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Governmental Relations

Statement of Dennis I. Belcher, Partner, McGuireWoods LLP
Richmond, Virginia

Testimony Before the Subcommittee on Select Revenue Measures of the House Committee on Ways and Means

July 13, 2006

Chairman Camp and distinguished members of the Subcommittee, I am Dennis I. Belcher, a partner in the Richmond, Virginia office of the law firm McGuireWoods LLP. I have been in the private practice of law for more than thirty years and have spent my career representing clients in estate planning. In my law practice, I advise clients on how to minimize federal and state estate, gift and generation-skipping taxes (“transfer taxes”) using estate planning techniques so as to maximize the assets passing to family members and other beneficiaries.
I am currently an officer in the American College of Trust and Estate Counsel (“ACTEC”). ACTEC is a non-profit professional association comprised of approximately 2,600 lawyers who are selected on the basis of professional reputation and ability in the field of trusts and estates and having made substantial contributions to those fields through lecturing, writing, teaching, and bar leadership activities. I am the past Chairman of the American Bar Association’s Real Property, Probate and Trust Law Section, which has approximately 30,000 members who are interested in the areas of probate, trust law, and real estate law. I am also a member of a Task Force, called the Patenting Estate Planning Techniques Task Force (the “Task Force”), created by ACTEC in 2005.
I am testifying today on my own behalf and on behalf of ACTEC and the Task Force. My testimony represents my own views, the views of ACTEC and the Task Force, but not those of my firm, any of its clients, or the American Bar Association.

Summary

From my experience and discussions with other estate planning professionals, I believe that:
Patents for tax reduction strategies in the area of transfer taxation are creating problems for many taxpayers;
If patents for transfer tax reduction strategies are not prohibited, this type of patent will in all likelihood expand and create problems for more taxpayers; and
Patents for tax reduction strategies should be prohibited either by the U.S. Patent and Trademark Office or by legislation.

Background

Until 2003, few estate planning advisors[1] gave consideration to patents when advising clients about estate planning. That view changed in 2003 when an individual was awarded a patent for an estate planning technique that the patent holder called a “SOGRAT”.[2] (Although the SOGRAT patent was awarded in 2003, anecdotal evidence suggests there are still a significant number of estate planning advisors who are not aware that patents can be awarded for transfer tax reduction techniques.) According to the patent, a SOGRAT involves a grantor retained annuity trust funded with nonqualified stock options. (A grantor retained annuity trust, referred to as a GRAT, is an estate planning technique authorized by Congress, the Treasury Department, and the Internal Revenue Service.[3]) When word of this patent spread through the estate planning community, most estate planning professionals were shocked to learn that an individual could patent a common estate planning technique used in connection with a specific asset, the purpose of which is to allow taxpayers to minimize their federal estate and gift tax liability, particularly a technique authorized under the Regulations issued by the Treasury Department and approved in many Internal Revenue Service rulings.
In response to concerns about the impact of using patents to restrict the availability of commonly used estate planning techniques, such as GRATs, experienced estate planning lawyers discussed the ramifications of such patents at a meeting of ACTEC’s Estate and Gift Tax Committee in October 2004. I had the privilege of chairing that meeting. Because of the serious nature of the concerns expressed at this meeting, ACTEC created the Task Force to study this issue[4]. Once the existence of the Task Force became generally known to the estate planning community, other professional organizations joined the Task Force. Organizations with members on the Task Force now include the American Bar Association’s Real Property, Probate and Trust Law Section, the American Bankers Association, and the AICPA.[5] Members of the Task Force agree about the seriousness to taxpayers of the issues presented by the patenting of estate planning techniques. Although the Task Force has not completed its study or issued findings or a formal report as of this date, the Task Force has authorized me to testify on its behalf. Because ACTEC agrees with the Task Force’s concern, on July 8, 2006, ACTEC also authorized me to speak on behalf of ACTEC.
The purposes of my testimony are to (1) inform Congress that a patent of one transfer tax reduction technique, the SOGRAT patent, is presenting significant problems to many taxpayers, and (2) recommend that either the U.S. Patent and Trademark Office or Congress prohibit the patenting of tax reduction strategies before the patenting of this type of strategy becomes more widespread and affects more taxpayers.[6]

The SOGRAT Patent

In some instances, Congress, the Internal Revenue Service, and the Treasury Department have authorized tax reduction techniques which taxpayers may take advantage of to reduce their federal tax liability. Examples of government authorized tax reduction techniques in the estate planning area include the federal estate and gift tax marital and charitable deduction, the gift tax annual exclusion, charitable remainder and lead trusts, and GRATs. A GRAT is an irrevocable trust in which the grantor retains an annuity for a fixed term (usually two or more years) and at the end of the term the remaining trust assets pass to beneficiaries selected by the grantor (usually the grantor’s family). The grantor transfers assets to the GRAT that the grantor believes will appreciate significantly over the term of the trust. Under Internal Revenue Code section 2702, the Regulations issued by the Treasury Department under section 2702, and rulings issued by the Internal Revenue Service, the grantor is able to deduct for gift tax purposes the value of the grantor’s retained annuity, thereby reducing the amount of the gift to the grantor’s family.[7] Because of the taxpayer’s ability to transfer appreciation on assets in the GRAT to family members at a reduced gift tax cost, the GRAT is a frequently used estate planning technique.
On May 20, 2003, the U.S. Patent and Trademark Office awarded Mr. Robert C. Slane of Wealth Transfer Group, L.L.C. a patent for a GRAT funded with nonqualified stock options, which Mr. Slane calls a SOGRAT (a stock option granter retained annuity trust).[8] The first claim in the SOGRAT patent is:
A method for minimizing transfer tax liability of a grantor for the transfer of the value of nonqualified stock options to a family member grantee, the stock options having a stated exercise price and a stated period of exercise, the method performed at least in part within a signal processing device and comprising:
Establishing a Grantor Retained Annuity Trust (GRAT);
Funding said GRAT with assets comprising stock options,
The stock options have a determined value at the time the transfer is made;
Setting a term for said GRAT and a schedule and amount of annuity payments to be made from said GRAT; and
Performing a valuation of the stock options as each annuity payment is made and determining the number of stock options to include in the annuity payment.
Problems Created by the SOGRAT Patent
The existence of the SOGRAT patent is preventing taxpayers from using a government authorized estate and gift tax reduction technique, thereby presenting problems to taxpayers in planning their affairs. During one of the Task Force discussions, one Task Force member reported that the holder of an estate planning patent recently contacted an estate planning advisor employed by a financial institution and informed the advisor that the patent holder was the owner of the estate planning technique suggested by the advisor in a newsletter to clients. The advisor sought legal guidance on the proper course of action. Notwithstanding that the advisor’s lawyer believed the patent may be invalid, the lawyer recommended that the advisor not risk using the patented technique without permission of the patent holder. The lawyer gave this advice presumably because of the high cost of defending a patent infringement law suit or prosecuting a suit to invalidate the patent. After discussions, the advisor agreed not to suggest the use of the legally authorized estate planning technique in connection with a particular type of asset without informing clients and their lawyers of the existence of the patent so that the client and lawyer would be responsible to make their own judgments about the validity of the patent and the degree to which it needed to be honored.
There is a lawsuit pending against a taxpayer alleging the infringement of the SOGRAT patent. On January 6, 2006, the SOGRAT patent holder filed suit in the Connecticut United States Federal District Court for infringement of the SOGRAT patent. The defendant in the lawsuit is Dr. John W. Rowe, the Executive Chairman of Aetna, Inc. The lawsuit is in the discovery stage and is anticipated to go to trial in 2007. Because I understand that the lawsuit is being prosecuted vigorously, the lawsuit cannot be considered a nuisance lawsuit. When this lawsuit was discussed at ACTEC’s Estate and Gift Tax Committee on July 8, 2006, the vast majority of lawyers present (more than 100 experienced estate planning lawyers) indicated that they would not recommend to any client the use of a GRAT funded with nonqualified stock options without disclosing the existence of the SOGRAT patent and the pending lawsuit. In addition, these lawyers indicated that they would be reluctant to allow a client to use this technique without the permission of the patent holder.
Because I am not trained in intellectual property law, I cannot comment on the validity or non-validity of the SOGRAT patent. But, I am qualified to address the taxpayer problems created by patenting estate tax reduction techniques because of my thirty years’ experience in representing taxpayers. Like most experienced practitioners, I am troubled by the SOGRAT patent for several reasons. First, an individual has been allowed to privatize a tax reduction technique authorized by the United States government. Second, because GRATs can be and are used for any type of asset[9] , there is nothing unique about coupling a GRAT with nonqualified stock options. Because nonqualified stock options have desirable features affecting the valuation of the options for transfer tax purposes, the use of nonqualified stock options in a GRAT may be considered rather obvious. In summary, the SOGRAT patent is creating problems with taxpayers because of the chilling effect on the use of this authorized technique.

