September 4, 2012

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Estate Planning Considerations

Tax Alert--Estate Planning Considerations Before Year-End
As you know, at the end of 2010 Congress passed a short-term fix to the estate and gift tax laws by a bill with the long-winded title: The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the "Tax Relief Act"). Between January 1, 2010, and December 31, 2012, the Tax Relief Act provided several important benefits for those subject to estate and gift taxes and the generation skipping tax.

The exclusion from estate tax was increased to $5 million (plus an inflation adjustment after 2010) and the estate tax rate over that exclusion amount was reduced to 35%. The Tax Relief Act also "unified" the gift and estate tax systems so that the exclusion amount for lifetime gifts is the same amount as the estate tax exclusion and use of the gift tax exclusion uses up an individual's estate tax exclusion, dollar¬for-dollar. The $5 million exclusion also applies to the generation skipping tax (the "GST") for gifts or testamentary bequests that are made to grandchildren and more remote beneficiaries. One further and important temporary change is that the Tax Relief Act created a concept called "portability," which allows a surviving spouse to add to his or her exclusion amount the value of the first spouse's estate that doesn't exceed the $5 million exclusion. (Please note that the Tax Relief Act has not altered prior law which allows a spouse to leave a surviving spouse any amount of assets without being subject to estate tax on the first spouse's death.)

There has been and continues to be much speculation and rumor on what Congress may do near the end of 2012 to address the temporary nature of the benefits provided by the Tax Relief Act. Prognostications on this matter are further complicated by a Presidential election year and by Congress's recent track record for partisan bickering and stalemate. If Congress takes no action on or before December 31, the estate and gift tax and the GST will revert to levels reached in 2001. This means that as of January 1, 2013, the estate and gift tax exclusions, as well as the GST, will be only $1 million and the tax rate for estate and gift taxes would be graduated up to 55% (with a 5% surtax for transfers over $10 million) and a flat 55% rate for all GST transfers over the exclusion amount.

We have no better "crystal ball" than others as to what Congress may do. There has been discussion in Congress about a number of possible resolutions, including making the Tax Relief Act permanent, repealing the estate tax altogether but leaving the gift tax and GST as law, making permanent or temporary an intermediate estate tax exclusion amount of $3.5 million and a gift tax and GST of $1 million, or extending the Tax Relief Act at some later date in 2013 for another short period, which could be done retroactively to January 1, 2013 or not. Because of all this uncertainty and the substantial benefits that the Tax Relief Act provides, we wanted to give you some of our ideas about possible actions to take before year end to take advantage of the Tax Relief Act and to allow you to have sufficient time to consider your options and permit us to assist you in a timely fashion if you do decide to act without a mad dash at year-end.

There are many techniques that can be used to accomplish life time gifting. They are dependent on what type of assets a person has, whether they are of a high or low basis and likely to appreciate or not, the donor's need for continuing income, and the needs of the potential beneficiaries, etc. Many of these techniques may be familiar to you and others may not. Examples include:

  • Gifts of Life Insurance -- creating an Irrevocable Life Insurance Trust ("ILIT") and funding future premiums in advance or purchasing a single-premium policy. The insurance proceeds are outside of your estate and can be used to buy assets from the estate or make loans to it if the estate owes taxes, and, if not, the proceeds can be directed to family or charitable beneficiaries.
  • Gifting a Residence -- using the Qualified Personal Residence Trust ("QPRT") technique or giving a remainder interest in a residence upon your death (a "non-QPRT"). Reduced home values now are helpful although our low interest rates can reduce the benefit somewhat.
  • Grantor Retained Annuity Trusts-- particularly useful for hard to value assets that do produce income, such as oil & gas or commercial real estate. These trusts allow one to receive a return of most or all of the assets given in the form of income at a set interest rate over a predetermined time period with the result that appreciation in the value of the assets is left in trust for your children or other beneficiaries.
  • Sale to an Intentionally Defective Grantor Trust-- This technique avoids current income tax on the sale of assets to the trust and allows the trust to purchase the assets from you with a promissory note at today's low interest rate. Appreciation on the assets passes free of estate and gift tax to the trust's beneficiaries.
  • Lifetime Gifts to a Credit Shelter Trust for Benefit of a Spouse Using Nonreciprocal Trusts -- This technique allows each spouse to be a beneficiary of the other's trust and receive current income and a testamentary gift where there is a concern about whether assets given away may still be needed to preserve one's lifestyle.
  • Family Limited Partnerships and Limited Liability Companies -- This technique allows interests in the entity to be gifted to family members using less of the gift tax exclusion due to discounts for lack of marketability and minority interests. Members of Congress continue to discuss the possibility of eliminating use of these discounts in any future estate tax legislation. 
  • Regardless of whether you decide to use one of these or other techniques to pass on assets outside of the reach of estate or gift taxes, we encourage you to make annual gifts of up to $13,000 ($26,000 with your spouse) to each of your children or others. These gifts do not eat into your lifetime estate and gift tax exclusion amounts. In addition, you are free to pay directly to schools and medical providers, without any dollar limit, the educational and medical expense of children and grandchildren. For those of you considering gifts valued at more than $1 million, we encourage you to consider doing so before year end in the event that Congress reduces the lifetime gift tax exclusion amount to $1 million in 2013, as has been proposed.

For those of you considering very substantial gifts that are intended to take advantage of the current $5.12 million exemption - which could be reduced in 2013 to somewhere between $1 million to $3.5 million under current Congressional proposals - we also encourage you to undertake such gifts before year end and contact us in the near future so that there is adequate time to structure such gifts and obtain appraisals as necessary.

Feel free to speak directly with any of our attorneys in our Trust and Estate Planning practice.