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Winning at Darwin's game: changes in federal law--plus Illinois' estate tax, newly decoupled from the federal tax schedule, and our new "virtual representation" statute--present survivor-style challenges and opportunities to estate planners.


Many estate planners and financial professionals have marked this as the end of an era in which they thrived, munching on the foliage of probate avoidance, the credit-shelter trust, and the family limited partnership. The carnage of federal legislation, the battering of family limited partnerships and the threat to various appreciation-removal techniques, such as GRATs, have left an indelible mark on the estate-planning profession.

Some continue to predict that in 2010 there will be a great freeze and the estate planners that survived the economic downturn will finally collapse from professional starvation.

The challenges

One of the most common estate-planning challenges leading up to the dawn of extinction was federal legislation passed in 2001 commonly referred to by the acronym "EGTRRA." (1) This law is known for nearly tripling the exclusion from estate tax and reducing the marginal tax on estates and gifts. Most notably for the estate-planning profession, a married couple went from being taxable when their joint estates surpassed $2 million in assets to being taxable only if they surpassed $7 million.

The raised applicable exclusion caused estate-tax planning to be less necessary and therefore less desirable. The lush garden of the estate planning professional, flowering with credit shelter trusts and/or the disclaimer plan, wilted.

But estate planners are adaptable creatures. There were still larger estates and family business owners that needed the skill and creativity of an estate-planning professional.

To serve their needs, estate planners introduced family limited partnerships and family limited liability companies. The popularity of these entities mushroomed. They allowed older generations to transfer wealth to younger generations at discounted values and at a fraction of the gift-tax cost while maintaining significant control. (2)

The IRS and Tax Court reacted with a smattering of rulings that made it almost impossible to determine when these strategies would work and when they would fail. And when they failed, they failed badly. The future of the family limited partnership is now even more bleak. The White House revenue plan for 2010 (often referred to as the "Greenbook") threatens to disregard and thereby disallow the discounts taken in family limited partnerships. (3)

Then there was Circular 230 and the expanded scope and penalty provisions of Internal Revenue Code section 6694. (4) Under Circular 230 regulations, attorneys did not know how to offer clients written tax advice, even about the use of a disclaimer trust or an annual exclusion gift, without having to include a mandatory disclaimer that the advice essentially could not be relied upon by the client: "This letter is not intended or written by us to be used and cannot be used by anyone for the purpose of avoiding federal tax penalties that may be imposed by the federal government."

Clients and attorneys were confused. They did not know how to interpret Circular 230, and the timing of these regulations was especially harmful, coming in the wake of the prosecution of a law firm and consulting firm for creating and selling tax shelters.

The scope of section 6694, which previously applied return-preparer penalties only to income tax preparers, was expanded to include preparers of estate and gift tax returns and assessed a penalty on the tax preparer of up to 50 percent of the preparation fees. The section 6694 penalty-related provisions had a chilling effect on estate-planning practitioners preparing tax returns.

To recap, the diet of the estate planner was stripped of its primary food group, the credit-shelter trust and/or disclaimer. Then, its alternate food groups, the family limited partnership and tax return preparation, became dangerous to eat. All in all, it seemed that Darwin had estate-planning practitioners on his short list for extinction.

However, shrewd and adaptable creatures find new survival methods. They prepared grantor retained annuity trusts --GRATs--to shift appreciation away from their clients to another generation with minimal or no gift tax. Even in an economy that made thousands of lawyers extinct, a GRAT was still a viable estate-planning tool in a low interest rate environment, and remained a lush feeding ground for estate planners.

But then came the Greenbook, which proposes that GRATs have a minimum 10-year term. Most GRATs are structured to have a two-to-three year term to avoid the risk that the grantor will either die during the term, causing the trust corpus to be includible in the grantor's gross estate and therefore subject to estate tax, or the risk that the trust assets will depreciate rather than appreciate. The White House proposal on GRATs, if adopted, will make GRATs a limited delicacy for both planners and their clients.


To survive these targeted attacks, Illinois estate planning practitioners are digging deeper, focusing on local legislation and alternate planning needs.

Recently, with the assistance of the ISBA Trust and Estates Council and several Illinois estate-planning practitioners, QTIP and virtual-representation legislation passed both houses and is awaiting the governor's signature as this article goes to press. (5)

The virtual representation legislation is designed to encourage private settlement of trust disputes by authorizing a trustee, together with current and presumptive remainder beneficiaries of a trust, to resolve disagreements and ambiguities regarding the administration and operation of a trust without the expense, delay, and animosity of litigation. (6)

The Illinois QTIP is a topic of increasing concern among estate planning practitioners. For persons dying in 2009 and later, the Illinois estate tax is decoupled but still awkwardly tethered to the federal estate tax regime.

