As we head into 2012, we are afforded another opportunity to employ wealth transfer strategies at unprecedented levels for at least one more year. I’ve put together this blog post to help you understand the major advantages presented by the government’s current set of gift tax rules, many of which may only remain available for a short time.
Significantly Greater Lifetime Gifts Can Be Made Transfer-tax Free
For 2011, the estate tax exemption is $5 million (indexed to $5.12 million for 2012) for inter vivos (lifetime) transfers with a top rate of 35%. This gives married couples up to $10 million in combined transfer capacity while altogether avoiding estate taxes. In addition, the marginal tax rate applicable to transfers in excess of this exclusion amount is at a historic low.
For the better part of a decade, there has been disparity between the amount that could be gifted transfer-tax free during one’s lifetime and the overall estate tax exemption applicable at death. For gifts made from 2002 through 2011, only $1 million in non-spousal* transfers could escape taxation through offset of one’s lifetime exemption. Increasing the allowable inter vivos transfer amount to $5 million gives taxpayers a wide berth of opportunity to shift assets to the next generation without incurring any federal estate tax liability.
Opportunities for Transfer-tax Free Growth
The expansion of the allowable gift tax exemption provides us with more avenues than ever before to transfer wealth tax free. This may prompt a rush to push down assets to future generations in order to take advantage of the expanded gifting limits. Despite this, avoid gifting with an irrational exuberance. All gifting strategies should contemplate cash flow needs of the grantor well into the future. Transfers of appreciable assets through such mechanisms as grantor retained annuity trusts (GRATs), sales to defective trusts, etc. can provide leverage for gratuitous transfers of assets in a tax-efficient manner. Just think of the possibilities of compound growth of assets for children and grandchildren when you have a 30, 40 or even 50 year time horizon – all occurring outside of the grantor’s estate. Along with this expanded gift tax exemption comes a gratuitous Generation-Skipping transfer tax exemption. Multi-generational transfers can be effected to bypass the estates of the grantor’s children altogether. This can be an effective device in dynasty planning situations or situational-specific areas, such as generating cash flows within Special Needs trusts of grandchildren. One caveat is to avoid transferring highly appreciated property at a fair market value that may be unsustainable or have significant potential for depreciation in the future. This will erode the grantor’s overall exemption without providing the recipient with the benefit of a stepped up income tax basis in the future.
Income Tax Basis Considerations
For federal estate tax purposes, decedents’ estates are valued as of the date of death (or alternate valuation date). Inherited property is afforded a stepped-up income tax basis to the date of death value of the property. Gifting, on the other hand, provides for a carryover basis. It is important to note that, in some cases, the transferee’s basis for gain or loss can be different for gifted property. A separate basis determination may be necessary upon the subsequent sale or disposal of gifted assets. This depends on the fair market value (FMV) of the asset on the date the transfer is made. Basis for determining income tax gain is determined by considering the property’s basis in the grantor’s hands (plus gift tax paid on amounts representing unrealized appreciation). Basis for deducting an income tax loss on business or portfolio assets is determined by the lesser of the grantor’s basis or FMV on the transfer date.
Proposed legislation limiting valuation discounts attributable to minority interests or for a lack of marketability have not yet taken hold, so contemplating such transfers on a timely filed gift tax return, with full supporting documentation such as a qualified valuation, can give effect to substantial savings. This legislation has significant impact on interests in closely-held assets such as family limited partnerships, which will want to consider that this type of limitation may be a very real possibility in the future.
Temporary Portability of Exemption between Spouses for 2011 & 2012
For individual decedents’ estates arising during 2011 or 2012, the executor can elect to apply any unused portion of the estate tax exemption of the first spouse to die to the surviving spouse’s estate. Although legislation has provided for portability of the estate & gift tax exemption amount, there is no similar provision for generation-skipping transfer tax portability.
Revisiting your estate planning documents may make sense where inherent provisions may have tied potentially-devised property to bypass or credit shelter trusts to the maximum estate tax exclusion. This may effectively (unintentionally) disinherit a spouse in situations where resistance may be anticipated as a result of subsequent marriages or where disclaimers could prove potentially ineffective. In addition, this may cause avoidable issues of limited accessibility or invasion restrictions imposed on the surviving spouse that are part and parcel of bypass trusts.
After 2012, the transfer tax exemption reverts back to $1 million. It is still undetermined whether a clawback of previously allowed exemption amounts will be invoked if tax rates revert to prior levels.
Annual Exclusion for Present-interest Gifts
As always, it is important to utilize each individual’s annual exclusion of $13,000 per recipient (for 2011 and 2012). Married couples can double this amount to $26,000 per recipient through effective utilization of gift-splitting. This is the amount of present-interest gifts which can be transferred annually (per recipient) without erosion of a taxpayer’s overall exemption.
Keep in mind that Congress can always find a way to upset even the most thoroughly conceived estate plan. Lack of certainty in the legislative environment, crushing budget deficits and economic woes facing whichever administration steps up to the plate in 2012 will all add pressure to the existing estate and gift tax framework. With a top federal gift tax rate slated to hit 55% in 2013 and political administrations poised to employ additional measures to tap into sources of tax revenues, there may be no better time than now to revisit your estate plan with your advisory team and leverage this opportunity before the window closes.
*Separate transfer tax limitations apply to non-U.S. citizen spouses
0 comment(s)