Share the Wealth, Escape the Tax

Say you’ve reached your “golden” years and have socked away enough bounty to eventually leave your heirs a nice financial cushion. Maybe, in fact, your nest egg totals well into the millions of dollars. If so, now would be a great time for you to remember the adage: You can’t take it with you.

Most wealthy people have done a modicum of estate planning by the time they reach “seniorhood,” but to the surprise of financial advisers, a lot of sophisticated, high-net-worth individuals and couples have failed as yet to seize on the rare opportunity presented by current estate and gift tax laws.
Here is the news in a nutshell: The heirs of a person who dies during 2012 leaving an estate valued up to $5.1 million will receive those assets completely free of federal estate tax.

The better news is, you don’t have to die to take advantage of the benefit. Through the end of 2012, a living individual may give up to $5.1 million – or $10.2 million for a married couple – to a child or grandchild without incurring the ordinarily hefty gift tax.

This unusual opportunity arises from a series of tax law changes made in Washington, D.C. When President Obama extended the George Bush-era tax cuts in late 2010, he also signed into law a large two-year increase in estate and gift tax exemptions that previously were capped at $1 million. As a result:

• For a taxpayer who dies before Dec. 31, 2012, leaving an estate with a net value of $5.1 million or less, the estate can pass to beneficiaries tax-free. Portions of the estate above that benchmark will be subject to a tax rate of 35 percent.

• As an alternative, an individual or couple can give up to $5 million or $10 million to grandchildren or great-grandchildren without incurring gift tax, because the new exemptions also apply to the federal generation-skipping transfer tax.

Unless Congress and the president act to extend these laws – a possibility no one should count on – the above benefits will expire at year’s end. With estate, gift and generation-skipping tax exemptions slated to drop to $1 million on Jan. 1, 2013, and the related tax rates set to rise to 55 percent, both giving and dying will become more expensive next year.

“The pressure is on to make substantial gifts before the end of the year because nobody knows what will happen after the November election,” says Kenneth Weiss, a tax lawyer who heads the estate planning practice in the McGlinchey Stafford law firm in New Orleans.

Weiss says he’s been working with a number of clients to plan how they’ll use the gift provisions to pare down their estates before 2012 ends. The easiest method is simply to write checks to the lucky recipients. “Cash is always in good taste,” Weiss quips. But he adds that individuals’ wealth often lies not in their bank accounts but in closely held businesses, which makes gift-giving trickier.

In order to give away a portion of a business, the owner must obtain a valid assessment of the company’s value, and that figure must satisfy the Internal Revenue Service. “It takes some time to get a good and proper valuation of a business, so you don’t want to wait too long to start,” Weiss says.

Whatever the form of the gift – cash, stock, a business, real estate or collectibles – the donor also will have to make decisions about how the transfer will occur. Often, assets move from an owner into a trust for the future benefit of the recipient. If the beneficiary is a minor, there may be restrictions on when and how he or she receives the assets.

One of the most important benefits of making gifts under current law is the opportunity to move assets tax-free into other hands where they can grow larger through investment or appreciation. By using the generation-skipping tax provision, for instance, parents could put up to $10 million into a trust for grandchildren and even future great-grandchildren in such a way that no tax will be due on the gift until the death of the great-grandchildren.
Meanwhile, the gift could greatly increase through investment, and the beneficiaries could use the income, possibly for a long time, without touching the principal.

Weiss points to another key feature of the federal gift tax law: It applies whether or not the gift is made to a relative.

“It’s particularly important to plan for nontraditional family units, like gay and lesbian, or heterosexual couples who don’t choose to get married,” he says. “A lot of New Orleans clients are in nontraditional family units, and the $5 million exemption is an important tool for them.”

Advisors are urging clients to examine their estate needs now in order to avoid facing difficult decisions at the end of the year. Determining who should get what can be a thorny and emotionally challenging process. “There are issues of control and family that can lead to discord,” Weiss says.

But the benefits of plunging ahead may outweigh the consequences of a delay. “Next year the tax exemptions drop to $1 million and the tax rate for gifts above that amount goes to 55 percent,” Weiss notes. “So if you’re in a position to make a substantial gift to children or others, this is the year the year to do it.”

Nuts and Bolts
Here are the key provisions of current tax laws that affect estate planning. These laws are slated to expire at the end of 2012.

Estate tax. Federal estate tax exemption this year stands at an all-time high of $5,120,000 per taxpayer. (The amount represents an inflation adjustment from the $5 million applicable in 2011.) The exemption applies to the estate of a person who dies in 2012 and didn’t make previous substantial gifts from the estate.

Gift tax. The lifetime exemption applicable to the federal gift tax also is $5,120,000 ($10,240,000 for a married couple) through the end of 2012. This exemption is in addition to, and doesn’t include, smaller annual gifts of up to $13,000 that are excluded from the tax under a separate provision.

Generation-skipping tax. The lifetime exemption from the generation-skipping transfer tax allows gifts in the same amounts as above to grandchildren and great-grandchildren. This exemption applies to the total of all gifts, whether made directly to children or to more remote descendants.

Givers should be aware that tax laws are always subject to a “clawback” – a future tax law change that could take back some of the benefits of current laws. An advisor can help assess the benefits and potential downsides of making gifts.