Estate, gift, and GST tax opportunities: Going, going, gone?
The current federal estate, gift, and generation-skipping transfer (GST) tax law presents a unique planning opportunity for high net worth taxpayers that may not be around for much longer. For the remainder of calendar year 2012, you can make lifetime gifts of up to $5,120,000 without the imposition of gift or GST tax. Depending upon your particular circumstances, there may be one or more gift planning options available to you to take full advantage of this situation.
The clock is ticking. When the calendar turns over on January 1, 2013, the law is scheduled to revert to a federal gift and estate tax exemption of only $1,000,000.
5/16/2012
Open PDF: Estate, gift, and GST tax opportunities: Going, going, gone?
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Act”) made some significant changes to the estate, gift, and generation-skipping transfer (“GST”) tax laws. One of the most impactful changes was the increase in the federal estate, gift, and GST exemption amount, which, for 2012, is $5,120,000 per taxpayer. This exemption amount, however, applies only until December 31, 2012.
As of January 1, 2013, the law is scheduled to revert to the way it was in 2001, which means a federal estate and gift exemption amount of only $1,000,000 per taxpayer.
The current federal estate, gift, and GST exemption, coupled with the scheduled impending reversion to the much lower exemption levels, provides unique and time-sensitive estate planning opportunities for taxpayers with significant wealth who wish to shift a portion of their assets to their children and more remote issue (as well as to other family members) in a tax efficient manner.
The following chart highlights some of the key changes to the federal estate, gift, and GST tax laws that we can expect based on the current state of the law.
| |
2012 |
2013
and after |
| Top estate tax rate |
35% |
55% |
| Estate tax exemption |
$5,120,000 |
$1,000,000 |
| Portability of unused estate tax exemption between spouses* |
Yes |
No |
| Top gift tax rate |
35% |
55% |
| Gift tax exemption |
$5,120,000 |
$1,000,000 |
| Gift tax annual exclusion |
$13,000 |
$13,000** |
| Annual exclusion for gifts to non-citizen spouse |
$139,000 |
$139,000** |
| GST tax rate |
35% |
55% |
| GST tax exemption |
$5,120,000 |
$1,390,000** |
* The concept of “portability” was also introduced as part of the 2010 Act and provides generally that the surviving spouse can take advantage of the unused estate tax exemption of the deceased spouse who has died in 2011 or 2012 without utilizing his/her exemption.
** Subject to inflation adjustment that is not yet available
Estate planning strategies for you to consider in 2012
For high net worth individuals, the current state of the gift tax law provides you with the ability to make lifetime gifts of up to $5,120,000 in 2012 without the imposition of gift or GST tax. As noted above, however, this opportunity may only be available for the remainder of 2012. Fortunately, there are many options available to you to take advantage of this unique situation. Depending on your particular circumstances, one or more of these options may be appropriate for you.
Long-term (or “dynasty”) trusts
The tax savings aspect of your estate planning is only one component of your overall plan and when contemplating a large gift other factors need to be considered as well. By using a long-term trust, also sometimes referred to as a “Dynasty Trust,” you have the ability to direct the timing and manner of enjoyment of your gift for many years in the future. In addition, by using a trust you can protect your beneficiaries from the claims of their creditors (which includes divorcing spouses) as well as from their own potential spendthrift habits. Dynasty Trusts can hold all types of assets, from cash and securities, to real estate to carried interests in venture funds or private equity funds.
Cash and property gifts
The most simplistic way to utilize the gift tax exemption is to make gifts of cash or property, such as marketable securities, to one or more beneficiaries, either outright or in trust. While outright gifts are appealing for their simplicity, they offer none of creditor and asset protection benefits associated with a trust and should only be considered in appropriate circumstances. In addition, with respect to any gift of cash or marketable securities, although such a gift provides you with the benefit of shifting future appreciation on the transferred assets to the recipient, there are potentially more efficient strategies to consider, as noted below.
Leveraged gifts
Depending upon the nature of the asset to be transferred as well as the structure in which that asset is currently held, some gifts may be able to be discounted for lack of marketability and/or lack of control, which enables you to transfer more value for each gift tax dollar. You might also consider making gifts of assets with depreciated values, which are likely to increase in value dramatically.
Family Limited Partnerships (“FLPs”) and Family Limited Liability Companies (“FLLCs”)
FLPs and FLLCs can be used in appropriate circumstances to create value by pooling resources in a single entity and transferring that value to younger generations without ceding complete control over the assets. Caveat: although Congress did not act to curtail the use of such vehicles (by limiting the fractional interest discounts that are typically applied to the transfer of ownership interests in such entities), FLPs and FLLCs are still on the IRS radar screen. Careful and thoughtful planning is a must, and respect for the underlying structure is imperative for success.