Patenting of Transfer Tax Reduction Techniques Should Be Prohibited

Because patents of transfer tax reduction techniques present problems to many taxpayers, the U.S. Patent and Trademark Office or Congress should prohibit these types of patents for the following reasons:
1. It should be against public policy for a private individual to patent a technique used to reduce a taxpayer’s tax burden;
2. Patenting estate planning techniques unfairly increases a taxpayer’s costs or the federal estate and gift taxes payable by the taxpayer if patented techniques are not used; and
3. Because a patent on a tax planning technique can add credibility to the technique, patents on objectionable or aggressive tax planning techniques can hurt compliance with the federal tax laws.
It is not the function of the Internal Revenue Service or the Treasury Department to curtail patents of tax planning techniques. Because of the nature of transfer tax reduction techniques, it may not be possible for the U.S. Patent and Trademark Office to make an adequate review of these techniques. Accordingly, a legislative solution may be the appropriate response to protect taxpayers and to curtail the patenting of all tax planning techniques before these patents become more widespread.
1. It should be against public policy for a private individual to patent a technique used to reduce a taxpayer’s tax burden.
A patent of a tax reduction technique is unlike other business method patents because it relates to taxes. If there is a business method patent in a particular area of business, a citizen has the choice to either pay for the right to use the technique, to engage in that business activity in a different way, or not to engage in that business activity at all. A taxpayer who complies with the tax laws does not have that choice – the taxpayer must pay his or her tax burden. In the familiar of words of Judge Learned Hand, however, “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”[10] It should be against public policy to allow a patent of a tax reduction technique because the patent prevents taxpayers from exercising their right to minimize their taxes within the limits of the law, and avoiding the activity in question, the payment of taxes, is not an option.
In addition, patenting tax reduction techniques allows private individuals to leverage the federal tax system thereby imposing an additional cost on taxpayers. As the tax rates vary, the value of a tax reduction technique patent will vary accordingly. Because a taxpayer pays the patent holder for the right to use a tax reduction technique to reduce the taxpayer’s tax burden, the patent holder is in effect imposing a tax in the form of a toll charge on the use of the technique.
There are a small but growing number of patents in the tax reduction area. If patenting tax reduction techniques is not stopped, the practice will spread to other areas of the tax law and affect more taxpayers. Although GRATs are used only by those taxpayers subject to the federal estate tax, there may be a rush to the U.S. Patent and Trademark Office when Congress passes the next tax bill with a new tax minimization provision. The first individual to file a patent should not be rewarded at the expense of those taxpayers trying legitimately to minimize their tax burdens. Consider the result if an individual had patented the transfer of appreciated securities to a charitable remainder trust, a technique similar in many ways to a GRAT, when Congress first allowed these types of trusts in 1969.[11] Because a patent holder cannot be compelled to grant a license for a patent, a patent holder could have precluded any taxpayer from using a charitable remainder trust, which was a congressionally authorized tax reduction technique, to the detriment of taxpayers and charity. Clearly, this is not in the best interest of the public and should be against public policy.
Patents on tax reduction techniques are different from other business method patents. Because patents of tax reduction techniques prevent taxpayers from minimizing a burden imposed by law and affecting all taxpayers, it should be against public policy to allow patenting of tax reduction techniques. Thus, either the U.S. Patent and Trademark Office or Congress should prohibit patents on tax reduction techniques.
2. Patenting estate planning techniques unfairly increases a taxpayer’s costs and federal estate and gift taxes.
Because taxpayers will have to pay a fee to use an estate planning technique authorized by law, many taxpayers will be forced to pay more in an effort legally to minimize their federal taxes. Before an estate planning advisor recommends that a client use a patented estate planning technique, the advisor has an obligation to point out the options and risks to the client of using a patented technique. When a client is considering the use of a patented estate planning technique, the client has these options: (a) file a lawsuit to invalidate the patent; (b) ignore the existence of the patent in the hopes that the patent holder will not discover its use; or (c) pay a licensing fee to the patent holder for the use of the technique. Because filing a lawsuit to invalidate the patent is expensive, filing a lawsuit is not a viable option.[12] If the client ignores the existence of the patent in the hopes that the patent holder will not discover its use, the risks to the client can be considerable and can include paying treble damages to the patent holder.
Patenting estate planning techniques unfairly increases the federal estate and gift tax liability of taxpayers. Some taxpayers will refuse to pay tribute to the holder of an estate planning patent. These taxpayers will be forced either to pay more than their fair share of federal estate and gift taxes or risk being sued for the unauthorized use of a patented technique. If the taxpayer refuses to pay tribute and does not want to take the risk of unauthorized use of the estate planning technique, the taxpayer will be forced to forgo the use of an estate planning technique authorized by law. Because the taxpayer will not be allowed to use this technique, the taxpayer will pay more than the taxpayer’s fair share of federal estate and gift taxes.
Under the ABA Model Rules of Professional Conduct (the “Model Rules”), a lawyer has a duty to explain issues that are likely to result in adverse legal consequences to the client.[13] Thus, an estate planning lawyer may have an ethical duty to learn about the existence of patents affecting estate planning and inform clients of existing patents on estate planning techniques sought to be used by the lawyer’s clients.[14] Under the Model Rules, lawyers must give candid and competent advice using any “legal knowledge, skill, thoroughness and preparation [which is] reasonably necessary.”[15] A lawyer must explain a client’s options to “the extent reasonably necessary to permit the client to make an informed decision” on a course of action.[16] Because of the possibility of adverse legal consequences to a client from the unauthorized use of a patented estate planning technique, a lawyer may have a duty to (i) determine the existence of any patent on an estate planning technique under consideration, (ii) inform the client of the existence of all patents, and (iii) advise the client of the possible adverse consequences of using the technique without the consent of the patent holder.
By allowing a patent on a transfer tax reduction technique, a taxpayer will either have to obtain the permission of the patent holder to use the technique (presumably for the payment of a fee) or have to forgo the use of the technique. Thus, patented transfer tax reduction techniques impose an additional tariff for those taxpayers who want to use legally authorized estate planning techniques to reduce their federal estate and gift taxes.
3. Because patents on aggressive tax planning techniques add credibility to an objectionable or aggressive technique, patents on tax planning techniques can hurt compliance with the federal tax laws.
Placing what many taxpayers may interpret as a seal of approval from the U.S. Patent and Trademark Office on an aggressive tax planning technique could mislead taxpayers as to the legality of the tax planning technique. Some taxpayers will believe that because a United States government agency has approved the technique, the technique must be a lawful and appropriate technique. Because a patent on an aggressive tax planning technique can add undeserved credibility to that technique, patents on tax planning techniques can hurt the enforcement of the federal tax laws.

