Grim, Biehn & Thatcher
The Taxpayer Relief Act of 1997 was signed into law by President Clinton on August 5, 1997. The Act contains many provisions that give taxpayers more reason than ever to begin estate planning or update their existing plans. Here are several of the more important changes with a discussion of how they might affect your client planning.
Increase in Lifetime Exemption (Unified Credit). The Unified Credit Exemption Equivalent, now called the “Applicable Exclusion Amount”, increases gradually, from $625,000 in 1998 to $700,000 in 2002-2003 and then increases more rapidly, to $850,000 in 2004, $950,000 in 2005, and $1,000,000 in 2006 and thereafter. In order to maximize estate tax savings for the family unit, wealthy couples had heretofore generally planned their estates by making sure that the less wealthy spouse had $600,000 of assets in his/her own name to take maximum advantage of the exempt amount. These clients should now be advised, in light of market swings and the change in the law, to review their holdings at least annually to take advantage of the increased exclusion. If the spouse is not a beneficiary of the credit shelter trust, taxpayers with moderate estates should be advised that automatically funding the credit shelter bequest to the amount of the maximum allowable exclusion amount will reduce the amount available to the spouse via the marital gift. This may not be consistent with their desires or the surviving spouse’s best interests. Any wills, trusts or other instruments specifically referring to the $600,000 exclusion should be reviewed and amended so that these documents will “self-adjust” as the limit changes.
Family Owned Business Exclusion (“FOBE”). This is an exceptionally complicated and ambiguous provision, but it is very important because in the limited situations in which it applies, electing it could result in estate tax savings of up to about $400,000. Section 2033A therefore cannot be ignored. The benefit of this provision decreases over time as the exclusion amount increases – the total of the two exclusions will always equal $1.3 million. (The maximum FOBE this year is therefore $675,000, it will be $600,000 in 2002-03). The provision permits the value of certain qualified family owned business interests (QFOBIs) to be excluded from a decedent’s gross estate, up to the maximum exclusion ($675,000 this year, decreasing to $300,000 in 2006 and thereafter). To qualify for the FOBE the value of the QFOBI (plus certain gifts the decedent made) must exceed 50% of the decedent’s adjusted gross estate (increased by certain gifts). The business must be either a proprietorship, or, if not, (i) 50% or more of the business must be owned by the decedent or members of his/her family, or (ii) at least 30% must be owned by the decedent and his/her family and either 70% or more must be owned by members of two families or 90% or more most be owned by members of three families.
The decedent and members of his/her family must have operated the business for 5 of the past 8 years. Of course, there are other requirements as well. There is a recapture provision if members of the decedent’s family do not continue to materially participate in the business for ten years after the decedent’s death. If spouses’ wills (each of whom owns a QFOBI) pass all amounts in excess of the Applicable Exclusion Amount to the surviving spouse via the marital deduction, the FOBE would not be used in the estate of the first spouse to die. This would result in an unnecessarily high estate tax liability on the second death.
Exclusion for Land Subject to a Qualified Conservation Easement. In addition to the existing estate or gift tax charitable deduction for a contribution to charity of a conservative easement, a new provision allows an estate to exclude up to 40% of the value of land subject to a qualified conservation easement(reduced by the amount of the charitable contrib ution deduction). A qualified conservation easement is a qualified conservation contribution as defined in IRC Section 170(h)(i) of a qualified real property interest to a qualified organization exclusively for conservation purposes.
To qualify for the exclusion, the land subject to the easement is limited to land which:
- is within 15 miles of an Urban National Forest;
- was owned by the decedent or a family member at all times during the 3 year period ending on the decedent’s death, and
- is subject to an IRC Section 170(h) qualified conservation easement granted by the decedent, a family member, the executor of the estate or a trust which holds the land.
The maximum amount excludible is the lesser of:
- the “applicable percentage” or
- the “exclusion limitation” ($100,000 in 1998 and increasing by $100,000 per year to $500,000 in 2002 and thereafter). The “applicable percentage” is 40% reduced by 2% for each percentage point (or fraction) by which the value of the easement is less than 30$ of the value of the land (determined without regard to the easement).
Therefore, if the value of the easement is 10% or less of the value of the land before the easement (i.e., granting the easement does not materially reduce the value of the property), the applicable percentage is zero.
The exclusion is elected by the executor on the estate tax return and is irrevocable. The exclusion applies to a decedent’s interest in a partnership, corporation or trust if the decedent owned at least 30% of the entity directly or indirectly. The granting of a qualified conservation easement is not considered a disposition triggering the recapture provision of Section 2032A. There is no coordination with the FOBE provisions.
It is interesting that the exclusion may be invoked by the executor’s creation of a qualifying easement after the decedent’s death. Executors and their counsel are cautioned to secure the written consents of all estate beneficiaries before granting such an easement, because granting the easement will in most cases reduce the value of the assets to be inherited by the beneficiaries.