As 2010 winds down, Congress’ failure to address the temporary repeal of estate and generation-skipping transfer (“GST”) taxes has created a number of planning opportunities. The federal estate tax was repealed on January 1, 2010, but is scheduled to be reinstated on January 1, 2011, at which point the federal estate tax exemption will be only $1 million and the maximum estate tax rate will be 55% (compared to the 2009 exemption of $3.5 million and rate of 45%). The GST tax will also be reinstated on January 1, 2011, with an exemption of $1.3 million and a maximum GST tax rate of 55% (compared to the 2009 exemption of $3.5 million and rate of 45%). At this point, the likelihood that Congress will act in 2010 to reinstate the estate and GST taxes, potentially even retroactively to January 1 of this year, is becoming more remote.
While estate and GST taxes were temporarily repealed, the federal gift tax has remained in effect, with a lifetime exemption of $1 million. For gifts made in excess of the lifetime exemption, the gift tax rate dropped from the 2009 level of 45% to its lowest rate in more than 75 years - 35%. This rate only applies to taxable gifts made in 2010. Combining the current economic climate and resulting lower asset valuations with the current gift tax rate, 2010 presents an incredible opportunity to transfer wealth at a much lower transfer tax cost.
By way of example, if an individual who has used her $1 million gift tax exemption were to give $1 million to her children this year, she would be required to pay gift tax of $350,000. If she had made that gift in 2009, she would have paid $450,000 of gift tax, and if she makes that gift in 2011, she would have to pay $550,000 of gift tax. The benefits of gifting become even more pronounced if the gift is of an asset with a significantly low current value and is likely to appreciate considerably in the future. If the same individual chose not to make the $1 million gift, the $1 million asset, plus all future appreciation on it, would be subject to estate tax on the individual’s death, at an estate tax rate possibly as high as 55%.
With no GST tax in 2010 and a gift tax rate of 35%, outright gifting to grandchildren presents a once-in-a-lifetime planning opportunity. If the outright gifts to grandchildren exceed both the annual exclusion amount and the $1 million lifetime gift tax exemption, they will be subject only to the current 35% gift tax rate. This is in stark contrast to the result if the same gifts were made in prior years – not only would the gifts have been subject to the 45% gift tax rate, but they also would consume GST exemption (or, if all of the donor’s GST exemption had been used, result in the imposition of GST tax at a rate of 45%). In 2011, the same gift will be subject to gift tax at a 55% rate and will also consume GST exemption.
Some clients are not inclined to give assets away, but are willing to part with some portion of the future appreciation. Several estate planning techniques can be utilized to achieve that result. One of the most attractive options is a GRAT (a grantor retained annuity trust). Basically, a GRAT provides an annuity to the person creating the trust (the grantor), with the remainder of the trust’s assets passing to the named beneficiaries at the end of the designated term. The required annuity to the grantor is based on (i) the trust term, which can be as little as 2 years, (ii) the value of the assets contributed to the GRAT, and (iii) the current required interest rate (published by the IRS, currently a record-low of 2%). The result is that virtually all appreciation on the contributed assets can pass without the imposition of gift tax. Some members of Congress have expressed interest in severely limiting the effectiveness of GRATs by imposing a minimum term of 10 years and a required taxable gift. Until Congress acts, however, the GRAT remains an extremely effective planning tool.
While the estate and GST tax landscape is uncertain and has many waiting to see what Congress will do, there are currently attractive gifting opportunities available – but you need to act soon. Many of these strategies may only be available through the end of 2010.