Possible Solutions

ACTEC and the Task Force have struggled with the appropriate solution to protect taxpayers from patents on transfer tax reduction techniques, particularly techniques authorized by law. Because ACTEC and the Task Force are not experts in intellectual property, we are reluctant to make recommendations. But, we will offer some observations. We see the following options to address this problem: (a) the Internal Revenue Service could curtail the use of tax planning technique patents; (b) the U.S. Patent and Trademark Office could curtail the use of tax planning technique patents; and (c) Congress could provide a legislative solution.
Because it is not the function of the Internal Revenue Service to curtail patents of transfer tax reduction techniques, we do not believe that enforcement by the Internal Revenue Service is the appropriate solution. ACTEC and the Task Force are concerned about relying on the U.S. Patent and Trademark Office to curtail or eliminate the patenting of tax reduction techniques, particularly transfer tax reduction techniques. If a patent examiner is not familiar with estate planning techniques, it will be difficult for the examiner to determine whether a patent should be awarded for a particular tax technique for several reasons. Presumably, patent examiners are generally not familiar with researching tax law and are not experienced in making the judgments that compliance with tax law requires.[17] Many lawyers, accountants, and financial planners give estate planning advice and do not publish their techniques but discuss these techniques in numerous meetings of professionals. For example, ACTEC’s Estate and Gift Tax Committee meets three times annually, discusses many estate planning techniques, but only produces summary minutes of the meetings. Other estate planning professional organizations operate similarly. It is possible that an estate planning technique will be discussed and will have widespread use, but a patent examiner would not have knowledge of the prior use of the technique and mistakenly award a patent for the technique. Although an individual could challenge the patent on the basis of prior work, one individual would not have a sufficient interest in the technique to invest legal fees to challenge the validity of the patent.
If the U.S. Patent and Trademark Office cannot prevent patents of tax reduction techniques, we hope that Congress will find that patenting tax reduction techniques is against public policy and pass legislation preventing these types of patents.

Conclusion

ACTEC and the Task Force on Patenting Estate Planning Techniques believe that patenting transfer tax reduction techniques is creating problems for many taxpayers. If patents for tax reduction strategies are not prohibited, this type of patent will in all likelihood expand and create problems for more taxpayers. We ask that patents for transfer tax reduction be prohibited either by the U.S. Patent and Trademark Office or by legislation.
In closing, I thank the Subcommittee and its staff for allowing me to give you my views on this topic.
[1] As used in this statement, estate planning advisors and professionals refers to lawyers, accountants, financial planners, and insurance professionals.
[2] Patent No. 6,567,790, Establishing and Managing Grantor Retained Annuity Trusts Funded by Nonqualified Stock Options.
[3] Internal Revenue Code section 2702 and Treasury Regulation section 25.2702-2(a).
[4] In addition to me, members of the Task Force from ACTEC are Louis S. Harrison and William C. Weinsheimer (Chair of the Task Force).
[5] The representatives from the American Bar Association’s Real Property, Probate and Trust Law Section include Steve R. Akers, Christine L. Albright, Alan F. Rothschild, Jr. and Michael D. Whitty. The representatives from the American Bankers Association include Kathleen C. Brown, Julianne M. Hallenbeck, and Joseph W. Mooney. The representatives from the AICPA are Evelyn M. Capassakis, Justin Ransome, and Steven A. Thorne. Ellen P. Aprill is a liaison to the Task Force from the American Bar Association’s Section of Taxation.
[6] The U.S. Patent and Trademark Office classifies patents dealing with tax reduction techniques as subclass 36T in Class 705. According to the Patent Office’s website, 48 patents have been issued in that subclass and there are 81 patent applications are pending.
[7] In the article by Robert L. Moshman, “Good GRATs and Great GRATs – And An Interview With Robert C. Slane,” The Estate Analyst, April, 2006, the author stated: “Despite cracking down on estate-freezing techniques, Chapter 14 provided a beautiful safe harbor. The grantor retained annuity trust, better known as GRAT, is explicitly authorized under section 2702.”
[8] Patent No. US 6,567,790.
[9] Estate planning lawyers in my law firm have used GRATs for many different types of assets, including real estate, marketable securities, stock in private businesses, and thoroughbred race horses.
[10] Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934).
[11] Internal Revenue Code section 664.
[12] According to one source, a suit to invalidate a patent may cost in excess of $1,000,000. See, “Patenting Tax Strategies,” Trusts and Estates Magazine, March 2004, page 44.
[13] Model Rules R. 1.4(b), 2.1 cmt.
[14] See Model Rules of Prof’l Conduct R. 1.1, 1.4, 2.1 (1983).
[15] Model Rules R. 1.1, 2.1
[16] Model Rules R. 1.4.
[17] ACTEC has volunteered to work with the U.S. Patent and Trademark Office to educate patent examiners on how to research estate planning techniques so as to determine the existence of prior work.
 

I.     Preliminary Remarks

It is an honor to appear before this distinguished Committee to testify regarding portability of the estate, gift, and generation-skipping tax (“GST”) exemptions[1] to a surviving spouse. Portability would simplify estate planning and estate administration for married couples; carry out our clients' nontax goals; and increase consistency with existing tax policy without creating any new tax benefit.

Although I am chair of the Transfer Tax Study Committee of the American College of Trust and Estate Counsel (“ACTEC”), I am here as an invited witness in my individual capacity. However, the legislative proposal that appears as Exhibit A to my written testimony was prepared by ACTEC's Transfer Tax Study Committee and was unanimously approved by ACTEC's Board of Regents on March 10, 2008. Accordingly, when I speak in support of that proposal, I am authorized to speak on behalf of ACTEC, as well.

ACTEC is a non-profit professional association of approximately 2,600 trust and estate lawyers selected on the basis of professional reputation and ability in the field of trusts and estates and substantial contributions to that field through lecturing, writing, teaching, and bar leadership activities. ACTEC does not take positions on matters of tax policy and politics, including rates, exemptions, effective dates, and phase-ins. Nevertheless, on the basis of the extensive experience of our members in working with the estate, gift and generation-skipping transfer taxes as applied to our clients' circumstances, ACTEC offers technical observations concerning how the tax laws work and recommendations for making them operate more effectively to carry out the policies expressed by Congress.

In my view, portability may be the best estate tax planning idea for a surviving spouse since the unlimited marital deduction in 1981. Portability has already received significant attention from Congress. Specifically, portability was an important feature of H.R. 5970, in the 109th Congress, which was passed by the House of Representatives on July 29, 2006, and set before the Senate as the subject of the cloture motion that failed by a 56-42 vote on August 3, 2006, as part of the effort of a number of Senators to work out a compromise on the future of the estate tax.

