This article is intended to provide an update on the implications of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Act”). Previous articles and communications have explained these changes to the law, but it is important to consider these issues again at this time since many of the provisions of the 2010 Act are set to expire at the end of this year.
In particular, we recommend that you give careful consideration to the following information if your assets are likely to be subject to estate tax and you desire to make current irrevocable gifts to reduce your estate below the likely taxable threshold. There is a current window of opportunity to make nontaxable transfers up to a total of $5 million during your lifetime or upon your death. As discussed in more detail below, this window may be narrowing for lifetime gifts and for transfers at death.
Without further action by Congress, on January 1, 2013, the maximum gift and estate tax rates will increase from 35% to 55%, and the gift and estate tax exemption amount will drastically decrease from a current unified amount of $5.12 million to $1 million. Further, the generation-skipping transfer (“GST”) tax rate will also jump from 35% to 55%, and the GST exemption will likewise drop from $5.12 million to $1.43 million.
If a change in the exemption amount has the potential to impact your estate plan, and if doing so is otherwise consistent with your estate planning goals, you may wish to consider making lifetime transfers in the near future. This may minimize the possibility that passage of a retroactive tax bill would result in a loss of the availability of the current exemption amount for those transfers.
There are many methods available to take advantage of the current gift and GST exemption amounts. You should consult with your estate planning attorney to determine which, if any, of these (or other) techniques is appropriate in light of your particular financial situation and estate planning goals.
The most straightforward way to transfer wealth during life is the outright gift. As a reminder, in addition to the availability of the lifetime gift tax exemption amount, the benefit of the “annual exclusion” is available for any gift of a present interest. The annual exclusion amount for 2012 is $13,000. Further, now may be the opportune time to gift assets outright to grandchildren due to the current availability of a $5.12 million GST exemption amount which may be reduced in the near future.
Gifts to Trust
An irrevocable trust can be a powerful estate planning tool. Funds transferred to an irrevocable trust (along with any appreciation) may be removed from your taxable estate. However, if properly drafted and executed, those trust funds may still be expended for the benefit of your spouse or children during your lifetime. Irrevocable trusts can also be tailored to provide for your beneficiaries and increase the protection of these assets from the claims of the beneficiaries’ creditors.
Types of irrevocable trusts that allow the grantor to retain an interest include Qualified Personal Residence Trusts (“QPRTs”), which are designed to hold your personal residence for a specified term prior to distribution to your intended beneficiaries. Grantor Retained Annuity Trusts (“GRATs”) leave the grantor the right to receive payments from the trust for a set number of years prior to distribution to the beneficiaries. A primary benefit of these two types of trusts lies with the valuation discount available for gift tax calculation purposes. Another type of irrevocable trust is the irrevocable life insurance trust (or “ILIT”) designed to exclude the proceeds from the taxable estate of the insured. There are other types of irrevocable trusts that may also be appropriate under certain circumstances.
In contrast, gifts to a revocable trust, sometimes referred to as a “living” or “inter vivos” trust, are generally not completed gifts, since the trust can be changed or revoked by the grantor at any time. Therefore, use of the lifetime exemption amount is generally not available for gifts to a revocable trust. However, there may be other reasons one may wish to transfer assets to a revocable trust.
A Quick Note on Portability
The 2010 Act also created the concept of portability. Generally, portability allows a surviving spouse the use and benefit of any unused estate tax exemption amount previously allocated to the deceased spouse who died during 2011 or 2012. For example, if Husband died having utilized $1.12 million of his exemption, the remaining $4 million could be transferred to Wife to result in a total exemption available to Wife of $9.12 million. Regarding portability, we offer four important reminders: (1) it is not available unless it is affirmatively elected on an estate tax return of the first spouse to die, (2) remarriage of the surviving spouse will alter the availability of portability treatment, (3) while most commentary suggests that portability will remain a part of the law beyond this year, the concept is part of the 2010 Act and is thus currently scheduled to expire at the end of this year, and (4) portability treatment is not available for the GST exemption.
Keeping an Eye on Clawback
Under current law, if there is indeed a reduction in the available exemption amount, there may be the possibility for “clawback” wherein an amount that was transferred tax free during life is taxed at death by operation of the reduced exemption amount in effect at the time of death. This can be of particular concern to clients who want to avoid payment of any estate tax until the death of a surviving spouse. It should be noted that most practitioners believe that this issue will be remedied legislatively. An in-depth discussion of the clawback issue is beyond the scope of this article, so please consult with your estate planning attorney for more details.