On December 17, 2010, Congress enacted the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Act”), which substantially increased the amount of property an individual could gift during their lifetime free of gift tax. Specifically, the 2010 Act raised the lifetime gift tax exemption from $1 million in 2010 to $5 million for 2011 and $5,120,000 for 2012. Gift tax rates were also decreased from a top rate of 55% in 2009 to 35% in 2010, 2011 and 2012. Additionally, the generation-skipping transfer (GST) tax exemption (which allows assets to pass for multiple generations free of transfer tax) was increased from $3.5 million in 2009 to $5 million in 2010 and 2011, and $5,120,000 in 2012.
These higher exemptions and lower rates, however, could vanish in less than 6 months. The 2010 Act only implemented these generous exemptions and rates through 2012. Beginning January 1, 2013, the gift and GST tax exemptions are scheduled to drastically decrease to $1 million and approximately $1.4 million, respectively. Gift tax rates will also revert back to a top rate of 55%. With the transfer tax being such a polarizing issue among political parties, it is unknown whether the gift and GST tax exemptions will reach 2012 levels again in the near future.
There are numerous ways to utilize your lifetime gift tax exemption during the last few months of 2012. Here is a list of a few of the most common methods:
1. Transfer interests in family businesses – Gifts of voting or nonvoting interests in a family LLC, partnership or corporation can be a great use of the exemption. You can retain control of the business by maintaining sufficient voting interests, yet the donee has a vested interest in the future success of the company. Additionally, valuation discounts can often be applied for transfers of minority or non-marketable interests, thereby leveraging the amount of assets transferred to the donee.
2. Fund a Irrevocable Life Insurance Trust (ILIT) – Life insurance can be used in an estate plan in numerous ways, such as providing liquidity for the payment of estate tax or leveraging the use of gift and GST exemption. If you have an existing ILIT, consider gifting cash to enable the ILIT to (i) pay premiums for years to come, (ii) pay-up the existing policy or (iii) acquire a better policy. If you do not have an ILIT as part of your estate plan, consider creating one.
3. Create a spousal/family trust – You may be hesitant to give away millions of dollars out of concern that your spouse may need the money someday, but you still want to take advantage of the increased gift and GST tax exemptions. By creating a family trust for the benefit of a spouse (and descendants if desired), you can use your exemption, remove the property from estate tax at your death and the death of your spouse and create a “rainy day” fund for your spouse in the event a need arises in the future.
4. Create a dynasty trust – This is one of our personal favorites. By making a gift to a trust that is structured to last for multiple generations, you can remove the gifted assets and the appreciation and income on those assets from the estate tax for up to 360 years in Florida! The dynasty trust can even be structured to grow tax-free to the beneficiaries during your life by allocating the tax burden to you and not the trust. Your payment of the income tax would not be treated as an additional gift.
5. Cancel existing debts – Perhaps you loaned money to family members, friends or trusts at minimal interest rates to help the borrower(s) purchase property, invest in a business, etc. If you do not need the loan payments, consider forgiving the balance of the debt. Canceling a debt can be a great way to remove a burden on the borrower without incurring gift tax.
These are just a few of the options available to utilize gift and GST tax exemptions. Before making any gifts, however, you should always be sure to fully consider how the gift will affect you. Here a few considerations to keep in mind when deciding what to give and how much:
1. What are your cash flow needs and will they be met after the gift is made? Does this asset produce income that you need or want to maintain your lifestyle? Although making gifts in 2012 is great tax planning, you may not be anxious to reduce your living expenses to accommodate these gifts. If cash-flow is a concern, consider gifting non-income producing assets, such as a vacation home, life insurance, or vacant land.
2. What is the tax basis of the gifted asset? Appreciated assets generally would receive a stepped-up basis at your death. In contrast, an asset that you transfer by gift generally will have the same basis in the hands of the donee as it did in your hands. An important question to ask is whether the benefits of the gift outweigh the loss of the stepped-up basis. A few techniques are available, however, to make gifts while preserving the opportunity to get a stepped-up basis at your death.
3. Is there a chance you or your spouse will need this specific asset at some time in the future? If so, careful planning will be necessary to ensure that the asset can be reacquired in the future without losing the tax benefits of the gift.
4. Do you trust that the donee will manage the gifted asset appropriately? We generally advise clients to always make gifts in trust because of the numerous tax and non-tax benefits afforded by a trust. If the donee is not prepared to take control of the gift, or is simply too young to receive the gift outright, make the gift in trust and designate someone you can rely on to properly manage the trust assets.
If you are interested in taking advantage of the increased gift and GST exemptions and/or lower rates in 2012, we encourage you to act soon. The benefits afforded by many gifts are enhanced when proper planning and due diligence are done in advance. Moreover, appraisals may be needed and can take weeks or months to have prepared. With less than 6 months left until the gift and GST exemptions are scheduled to revert back to $1 million and $1.4 million, respectively, time may be running out.