In my remarks today I will first describe portability, second, discuss reasons that compel me and my ACTEC Fellows to recommend the passage of estate tax legislation that includes portability, third, make a few observations regarding the use of portability in practice, and lastly compare H.R. 5970 to the ACTEC Proposal.

II.    The Case for Portability

A.      What is “Portability”?

In general, portability is the transfer of a the deceased spouse's unused exemption to the surviving spouse. Specifically, under current law, each citizen or resident has a $2 million exemption from estate tax. It is common to say that a married couple has twice that, or $4 million. That is not an accurate picture of how the estate tax system works. Rather, under current law, upon the death of the first spouse and the transfer of all assets to the surviving spouse, the $2 million exemption of the deceased spouse is lost. When the surviving spouse dies, her estate may contain the assets of both spouses, but the estate of the surviving spouse will only have a single $2 million exemption. In order to avoid wasting the deceased spouse's exemption, the deceased spouse must either transfer assets to someone other than the surviving spouse, or place the exemption amount in an irrevocable bypass trust. Those two options are often counter to what the couple desires. Portability solves this dilemma.

B.      Evaluation of Portability.

In general, we recommend portability for four important reasons, namely to:

(1)    Simplify transfer tax planning and after-death administration;

(2)    Satisfy client desires to provide security and flexibility for the surviving spouse;

(3)    Achieve greater consistency with existing tax policy that treats a married couple as a unit; and

(4)    Importantly, accomplish by statute the same results that a married couple may achieve by complicated planning and estate administration.

1.     Simplification. The most obvious feature of portability is that it vastly simplifies estate planning and after-death administration for a married couple.

a.     With portability, a married couple would no longer have to create a bypass trust upon the death of the deceased spouse, in order to use the exemption of the deceased spouse. Although “bypass” is easy to say, a number of complications come to mind in the use of a bypass trust.

First, estate planners commonly use a marital deduction formula clause in drafting a bypass trust. The purpose is to ensure that the bypass trust receives the greatest amount possible covered by the exemption but does not go over the exemption thereby triggering estate tax. Instead, any amount in excess of the exemption amount would go to the survivor's trust, which qualifies for the marital deduction so that the two trusts together would make maximum use of the deceased spouse's exemption while protecting any excess from tax with the marital deduction. The result of making this optimal use of the exemption by a deceased spouse is a complicated formula virtually impossible to explain to anyone who is not an estate planning attorney or other professional.

A second complication is that an irrevocable bypass trust is a separate taxpayer. This means the bypass trust needs a separate ID number and a separate income tax return. With portability, there would be no separate trust, the surviving spouse would continue to use her own social security number and would not have to file a separate income tax return in addition to the survivor's individual 1040.

Third, after the death of the first spouse to die, the division of assets between the marital deduction trust and a bypass trust is typically accomplished after the filing of a federal estate tax return, due initially nine months after death. As a result, there needs to be a preliminary trust to hold the decedent's assets between the date of death and the funding of the trusts. The administrative trust in turn is a separate taxpayer, requiring yet another new ID number and an additional income tax return. With portability, there would be no need for an administrative trust; the decedent's assets would be treated as transferred to the surviving spouse on the date of death of the first spouse to die.

b.     Another complexity under current law is that the estate of the first spouse to die must contain sufficient assets to use the exemption of the deceased spouse. Unless the couple is confident of which spouse will die first, this means that each spouse must have assets in his or her name sufficient to use the exemption. The result is that complicated tax planning drives how a married couple hold title to their property, rather than nontax, personal reasons. This may require asset transfers from the spouse with the higher net worth to the other spouse, which might otherwise be unnecessary, undesirable, impractical, or in some other way be inconsistent with the couple's overall planning.

Even in a community property state, such as California, clients frequently have inheritances, property brought from a non-community property state, or assets owned before marriage that are separate property and create a different net worth for each spouse. With portability, the deceased spouse's unused exemption would pass to the surviving spouse, regardless of the value of the deceased spouse's estate.

2.     Conformity to Client Nontax Goals.

A second important reason we support portability is that clients typically prefer that the surviving spouse be the full owner of the couples' combined estate upon the death of the first spouse. A bypass trust divides ownership of the deceased spouse's estate between the income beneficiary and the remaindermen who receive the assets upon the death of the surviving spouse. Even if the surviving spouse holds a limited power of appointment over the bypass trust so that the survivor controls who owns the remainder, the surviving spouse is still faced with less than outright ownership of the assets in the bypass trust. This separate ownership raises issues of fiduciary duties owed to the remainder beneficiaries by the trustee, whether the trustee is the surviving spouse or someone else.

3.     Consistency with Existing Tax Policy.

A third reason that portability makes sense is that it is consistent with other ways the tax law recognizes a married couple as, in effect, a single economic unit, e.g., joint income tax returns, gift-splitting for gift tax purposes, and the unlimited marital deduction.

a.     For example, in 1981, when the marital deduction for transfers between spouses was made unlimited, the Finance Committee stated that “[t]he committee believes that a husband and wife should be treated as one economic unit for purposes of estate and gift taxes, as they generally are for income tax purposes.” S. Rep. No. 97-144, 97th Cong., 1st Sess. 127 (1981).

b.     In addition, portability would permit the actual result for a married couple to match the way the exemption is often viewed and discussed, including by lawmakers, as, for example “$2 million per person, and $4 million for a married couple”. Rarely do we hear the exemption referred to as $2 million per person, and $4 million per married couple who retains legal counsel and engages in careful, complex planning.

4.     Portability Does Not Open a New Door.

Not only are there significant reasons that favor portability, it is important to keep in mind that portability does not open a new door. Under current law, a married couple can achieve the same goal of use of the deceased spouse's exemption as portability does. The difference is that current law (1) requires a married couple to engage in complicated planning and put up with complex administration; and (2) impairs the security of sole ownership that a surviving spouse could otherwise enjoy.

In summary, portability would (I) simplify estate planning and estate administration for married couples; (2) carry out clients' nontax goals; and (3) increase consistency with existing tax policy. All these benefits can be obtained without giving a married couple a new tax benefit.

C.      Who Will Benefit from Portability?

1.    Portability should be most useful to a married couple with a combined estate of more than $2 million but no more than $4 million at the time of death of the surviving spouse. For convenience when I refer to $4 million, I am referring to double one exemption, which is currently $2 million per person. In these circumstances, the couple could use portability to both avoid all estate tax on their combined estate and avoid the use of a bypass trust for estate tax planning.

2.    The greater the combined net worth of a married couple, the less useful portability will be. This is for two reasons: First, the higher the net worth, the more likely the couple will make distributions to children on the first death thereby using the exemption of the first spouse. Second, the larger the combined estate, the greater role that appreciation of the deceased spouse's estate in the survivor's estate will play.

III.   H.R. 5970 and the ACTEC Proposal

A.      H.R. 5970 and the “Break-through”.

One of the technical challenges to implementing portability was the tracing problem. Tracing refers to tracking assets from the deceased spouse to the surviving spouse in order to determine how much unused exemption should be transferred to the surviving spouse's estate. H.R. 5970 solved this problem by transferring the entire unused exemption of the deceased spouse to the estate of the surviving spouse but capping the amount of unused exemption the survivor's estate can use to the same amount as the survivor's exemption. Therefore, the total exemption in the surviving spouse's estate would never exceed twice the amount of a single exemption.

Moreover, “capping” not only avoids difficult tracing, it also prevents abuse by a surviving spouse who would marry a series of ill paupers in order to accumulate their unused exemption. The unused exemption of all predeceased spouses would be capped at the amount of the surviving spouse's exemption.