Irrevocable Life Insurance Trusts (“ILITs”)
Life insurance is another type of leveraged gift that may be an ideal strategy for “dynasty planning” by using your GST exemption. A properly drafted and funded ILIT (which might own insurance on one or more individuals) will exclude the proceeds of that insurance from the estates of both a husband and a wife. Traditionally, most ILITs make use of the $13,000 annual gift tax exclusion to pay the premiums on the insurance. Unfortunately, if your goal is to avoid making taxable gifts each year, this strategy limits the amount of insurance that can be purchased and depends upon the number of beneficiaries of the ILIT who can have so-called “Crummey withdrawal rights.” With the increased gift tax exemption amount, new strategies can be employed to purchase larger policies.
The ILIT strategy can also be useful if you already have an existing ILIT. For example, if you are currently using your annual exclusion to make gifts to the ILIT, you might want to pre-fund your ILIT with a large gift in 2012 so that no future gifts will be required to the ILIT to cover the remaining premium payments. This very simple cash gift relieves some of the administrative burden associated with the ILIT, and also “frees up” your annual exclusion gifts so they can be used in other ways (perhaps as outright gifts to your children who are now young adults).
Qualified Personal Residence Trusts (“QPRTs”)
This statutory technique involves the gift of a personal residence to a trust for the benefit of your children while retaining use of the residence for a specified period of time. Your retained interest in the house reduces the value of the gift, enabling you to transfer a valuable asset for something less than its full fair market value. In addition, a husband and wife (or any set of co-owners) may be able to take advantage of fractional interest discounts by each establishing his or her own QPRT. This strategy can be especially useful if your wealth is “tied up” in a personal residence (which can be a vacation property) and where you wouldn’t otherwise feel comfortable making cash gifts. Although the current low-interest rate environment reduces some of the effectiveness of this strategy, it is a tried and true statutorily permitted technique that is easily quantifiable.
Sales to intentionally defective grantor trusts
This strategy is used to “freeze” the value of an asset in your estate while transferring most of the appreciation to the beneficiaries of a trust. This strategy works by establishing an irrevocable trust that will purchase an asset from the taxpayer in exchange for a promissory note. To the extent that the asset increases in value (or generates income in excess of the required debt-service on the promissory note), such value will accrue for the benefit of the trust beneficiaries free of transfer tax. The key to this strategy, however, is having a funded irrevocable trust, and the gift tax exemption in 2012 offers the perfect opportunity for that funding. Even if you cannot currently identify an asset that might be sold to such a trust, by funding the trust today you set yourself up to be able to utilize this strategy in subsequent years with an adequately capitalized trust. Ideal assets for this technique include stock in S corporations, income producing real estate, or other closely held businesses with a predictable cash flow. Unlike GRATs (which are discussed below), this technique is also ideal for dynasty planning.
Grantor Retained Annuity Trusts (“GRATs”)
Another “freeze” technique, a GRAT, works by having you make a gift to a trust while retaining the right to an annuity from the trust over a fixed term of years. Because the value of the retained annuity is almost exactly equal to the value of the gift made to the trust, you have made only a very small taxable gift when setting up the GRAT. The upside to a GRAT occurs when the asset in the trust increases in value at a rate that exceeds the IRS’s deemed rate of return (which is currently very low). In order for the assets to be removed from your estate, you must outlive the trust term. In light of this constraint, many taxpayers utilize short term GRATs, which can be as short as two years. Despite the fact that this planning strategy actually utilizes very little of your gift tax exemption (and is therefore not designed to take advantage of your 2012 gift tax exemption), GRATs are still as viable as ever and are especially useful for assets such as income producing real estate, closely held business interests with a predictable dividend, stock in start-ups with high growth potential, and publicly traded securities deemed long-term holds in a taxpayer’s portfolio. Timing is still crucial with GRATs, however, as their minimum term has been the subject of much discussion in Congress and there is some concern that their utility will be diminished through legislative action.
Intra-family loans
While not a gift tax planning strategy per se because no actual gift is made, the current low interest rate environment offers a fantastic opportunity for you to transfer wealth to lower generations by making loans at the statutorily fixed interest rates. The following chart illustrates the prevailing rates for loans made to family members in May 2012 depending upon the length of the loan (and assuming annual compounding):
|
Term of Loan |
Lowest Applicable
Federal Rate for
May 2012 |
| Less than 3 years... |
.028% |
| More than 3 but less than 9 years... |
1.30% |
| More than 9 years... |
2.89% |
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