On January 1, 2009, the federal estate tax applicable exclusion increased to $3.5 million per individual, while the Illinois equivalent remained at $2 million per individual. Prior to the Illinois QTIP legislation, estate plans that did not actively elect to defer the payment of Illinois estate tax until the second death or that funded the credit portion of the trust with the federal applicable exclusion amount of $3.5 million could have resulted in an Illinois estate tax on the difference between the federal exclusion of $3.5 million and the Illinois equivalent of $2 million for decedents dying in 2009. (7)

Justin Karubas, chair of the legislation committee of the ISBA Trusts and Estates Council, describes the importance of this QTIP legislation:
   We need this law to avoid surprises to
   those couples who have planned their estates
   and expect no tax will be due when
   the first spouse dies. For the last 23 years
   the surviving spouse has not had to pay any
   estate tax to Illinois because they had a traditional
   estate plan. But because of a quirk
   in the Illinois law the surviving spouse may
   have to pay estate tax to Illinois. (8)


Estate planning practitioners have developed new armor against economic hazards and shrinking sources of business. In addition to successfully focusing on local law, they have adapted and are focusing on marketing the other valuable aspects of estate planning, including asset management, disability planning, dispute avoidance for estates and trusts, discord avoidance in business arrangements, and alternate asset protection methodologies.

It seems that estate-planning practitioners have survived the most unfavorable variations to their environment. They are winning at Darwin's game.

(1.) Economic Growth and Tax Relief Reconciliation Act of 2001, Pub Law 107-16, 115 Stat 38 (June 7, 2001) (EGTRRA).

(2.) The technique usually entails the transferor transferring property to a limited partnership. Minority interests in the partnership are then given to transferees. If properly structured, and legitimate and credible non-tax reasons are established for the creation of the FLP, the value of the minority interests can be discounted for gift and estate tax purposes because of lack of marketability and lack of control. Further, the value of the interest that remains the property of the transferor may be discounted if held until death. Discounts can be substantial. When the strategy fails, the property may be deemed to have been gratuitously transferred or the transfer may be deemed to be an indirect gift of assets rather than a direct gift of partnership interest.

(3.) In May 2009, the Treasury Department released its "General Explanations of the Administration's fiscal year 2010 Revenue Proposals (the "Greenbook"). Though a proposal and not a law, the Greenbook signals that there will be significant limitations on the use of valuation discounts in family limited partnerships and limited liability companies. Some advantages of family limited partnerships and limited liability companies are the estate and gift tax valuation discounts resulting from the restrictions on management, distributions, liquidation, and transferability associated with interests that are transferred to family members or trusts for family members. Specifically, referencing section 2704(b) of the Code, the Greenbook proposes that restrictions in business agreements on which valuation discounts were based, shall be disregarded in determining the value of the transfer of any interest in a corporation or partnership to a member of the transferor's family if such restriction has the effect of reducing the value of the transferred interest for purposes of the estate and gift taxes but does not ultimately reduce the value of such interest to the transferee.

(4.) Small Business and Work Opportunity Tax Act, aka PL 110-28, revised IRC section 6694 and the accuracy standards that govern the preparation of tax returns that formerly applied to the income tax preparers but not to estate and gift tax preparers as well, revising IRC section 6694.

(5.) See New Virtual Representation Law, by Lyman Welch, 55 ISBA Trusts & Estates Newsletter 8 (June 2009). Lyman Welch and the ISBA Trusts and Estates Council helped author the legislation and resolve issues and questions regarding the legislation presented by the Illinois Legislature.

(6.) Id; amends section 16.1 of the Trusts and Trustees Act; SB 188.

(7.) Gary R. Gehlbach and Emily R. Vivian, Illinois Estate Tax Planning in 2009 and Beyond, 97 111 Bar J 80 (February 2009).

(8.) The legislation, which originated as HB 255 and became SB 2115, amends 35 ILCS 405/2.

Katarinna McBride <> is a wealth preservation partner with the Chicago firm of Beermann Swerdlove, LLP and editor of the ISBA Trusts and Estates newsletter.
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Title Annotation:ESTATE PLANNING
Author:McBride, Katarinna
Publication:Illinois Bar Journal
Date:Aug 1, 2009
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