ACTEC recognizes this technical break-through in H.R. 5970, and the ACTEC Proposal incorporates the capping technique.

I will turn now to the differences between H.R. 5970 and the ACTEC Proposal.

B.      Relieve Burden of the Required Election.

First, under H.R. 5970, new section 2010(c)(6)(A) permits portability only if the executor of the deceased spouse's estate so elects. We believe that the election will be desirable in virtually every situation, and that a required election will be burdensome and a trap for the unwary.

A required election for portability is likely to result in the same confusion produced when we had a qualified terminable interest property trust (“QTIP”) election for the marital deduction. The IRS required that simply listing assets on Schedule M of the federal estate tax return was not sufficient to obtain the marital deduction. An affirmative check-the-box election had to be made. This rule led to several private letter rulings that disallowed the marital deduction. As a result of these unfavorable rulings, and approximately 10 years later, a new rule was finally adopted that did not require a box to be checked to make the QTIP election.

C.      Give Option to File Estate Tax Return or Income Tax Return for Deceased Spouse.

H.R. 5970 requires that the unused exemption of a deceased spouse cannot be transferred to the estate of the surviving spouse unless a federal estate tax return is filed for the deceased spouse. (As mentioned above, ACTEC recommends that the executor not be required to make an election for portability to apply.) Although the ACTEC proposal requires the timely filing of an estate tax return for the deceased spouse, we also suggest that there be an option of filing a special schedule to the deceased spouse's final income tax return as a substitute for an estate tax return.

The reason for the income tax filing option is that in any situation where portability would apply, then, by definition there would be no tax due on the deceased spouse's estate, and frequently, no estate tax return would be necessary, except to establish there was unused exemption. If there were tax, then there would be no unused exemption to transfer to the survivor's estate. The income tax option is offered as a less onerous way of complying with the need to notifY the Internal Revenue Service (IRS) that portability would apply upon the death of the surviving spouse.

Although some might view the income tax return as an inappropriate vehicle for providing the fair notice the Service needs, the ACTEC proposal does not automatically allow any statement on an income tax return to suffice. We believe that the concern for fair notice should be addressed by Treasury, which would be authorized to issue “instructions, regulations, directions or forms”.

D.      Extend Portability to the Generation-Skipping Transfer Tax (section 102(a) & (b) of H.R. 5970 and Section 2631 (c) of the Code).

Second, H.R. 5970 makes the exemption portable for gift and estate taxes, but not for the generation-skipping tax exemption. Our experience is that taxpayers who make taxable transfers often consider gifts at death to grandchildren. Moreover, linking the GST exemption to the estate and gift tax exemption will simplify planning and there is no reason to make the GST exemption different than the other transfer taxes. Like the gift and estate tax exemption, portability of the GST exemption is available under current law to taxpayers who engage in sophisticated estate planning. For these reasons, ACTEC recommends extension of portability to the GST exemption.

E.      Clarify Whether Privity is Required.

Privity means that the exemption would only be portable between a married couple. Without requiring privity, there could be a transfer of an exemption from a deceased husband to a surviving wife, who would in turn transfer both her unused exemption and her first husband's unused exemption to a second husband.

H.R. 5970 did not appear to require privity, but that is not entirely clear. We believe if Congress intends to allow portability without privity, it is not entirely clear that Congress explicitly considered this issue or its implications. If the policy judgment regarding privity was not considered in H.R. 5970, that judgment should be made now. While ACTEC acknowledges that this is the type of judgment call that lawmakers should make, we believe that a privity requirement would adversely affect very few spouses and that most spouses would find privity to be a natural and acceptable requirement.

F.      Clarify That a Surviving Spouse's Estate Can Receive Unused Exemption from More than One Deceased Spouse. (Section 102(a) of H.R. 5970 and New Section 2010(c)(4) and (5) of the Code).

It is relatively clear from H.R. 5970 that a surviving spouse who has lost two or more spouses to death may use the unused exemption of all such predeceased spouses, subject to a cap of the amount of the surviving spouse's exemption. Apparently H.R. 5970 permits a surviving spouse to accumulate exemptions from all prior deceased spouses but caps the amount of exemption that may be accumulated. We propose clarifying H.R. 5970 by inserting the word “all”.

G.      Broaden Treasury's Regulation Authority (Section 102(a) of H.R. 5970 and New Section 2010(c)(7) of the Code).

We recommend that Treasury be given broader authority to issue what are often viewed as “legislative regulations”. The deliberate process of drafting regulations, with solicitation of public input through the notice and comment process and otherwise, is well-suited to fleshing out the administrative rules to govern the details of implementing portability.

In conclusion, portability is a great idea. I sincerely hope that with the support of this Committee, portability will be a great idea whose time has come.

EXHIBIT A

2008 Report on Study of Statutory Proposal for Simplification of Transfer Tax Planning for the Unified Credit and GST Exemption

In 1992, the Transfer Tax Study Committee recommended a proposal for the simplification of federal estate and generation-skipping transfer tax planning and compliance through the enactment of amendments to sections 2010 and 2631 of the Internal Revenue Code of 1986. The Committee updated this report in 2004 and is now further updating the proposal. This proposal is based on HR 5970 and not the version approved in 1992, except that this Report unlike HR 5970 applies to the GSTT as well as the gift tax and the estate tax. Like HR 5970, this Report assumes unification of the gift and estate tax.

The proposal would amend subsections 2010(c) and 2505(a), providing for the transfers of any unused portion of the applicable credit amount (unified credit) of a deceased spouse to the surviving spouse. For the most part the proposal adopts the amendments to section 2010(c) set forth in the “Estate Tax and Extension of Tax Relief Act of 2006,” H.R. 5970 (109th Congress), which the House of Representatives passed on July 29, 2006. The amount of the transferable credit would not be limited to the tax that the property transferred to the spouse would generate but instead would be equal to the transferor spouse's entire (otherwise unused) applicable exclusion amount. This proposal would also amend subsection 2631 to create a new Section 2631(c) allowing the transfer of any unused portion of a decedent's GST exemption to the decedent's surviving spouse.

The Committee recommends re-adoption of the proposal as set forth and explained in this report. The Committee's report first explains the provisions of current law and the need for change, and then describes the proposed amendments to sections 2010, 2505 and 2631.

Current Law

By operation of the applicable credit amount, each decedent's estate is entitled to exclude a portion of its assets from estate taxation. The amount that is excludable is known as the “applicable exclusion amount,” as set forth in section 2010(c)(2).

As amended by the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), the applicable exclusion amount for estate tax purposes is $2,000,000 in the case of decedents dying in 2008 and $3,500,000 in the case of decedents dying in 2009 reduced, in effect, however by the amount of the credit used to offset gift taxes otherwise payable. For gift tax purposes, the credit is equal to the tax generated by the first $1,000,000 of taxable transfers made by the individual.

Under EGTRRA, no estate taxes are imposed for decedents dying in 2010.

To the extent that the applicable credit amount is not used against taxable transfers by the individual, it is lost.

Each individual is entitled to a GST tax exemption under section 2631. Since 2003, the GST exemption is equal to the estate tax applicable exclusion amount. To the extent that the exemption is not allocable to GST transfers made by the individual during life or at death, it similarly will be lost.

Marital Deduction Planning

Under sections 2056 and 2523, transfers to the decedent's (surviving) spouse are deductible from taxable transfers, and thus do not generate a transfer tax against which the applicable credit amount can be taken. In other words, an individual who transfers all property to his or her spouse does not pay a tax but does not utilize the otherwise available credit. On the spouse's subsequent death, however, all of such property then remaining will be includible in that spouse's estate.

