directed to various trusts is what the settlor really intends. For example, for many years the unified credit was $600,000 and the generation skipping exemption was in the range of $1 million. That would often mean that a credit shelter or family trust would have $600,000 in it and the balance would likely pass to a surviving spouse either free of trust or in a qualifying marital trust. In such a plan, the credit shelter trust would now receive $1 million at the death of a settlor in 2002 and double that amount of the settlor dies in 2006. This may work well from a tax planning perspective, but it may not be what the settlor really wants, particularly in the typical situation where the primary objective is to benefit the surviving spouse.

Similarly, the generation skipping exemption amount for many years was in the range of $1 million. Although it is still in that range ($1.1 million this year), the exemption will increase to $1.5 million in 2004 and $2 million in 2006. Thus, if an estate plan directs the maximum exempt amount into a generation-skipping trust, it may keep more in trust than the settlor intends. These are the sorts individual questions that can be analyzed only by the creator of the estate plan, in light of his or her specific objectives, and with appropriate guidance and advice from his or her professional advisors. Last year’s tax bill represents a significant change in circumstances that will warrant a review and reassessment of existing plans by many of us.

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Disclaimer: Nothing in this Client Alert should be taken as legal advice for any individual case or situation. The information in these articles is intended to be general in nature and should not be relied upon for any specific set of circumstances. You should consult with an experienced attorney before applying the information in this Client Alert to your own situation.