FURTHER UPDATE: Major Lifetime Gifting in 2012

Introduction: Federal Estate Tax, Gift Tax and Generation-skipping Transfer Taxes in 2012

As of September 2012, the December 2010 reforms to the federal estate, gift and generation-skipping transfer taxes will continue in effect at least through the end of 2012, as follows:

  • The federal estate tax has a $5,120,000 exemption (up from the 2011 $5,000,000 exemption amount because of an inflation adjustment), and a 35% flat rate.
  • The federal gift tax and generation-skipping transfer tax also have a $5,120,000 exemption and a 35% flat rate.
  • The beneficial “step up in income tax basis” rules continue.
  • The “portable exemption” rules will allow a surviving spouse who dies before January 1, 2013 to use a deceased spouse’s unused federal exemption.

Since December 2010, the Congress has done nothing to make these estate tax, gift tax and generation-skipping transfer tax reforms permanent, or to correct the “postponed gift tax” or “clawback” technical problem in calculating federal estate tax for decedents who make major lifetime gifts in 2011 or 2012 and die after 2012. In February 2012 the Obama administration again asked that the federal estate tax exemption amount be reduced to $3,500,000, that the federal gift tax exemption amount be reduced to $1,000,000 and that the portable exemption rules be made permanent.

The Washington estate tax continues in effect with the same $2,000,000 exemption and gross rates from 10% to 19%, and is still unlikely to change for the foreseeable future.

Prospects for 2013: Will the Congress Do Anything?

After 18 months the Congress gives every indication that it will do nothing with these rules before the November 2012 elections and, unless the election results are truly remarkable, do nothing before 2013 arrives.

Act Now if You Want to Make Major Lifetime Gifts

For this reason, many of our high net worth clients are making major lifetime gifts using their $5,120,000 federal gift tax exemptions. If you want to make such gifts, start planning now – don’t wait until the end of 2012.

Top Ten Ideas for 2012 Major Lifetime Gifts

With careful analysis and a little time, we can address the necessary tax issues (including the postponed gift tax issue), family issues and asset valuation issues, so that your gifting arrangements are completed before 2013. Here are 10 strategies worth considering:

  1. Prefund family distributions under your will or revocable living trust-in many cases, making such gifts now can easily be accomplished, postponing benefits to family members until your death.
  2. Use limited liability company or other business entity interests for the gifts-the key to making such gifts usually is getting started early on the valuation analysis.
  3. Give fractional interests in real estate, which can be valued using “fractional interest” discounts-there are a variety of joint ownership arrangements available to clarify post-gift management of such real estate assets.
  4. Sell limited liability company or other business interests to an “intentionally defective grantor trust”, taking back a low-interest installment note-for September 2012, a 9-year note can bear interest at an annual rate as low as 0.84%, a historic low for the mid-term Applicable federal Rate.
  5. Forgive a loan-if you made a low-interest loan to a family member and interest rates are lower now, consider forgiving (or at least restructuring) the loan using part of your gift tax exemption.
  6. Give away your residence using a “qualified personal residence trust”, retaining the right to live in the residence for a term of years-while QPRTs are not as effective when interest rates are low, they are still a practical, well-established way to leverage the gift tax exemption.
  7. Terminate a QTIP trust or make some other form of “net gift”-if you are a surviving spouse, consider terminating any marital deduction trust you received, to obtain beneficial “net gift” tax treatment. Or make some other form of gift requiring the donee to pay the gift tax.
  8. Establish an irrevocable life insurance trust, to create an estate tax-sheltered reserve fund-if you are insurable and the right life insurance product can be found, such a trust can be an efficient way to provide for post-death liquidity.
  9. Establish a charitable remainder trust or charitable lead trust, to give back to the community-by using well-established charitable remainder trust or charitable lead trust arrangements, leverage your gift tax exemption with the charitable deduction.
  10. Give cash to family members and friends-if none of the strategies described above seems right, keep it simple and give cash to those you love.

Why make gifts during 2012, when the federal gift tax exemption is high? There are four reasons: (1) diverting appreciation in the gifted asset to the donee, (2) diverting post-gift income to the donee, (3) transferring undervalued assets (like real estate), which might later appreciate, and (4) avoiding the Washington estate tax, since Washington has no gift tax.

Are there any reasons not to use certain assets for major lifetime gifts? There are. Here are two: (a) Highly appreciated assets might lose the beneficial step in income tax basis at death. (b) If you give away your liquid assets, they might be unavailable in your later years, when you really need them.

Steps to Take in Early 2013

If the Congress in fact does not act before the end of 2012 and, among other things, the $1,000,000 federal estate tax exemption returns, here are two steps to take in early 2013:

  • Review your estate planning documents-in particular, your will or revocable living trust-to make sure that any formula gift provision still works, given the $1,000,000 federal estate tax exemption.
  • For post-2012 gifts, focus first on the federal gift tax “annual exclusion”, currently $13,000.

The Riddell Williams Trusts, Estates and Personal Planning Group:   Michael D. Carrico, James W. Minorchio, Douglass A. Raff

PDF of News Alert.