In the case of spousal estates of more than the applicable credit amount, accepted estate planning makes some of the assets taxable at the death of the first spouse to die, and the balance at the death of the surviving spouse, so that the applicable credit amount of each can be used. In the simple case of combined assets of $4,000,000 (in 2008), for example, the usual plan would result in $2,000,000 being subject to taxation in the estate of the first spouse to die, but not in the estate of the survivor. This result typically is obtained in estate planning documents through a formula that takes into account gifts made during lifetime that reduce the applicable credit amount as well as other adjustments. At least $2,000,000 is subject to taxation in the estate of the survivor. In each estate, the tax generated by the transfer tax is sheltered by that individual's applicable credit so no estate taxes are owed.

This type of transfer tax planning necessitates the creation of trusts to manage some or all of the family's joint assets. The only practicable way to prevent the property protected by the applicable credit amount of the deceased spouse from being subject to transfer taxation in the estate of the surviving spouse is to put the property in a trust over which the surviving spouse does not have any “strings” that would trigger gross estate inclusion. Even if the surviving spouse does not need a trust for property management purposes, such a trust must be created for tax planning reasons.

GST Exemption Planning

Each spouse is entitled to a $2,000,000 GST exemption (in 2008). It therefore is possible for a husband and wife collectively to shelter $4,000,000 worth of assets from the generation-skipping transfer tax (the “GST Tax”). In order to do so, however, each spouse must make a transfer of $2,000,000 that will be subject to the GST tax.

Unless the surviving spouse has sufficient assets to effectively use his or her GST exemption, the only practicable way to effectively utilize both spouses' GST exemptions, while preserving the resources for the use of the surviving spouse, is to create trusts. Generally, one or more trusts are structured so that the transferor's GST exemption can be applied to them (a credit shelter trust and/or a “Reverse QTIP Trust”). The balance of the assets then will pass to the surviving spouse in such a way that they will be includible in his or her gross estate (that is, either outright or in a marital trust), so that the surviving spouse will be, or will be deemed to be, the “transferor” of those assets under section 2631(a), allowing his or her GST exemption to be allocated to it.

For both estate tax and generation skipping transfer tax purposes, the amount that can be potentially sheltered from tax increases to $3,500,000 per individual in 2009. There is no GST tax for transfers occurring in 2010. The provisions of EGTRRA cease to apply after 2010 in accordance with the “sunset” provisions of EGTRRA.

Reasons for Change

Current transfer tax law can unnecessarily dictate the testamentary plans of decedents because trusts must be created to take advantage of the applicable credit amount and GST exemption allocable to the first spouse. Testators who otherwise would want to leave the entire estate to the surviving spouse outright are forced to put the property in trust in order to take advantage of these amounts.

In addition, in order for the estate of the first spouse to die to take advantage of the applicable credit amount, he or she must have in his or her estate assets at least equal to the “applicable exclusion amount” (that is, the amount of assets sheltered from tax by the applicable credit amount). This may require asset transfers from the wealthier spouse to the poorer spouse that might otherwise be unnecessary, undesirable, not practical either legally or practically, or otherwise inconsistent with the couple's overall planning.

This issue became increasingly acute under EGTRRA because the amount that can potentially be protected from the estate and GST tax has increased in steps to $2 million currently and $3,500,000 for 2009. In order to take maximum advantage of these exclusions, each of the spouses must have at least this amount in each's individual name. Further, assuming if the “sunset provisions” of EGTRRA take effect, that is, the amounts that can be protected are reduced to pre-EGTRRA levels after 2010, the amount so transferred will prove to have been unnecessary.

Married couples should be able to transfer assets with the protection of their combined applicable credit amounts regardless of the happenstance of who dies first, and regardless of their level of sophistication.

Couples can continue to utilize credit shelter trust planning if they prefer for tax or other reasons. Credit shelter trusts can result in somewhat lower overall estate tax costs for a couple since the appreciation of the assets held in such a trust will not be subject to estate tax whereas it would be if held by the surviving spouse outright. In addition, couples may prefer to leave all or a portion of their assets in trust for a survivor for non-tax reasons, e.g. financial management, protection against remarriage, an improvident spouse and the like.

Under the proposal, an individual cannot retransfer to a subsequent spouse any applicable credit amount or GST exemption that such individual acquires from a deceased spouse and does not use during such individual's lifetime or at his or her own death. The credit can be used by a surviving spouse only if a United States citizen or resident at time of death.

Proposed Amendment of Sections 2010(c)

Section 2010(c)

(c) Applicable Credit Amount-

(1) IN GENERAL- For purposes of this section, the applicable credit amount is the amount of the tentative tax which would be determined under the rate schedule set forth in section 2001(c) if the amount with respect to which such tentative tax is to be computed were the applicable exclusion amount.

(2) APPLICABLE EXCLUSION AMOUNT- For purposes of this subsection, the applicable exclusion amount is the sum of:

(A) the basic exclusion amount, and
(B) in the case of a surviving spouse, the aggregate deceased spousal unused exclusion amount.

(3) BASIC EXCLUSION AMOUNT-

(A) IN GENERAL- For purposes of this subsection, the basic exclusion amount is $_________
(B) INFLATION ADJUSTMENT- In the case of any decedent dying in a calendar year after 2010, the dollar amount in subparagraph (A) shall be increased by an amount equal to--

(i) such dollar amount, multiplied by
(ii) the cost-of-living adjustment determined under section1(f)(3) for such calendar year by substituting 'calendar year 2009' for 'calendar year 1992' in subparagraph (B) thereof.

If any amount as adjusted under the preceding sentence is not a multiple of $100,000, such amount shall be rounded to the nearest multiple of $100,000.

(4) AGGREGATE DECEASED SPOUSAL UNUSED EXCLUSION AMOUNT For purposes of this subsection, the term .aggregate deceased spousal unused exclusion amount' means the lesser of--

(A) the basic exclusion amount, or
(B) the sum of all deceased spousal unused exclusion amounts of the surviving spouse.

(5) DECEASED SPOUSAL UNUSED EXCLUSION AMOUNT- For purposes of this subsection, the term 'deceased spousal unused exclusion amount of the surviving spouse' means, with respect to each deceased spouse (of the surviving spouse) dying after December 31,2009, the excess (if any) of:

(A) the basic exclusion amount of the deceased spouse, over
(B) the amount with respect to which the tentative tax is determined under section 2001(b)(1) on the estate of such deceased spouse.

(6) SPECIAL RULES-

(A) RETURN REQUIRED- A deceased spousal unused exclusion amount may not be taken into account by a surviving spouse under paragraph (5) unless the executor of the estate of the deceased spouse files a timely filed (including extensions) estate tax return or sets forth adequate information on a timely filed (including extensions) income tax return, as provided in instructions, regulations or directions, or fon11s prepared by the Secretary, for the deceased spouse from which one can determine the deceased spouse's unused exclusion amount.

(B) EXAMINATION OF PRIOR RETURNS AFTER EXPIRATION OF PERIOD OF LIMITATIONS WITH RESPECT TO DECEASED SPOUSAL UNUSED EXCLUSION AMOUNT Notwithstanding any period of limitation in section 6501, after the time has expired under section 6501 within which a tax may be assessed under chapter 11 or 12 with respect to a deceased spousal unused exclusion amount, the Secretary may examine a return of the deceased spouse to make determinations with respect to such amount for purposes of carrying out this subsection,

(7) REGULATIONS- The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subsection.

