The mad rush for new estate tax exemptions

Trying to guess what Congress will do with the death tax laws is like playing family planning roulette. In fact, there are bets and odds on whether the law changes will continue.

On Dec. 17, 2010, Congress bestowed a real gift on those with enough wealth to worry about what everyone thought was going to happen: anticipation of stiffer taxes. Thanks to Congress, it turned out to be a fool’s rush (at least for years 2010 through 2012). There were rushes to avoid what everyone thought Congress was going to do – increase estate and gift taxes to a maximum of 55 percent rate at $1 million exemptions.

Instead of bringing back the old 55 percent rate, Congress implemented a 35 percent tax rate. Not only that, it increased the estate tax exemption from $3.5 million to $5 million. But, they weren’t done. Congress also raised the lifetime gifting exemption to $5 million (in 2009), meaning that you could gift $5 million to your heirs during your lifetime that would be exempt. Additionally, if you are married, you and your spouse can have a combined $5 million and it is portable, meaning that one spouse can use what the other spouse didn’t use in their estate – up to $10 million.

The act is creating a new rush to take advantage of these higher tax exemptions. Estate planners are urging their clients to act before the latest law expires in 2012. Like they advised prior to Dec. 17, they are telling their clients that it’s better to be safe than sorry because who can predict what Congress might do in 2012? The assumption is that we will be back to the $1 million minimums and 55 percent tax rate as the government seeks answers to its budget deficit. But, there’s an equally popular notion that once levels of taxation are set, they seldom revert back.

So, the question for the wealthy and reasonably wealthy becomes, “Do I join the herd and start giving my fortune away to my heirs?” My answer is that following the herd may be the wrong thing to do. It also might be the right thing but it depends on your situation, your expectations and the size of your estate.

In general, the law:
• Favors the very rich who have estates over $20 million; and

• Benefits people with estates between $5 million to $10 million, as they will have a simpler plan to understand.

Before, you had $1 million that you could gift without tax but now, one has $5 million to work with on gifting. As a result, the very wealthy can gift much more without paying a gift tax. In addition, they could use family limited partnerships and the ability to discount the value of assets to gift a greater percentage of their estate.

However, they may want to take advantage of the $5 million exemption by gifting assets outright so that control and appreciation of gifted assets are totally out of their estate just in case the estate gift tax reverts back to different levels.

As you can see, it works for the wealthy and of course, works for those with assets of less than $5 million. But what if you are 65 years old and have $11 million? Your health is good and you and your spouse still want to take that trip around the world. While you feel it important that the $11 million in your estate not go to the IRS, you could be left with less than you need for the next 20 years if you gift all but $1 million away to your heirs.

Similarly, say you are an investor and believe you can grow those assets and need them to be liquid or at least to be in control of them in order to invest properly. If you outright gift them, you may no longer have control.

No one knows what will happen by 2013, not even Congress. They could extend the current rules or revert back to the pre-2010 rules with a $3.5 million estate exemption and $1 million gift exemption. So, is it worth considering 2011 and 2012 as “high opportunity years?” Secondly, if the rules do revert back, there will be a question as to how the utilization of the $5 million enters into the estate/gift calculations – the so-called “claw back calculation,” though few people believe this would actually be implemented.

In the meantime:
• Consider gifts up to the $10 million (jointly) if this can be done easily without destroying quality of life, which has many factors.

• Consider gifting discounted assets that will cause your estate to come back down to $3.5 million/$7 million just in case, and if you can afford to do so. An example of a discounted asset would be an asset that has been “fractionalized,” or divided among separate beneficiaries. Because the asset has been divided, it is worth less than what it was.

• Always determine how life insurance is includible in your estate. Many people forget about death benefits when calculating their estimates.

• Monitor your plans more frequently to see if you need to quickly change them due to Congressional changes.

• Consider cleaning up outstanding intra-family loans. Treat these as gifts.

• For GST tax (in 2010 there was none), make sure you elect out of the Automatic Allocation features. This allows you to determine the proper allocation to GST whose exemption is $5 million.

• Watch state laws – they may start to decouple from the federal estate laws to enhance revenue. Currently, 15 states and the District of Columbia impose their own estate taxes separate from the federal government.

• Simplify family loans, installment sale notes, etc.

• Consider large gifts to trusts for estate tax and creditor protection.

• Use the $4 million additional gift-out if the belief is that the gift amount will revert in 2013.
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Categories: Finance