On December 17, 2010, President Obama signed into law 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 give away during their lifetime free of transfer 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. The generation-skipping transfer (GST) tax exemption (which allows assets to pass for multiple generations free of transfer tax) also was increased from $3.5 million in 2009 to $5 million in 2010 and 2011, and $5,120,000 in 2012. Additionally, gift and GST tax rates were decreased from a top rate of 45% in 2009 to 35% in 2010, 2011 and 2012. The 2012 exemptions and rates are the most favorable in history.
However, these higher exemptions and lower rates are scheduled to dramatically worsen in less than three (3) months! Current law provides that the gift and GST tax exemptions will revert to $1 million and approximately $1.4 million, respectively, beginning January 1, 2013. Gift and GST tax rates also will 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.
There are numerous ways you can utilize your lifetime gift and GST tax exemption during the last few months of 2012. Here is a list of a few of the most common methods:
1. Cancel existing debts – Wealthy individuals often loan money to family members, friends and trusts at minimal interest rates to help the borrowers purchase property, invest in a business, etc. Lenders are often indifferent about whether they are repaid in full because they view the loan as helping someone out, not as an investment relied upon for cash flow. Canceling a debt can be a great way to remove a burden on the borrower without incurring gift tax and reduce estate tax at the same time.
2. 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. Control of the business can remain with the donor, yet the donee can have a vested interest in the future success of the company. Additionally, valuation discounts are often applicable for transfers of minority or non-marketable interests, which leverages the use of the gift and GST tax exemptions, allowing more assets to be transferred to the donee.
3. Fund an 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 or income producing assets to enable the ILIT to:
(i) pay premiums for years to come
(ii) pay-up the existing policy
(iii) acquire a better policy.
If you currently do not have an ILIT, consider creating one.
4. Create a spousal/family trust – Some individuals are hesitant to give away millions of dollars out of fear that their spouse may need the money some day. By creating a family trust for the benefit of a spouse (and descendants if you choose), the donor can use up his or her exemptions, remove the property from estate tax at the deaths of donor and the donor’s spouse and create a “rainy day” fund for the spouse in the event a need arises in the future. You can even supercharge your spousal/family trust by making it exempt from GST tax, thereby removing the trust assets from transfer tax for several generations.
5. 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 assets of the dynasty trust can even grow tax-free to the beneficiaries during the donor’s life by structuring the trust as a grantor trust. This means that the donor, not the trust or the beneficiaries, will pay the income tax on income and gains on the trust assets, which is not treated as an additional gift.
These are just a few of the options available to utilize your gift and GST tax exemptions. Before making any gift, however, you should always fully consider how the gift will affect you. Here are 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 want or need to live on? Although making gifts in 2012 is a great idea, many people are not anxious to cut their 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 receive a stepped-up basis at the owner’s death. An asset transferred by gift generally will have the same basis in the hands of the donee as it did in the hands of the donor. Therefore, an important question to ask is whether the benefits of the gift outweigh the loss of the stepped-up basis. Nonetheless, techniques are available to make gifts while preserving the opportunity to get a stepped-up basis at 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 eliminating the tax benefits of the gift.
4. How should the gift be made? We generally advise clients to always make gifts into a trust for the benefit of the intended donee (rather than outright gifts) because of the numerous tax and non-tax benefits afforded by a trust. For example, assets within a trust can be shielded from a beneficiary’s creditors and pass free of estate tax at the beneficiary’s death. These benefits are generally not attainable if the donee creates a trust for his or her own benefit after receiving the gift. Moreover, contributing the gift to a trust for a donee permits someone other than the donee to manage the gift, which can be very advantageous in situations where the donee is a minor or incapable of managing the asset on their own.
If you are interested in taking advantage of the increased gift and GST exemptions and/or lower rates in 2012, now is the time to act! There are less than three (3) months remaining in 2012. Appraisers are already overwhelmed with requests relating to year-end gifts and it may take several weeks or even months for them to provide an oral opinion of value. Moreover, the options available for making gifts decrease as the end of the year draws closer.
We have been monitoring legislative proposals concerning the transfer tax and, at this time, it does not appear likely that any legislation will be enacted prior to year-end extending the 2012 exemptions and rates. This means there is a good chance that 2013 will begin with gift and GST tax exemptions of only $1 million and $1.4 million, respectively. It is anyone’s guess whether Congress will enact legislation in 2013 restoring the 2012 exemptions and rates. In fact, many practitioners are projecting that any legislation modifying the 2013 exemptions and rates would not provide laws as favorable as 2012.
If you have any questions concerning the transfer tax laws or are interested in learning about gifting opportunities that may be available to you, feel free to contact any member of the Dean Mead Estate and Succession Planning Department.