Proposed Amendment of 2505(a)

2505(a)

(a) GENERAL RULE.- In the case of a citizen or resident of the United States, there shall be allowed as a credit against the tax imposed by section 2501 for each calendar year an amount equal to-

(1) the applicable credit amount under section 2010(c) which would apply if the donor died as of the end of the calendar year, reduced by

(2) the sum of the amounts allowable as a credit to the individual under this section for all preceding calendar periods.

Proposed Amendment of Section 2631

Section 2631 (c)

(c) GST EXEMPTION AMOUNT-

(1) IN GENERAL- For purposes of subsection (a), the GST exemption amount for any calendar year shall be the sum of: (A) the basic exclusion amount under section 2010(c) for such calendar year, and (B) in the case of a surviving spouse, the aggregate deceased spousal GST unused exemption amount.

(2) AGGREGATE DECEASED SPOUSAL GST UNUSED EXEMPTION AMOUNT- For purposes of this section, the term 'aggregate deceased spousal GST unused exemption amount' means the lesser of--

(A) the basic exclusion amount, or
(B) the sum of all deceased spousal GST unused exemption amounts of the surviving spouse.

(3) DECEASED SPOUSAL GST UNUSED EXEMPTION AMOUNT- For purposes of this section, the term ' deceased spousal GST unused exemption amount of the surviving spouse' means. with respect to each deceased spouse (of the surviving spouse) dying after December 31, 2009, the deceased spouse's unused GST exemption remaining after application of section 2632(e).

(4) SPECIAL RULES-

(A) RETURN REQUIRED- A deceased spousal GST unused exclusion amount may not be taken into account by a surviving spouse under paragraph (3) unless the executor of the estate of the deceased spouse tiles a timely tiled (including extensions) estate tax return or sets forth adequate information on a timely filed (including extensions) income tax return, as provided in instructions, regulations, directions, or forms prepared by the Secretary, for the deceased spouse from which one can determine the deceased spouse's GST unused exclusion amount.

(B) EXAMINATION OF PRIOR RETURNS AFTER EXPIRATION OF PERIOD OF LIMITATIONS WITH RESPECT TO DECEASED SPOUSAL UNUSED EXCLUSION AMOUNT Notwithstanding any period of limitation in section 6501, after the time has expired under section 650 I within which a tax may be assessed under chapter 13 with respect to a deceased spousal GST 6 unused exemption amount, the Secretary may examine a return of the deceased spouse to make determinations with respect to such amount for purposes of carrying out this subsection.

(5) REGULATIONS- The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subsection.

Explanation of Amended Sections 2010 and 2505

Amended sections 2010 and 2505 provide that an individual transfers to the surviving spouse any unused portion of his or her applicable exclusion amount.

The amount of the credit that can be transferred to a surviving spouse is defined by proposed section 2010(c) as the basic exclusion amount in excess of the tax imposed on the transfer of the deceased spouse's estate. A taxpayer can accumulate credits from prior spouses but cannot transfer those accumulated credits to a surviving spouse. In other words, transfer of credit is allowed only between spouses who were in privity - that is, were married to each other. The aggregate amount that can be accumulated is the amount equal to the exclusion amount at the time of the surviving spouse's death.

The Committee believes that no estate would want to decline the transfer of an available credit. Accordingly, the proposal presumes that any unused exclusion amount is transferred to the surviving spouse; that is no election is required.

H.R. 5970 did not appear to require privity between spouses. It is unclear whether the drafters intended this result. The accompanying explanations do not provide insight into the drafters' intentions on this issue. The Committee believes that if Congress intends to allow portability from spouse to spouse to spouse without privity, it should make that policy judgment explicit. If the policy judgment underlying portability without privity was not considered in the drafting of H.R. 5970, that judgment should be made now. While acknowledging that this is a judgment call that lawmakers should make, the Committee believes that a privity requirement would adversely affect very few spouses and that most spouses would find privity to be a natural and acceptable requirement.

In some cases, there will be a revenue increase as a result of portability since the assets transferred outright to a surviving spouse may appreciate during the spouse's lifetime which appreciation then will be taxed at the death of the surviving spouse. If the first decedent creates a credit shelter trust the appreciation in the assets of the trust is not taxed at the death of the surviving spouse. On the other hand, revenue may be lost in the case of taxpayers who are not currently engaging in estate tax planning, including those whose estates consist primarily of jointly held property and other non-probate assets that pass entirely to the surviving spouse.

The examples below illustrate the application of the proposed amendments. Each example assumes that S has not made any lifetime gifts, unless otherwise stated.

Example (1): The Decedent, D, has made no prior taxable gifts and has a gross estate of zero. At D's death, the basic exclusion amount as defined in section 2010(c)(3) is $2,000,000. D's surviving spouse, S, dies un-remarried when the basic exclusion amount is $2,000,000. S's applicable exclusion amount is $4,000,000, which is the sum of the basic exclusion amount at S's death plus D's unused exclusion amount.

Example (2): Assume the facts in example (I), except D has separate assets of $2,000,000, all of which he leaves to S. S's applicable exclusion amount is $4,000,000, which is the sum of the basic exclusion amount at S's death plus D's unused exclusion amount.

Example (3): Assume the facts in example (I), except D has separate assets of $1,000,000 all of which he leaves to his daughter. S's applicable exclusion amount is $3,000,000 which is the sum of the basic exclusion amount at S's death of $2,000,000 plus D's unused exclusion amount of$I,OOO,OOO.

Example (4): Decedent, D, has made $500,000 of prior taxable gifts and has separate assets of $500,000, all of which he leaves to his daughter. At D's death, the basic exclusion amount is $1,000,000. D's surviving spouse, S, dies un-remarried when the basic exclusion amount is $2,000,000. S's applicable exclusion amount is $2,000,000, which is S's basic exclusion amount. The deceased spousal unused exclusion amount is zero because the basic exclusion amount at D's death was $1,000,000, all of which was consumed by the $500,000 of prior taxable gifts and the $500,000 bequest to D's daughter.

Example (5): Assume the same facts in example (4), except after D's death, S marries D2. D2 has made no prior taxable gifts, and has a gross estate of $1,000,000 all of which he leaves to his daughter. At D2' s death, the basic exclusion amount is $2,000,000. S's applicable exclusion amount is $3,000,000 which is the sum of S's basic exclusion amount of $2,000,000 plus D2's unused exclusion amount of$I,OOO,OOO.

Example (6): Decedent, D, has made no prior taxable gifts and has separate assets of $2,000,000, all of which he leaves to his spouse S. At D's death, the basic exclusion amount is $2,000,000. After D's death, S marries D2. D2 has made no prior taxable gifts and has separate assets of $2,000,000, all of which he leaves to S. At D2's death, the basic exclusion amount is $2,000,000. S dies when the basic exclusion amount is $2,000,000. S's applicable exclusion amount is $4,000,000, which is the sum of S's basic exclusion amount of $2,000,000 plus the aggregate deceased spousal unused exclusion amount of $2,000,000. The aggregate deceased spousal unused exclusion amount as defined in section 2010(c)(4) is capped at the basic exclusion amount of $2,000,000 at S's death.

Example (7): Assume the same facts as in example (6), except the basic exclusion amount is $4,000,000 at S's death. S's applicable exclusion amount is $8,000,000, which is the sum of S's basic exclusion amount of $4,000,000 plus D's unused exclusion amount of $2,000,000 plus D2's unused exclusion amount of $2,000,000.

