The Window of Gifting Opportunities May Be Closing Quickly
June 19, 2012
On December 17, 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Jobs Creation Act of 2010 (the "2010 Tax Relief Act"). The 2010 Tax Relief Act unified the estate tax with the gift tax, instituting a $5 million exemption that could be used either during lifetime or at death. The generation-skipping transfer ("GST") tax exemption was also increased to $5 million. An equally encouraging tax rate for gift, estate and GST taxes was set at 35%. However, these gift, estate and GST rules were only scheduled to be in effect through the end of 2012. We are quickly approaching the cut off date and the likelihood that Congress will act prior to the upcoming November election is doubtful.
On January 1, 2013, if Congress does not act, the gift, estate and GST tax laws will revert to January 1, 2001 levels. Specifically, the federal estate tax and gift tax exemption will be only $1 million and the maximum tax rate will be 55%. The GST tax exemption will also decrease to $1.3 million with a maximum GST tax rate of 55%. The decrease in the gift tax exemption from $5,120,000 ($10,240,000 for married couples) to $1 million ($2 million for married couples) is probably one of the most significant changes.
The time has come to consider taking advantage of current historical gifting opportunities before they potentially vanish on December 31, 2012. There are a number of different ways to gift. Assets can be transferred by simple outright gifts or by forgiving outstanding loans. More sophisticated gifting methods can involve trusts which permit the donor to control how the assets will be held, managed and disbursed by the designated trustee.
There are significant advantages to gifting an asset during lifetime over transferring the same asset at death. Most notably, any income and future appreciation of the gifted asset will be outside the donor's taxable estate, thereby escaping imposition of estate tax.
For example, assume that on June 1, 2012, David gives $5,000,000 worth of securities to his son, Steven and that he has not previously used any of his gift tax exclusion. This transfer will not trigger a gift tax but will use $5,000,000 of David's estate/gift tax exclusion. If David dies in 2032with a taxable estate of $5,000,000, even assuming that the federal exclusion is then $5,000,000 with a 50% combined federal and state estate rate, $2,500,000 of estate taxes will be due. Meanwhile, Steven has happily watched his $5,000,000 gift of securities conservatively double every 10 years and increase to $20,000,000 by 2032. If the gift had not been made, David's taxable estate would have included the additional $20,000,000 of securities and caused a $10,000,000 estate tax liability. By making the gift, David's family saved $7,500,000 in estate taxes.
The benefits of lifetime gifts can be compounded when the gift is made in trust. First, the trust can be structured to shield the gifted assets from the claims of creditors, including spouses in the event of divorce. In addition, by allocating a portion of a donor's generation-skipping tax exemption to the transfer made in trust, the trust assets can be held for the benefit of children and future generations without ever being included in their estates for estate tax purposes.
While lifetime gifting obviously has its advantages, individuals may be hesitant to use their remaining gifting exemption because the donor is required to relinquish control of the gifted property. However, there may be a way for married couples to have their cake and eat it too. A spousal access trust allows the Trustee to make discretionary distributions of trust assets to the donor's descendants, as well as the donor's spouse. Therefore, although the donor may not directly benefit from the gift trust, the donor's family (through the donor's spouse) may receive distributions of trust assets as long as the distribution standard set forth in the trust agreement is satisfied. This alternative may provide the flexibility needed to make an individual comfortable with taking advantage of the window of gifting opportunity available through the end of this year.
When it comes to analyzing your options, we can help determine the potential tax savings associated with many different types of lifetime gifting strategies while also identifying and weighing the associated risks.