Example (8): Decedent, D, has made no prior taxable gifts and has separate property of $2,000,000 all of which he leaves to his spouse, S. At D's death, the basic exclusion amount is $2,000,000. S dies un-remarried with an estate of $3,000,000. At S's death the basic exclusion amount is $1,000,000. S's applicable exclusion amount is $2,000,000, which is the sum of the basic exclusion amount of $1,000,000 at S's death and the aggregate deceased spousal unused exclusion amount as defined in section 2010(c)(4) of $1,000,000, which is capped at the basic exclusion amount at S's death of $1,000,000 even though D had an unused exclusion amount of $2,000,000.

Example (9): Decedent has made no prior taxable gifts and has separate property of $2,000,000, all of which he leaves to his spouse, S. At D's death the basic exclusion amount is $2,000,000. After D's death, S marries D2. S has made no prior taxable gifts and has separate property of $4,000,000, all of which she leaves to D2. At S's death the basic exclusion amount is $2,000,000, and therefore S's applicable exclusion amount is $4,000,000, which is the sum of S's basic exclusion amount of $2,000,000 plus D's unused exclusion amount of $2,000,000. D2 dies un-remarried. At D2's death the basic exclusion amount is $3,000,000. D2's applicable exclusion amount is $5,000,000, which is the sum ofD2's basic exclusion amount of $3,000,000 plus S's unused basic exclusion amount of $2,000,000. This assumes D's unused exclusion amount is not carried over to D2, with whom D had no privity. If privity were not required, then D2's applicable exclusion amount would be $6,000,000, which is the sum ofD2's basic exclusion amount of $3,000,000 plus the lesser ofD2's basic exclusion amount of$3,000,000 or S's unused applicable exclusion amount of $4,000,000.

Example (10): Decedent has made no prior taxable gifts and has a gross estate of zero. At D's death the basic exclusion amount is $2,000,000. After D's death, D's surviving spouse, S, gifts $4,000,000 during a year when the basic exclusion amount is $2,000,000. S's applicable exclusion amount is $4,000,000, which is the sum of the basic exclusion amount at the time of the gift and D's unused basic exclusion amount of $2,000,000. S incurs no gift tax in the year of the gift.

Explanation of Amended Section 2631

Amended Section 2631 would allow for the transfer of the decedent's unused GST exemption. The proposal allows a decedent to bequeath the entire estate to the surviving spouse and leave to the surviving spouse the making of generation-skipping transfers.

The proposal thus avoids the necessity for decedents to create GST trusts in which the surviving spouse has an interest, in order to utilize the GST exemption. The proposal does not prevent the creation of GST trusts by the decedent to take advantage of leveraging inherent in the time value of money.

The Committee believes that most estates with significant GST tax exposure already take advantage of the planning opportunities to avoid the GST tax. Thus, the proposal should merely simplifY the planning process, without significant loss oftax revenue.

The following examples illustrate the application of amended section 2631:

Example (1): Decedent D has made no prior gifts and dies owning $1,500,000, all of which D leaves to D's spouse S. D dies when the basic exclusion amount is $2,000,000. S dies un-remarried when the basic exclusion amount is $2,000,000. S's GST exemption is $4,000,000, which is the sum of the basic exclusion amount of $2,000,000 in the year of her death and D's unused GST exemption of $2,000,000.

Example (2): Assume the same facts in example (I), except D dies with no assets. S's GST exemption is $4,000,000, which is the sum of the basic exclusion amount of $2,000,000 in the year of her death and D's unused GST exemption of $2,000,000.

Example (3): Decedent D has made no prior gifts and dies owning $2,000,000, of which D leaves $1,000,000 to D's grandchild GC (the child of D's son) and $1,000,000 to D's spouse S. D's son survives D. D dies when the basic exclusion amount is $2,000,000. D's executor does not affirmatively allocate D's GST exemption instead relying on the GST deemed allocation rules. S dies un-remarried when the basic exclusion amount is $2,000,000. S's GST exemption is $3,000,000, which is the sum of the basic exclusion amount of $2,000,000 in the year of S's death and D's unused GST exemption of $1 ,000,000 remaining after the deemed allocation of $1 ,000,000 left to GC.

Example (4): Decedent, D, has made no prior gifts and dies owning $2,000,000, all of which he leaves to a trust which provides all the net income to his son for life with the trust assets passing to D's grandchild GC upon D's son's death. D dies when the basic exclusion amount is $2,000,000. D's executor does not affirmatively allocate GST exemption and affirmatively elects out of the GST deemed allocation rules as permitted by section 2632. D's spouse, S, dies un-remarried when the basic exclusion amount is $2,000,000. S's GST exemption is $4,000,000, which is the sum of the $2,000,000 basic exclusion of $2,000,000 and D's unused GST exemption of $2,000,000. S or S's executor cannot allocate S's GST exemption to the testamentary trust established by D since S is not the transferor of that trust.

Example (5): Decedent D has made no prior gifts and dies owning $2,000,000 all of which he leaves to his spouse S. D dies when the basic exclusion amount is $2,000,000. After D's death, S marries D2. S dies with $4,000,000, all of which she leaves to D2. S made no prior gifts. At S's death, the basic exclusion amount is $2,000,000, and therefore S's GST exemption is $4,000,000, which is the sum of S's basic exclusion amount of $2,000,000 plus D's unused exclusion amount of $2,000,000. D2 dies un-remarried when the basic exclusion amount is $3,000,000. D2's GST exemption is $5,000,000, which is the sum of the basic exclusion amount of $3,000,000 at D2's death and S's unused GST exemption (traceable to her own basic exclusion amount) of $2,000,000. This assumes that D's unused GST exemption goes unused and cannot be transferred to D2, with whom D had no privity. If privity were not required, then D2's GST exemption would be $6,000,000, which is the sum of D2's basic exclusion amount of $3,000,000 plus the lesser of D2's basic exclusion amount of $3,000,000 or S's GST exemption of $4,000,000.

BIOGRAPHY FOR SHIRLEY L. KOVAR FOR SENATE FINANCE COMMITTEE HEARING ON PORTABILITY, APRIL 3, 2008

Shirley L. Kovar is a trusts and estates attorney with the law firm of Branton & Wilson in San Diego, California. She is a certified specialist by the State Bar of California in trusts and estates law, and she speaks and writes on trusts and estates subjects. She is a Fellow in the American College of Trusts and Estates Counsel where she chairs the Transfer Tax Study Committee. Shirley is an academician in the International Academy of Estate and Trust Law. Shirley has also served as a member and adviser to the Executive Committee of the California State Bar Section on Trusts and Estates, where she chaired the Litigation Committee and served as Liaison of the Executive Committee to the California Law Revision Commission on the no contest clause. Shirley is past chair of the Trusts and Estates Section of the San Diego County Bar Association. Shirley is listed in Super Lawyer Magazine as among the top 5% of trusts and estates lawyers in Southern California, Shirley graduated from the University of Kansas Law School in 1974, where she served as Editor in- Chief of the Kansas Law Review and was a member of the Order of the Coif. Shirley lives in Coronado, California with her husband of37 years, Linn S. Kovar.

[1] The estate, gift and GST exemptions technically operate as a “unified (cumulative) credit” against the tax, but for simplicity they are commonly referred to as exemptions and in most cases operate exactly as exemptions would.


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