There are just a few months left to address what some practitioners are calling the end of the “golden age” in estate planning. During a conference call in August 2012, John O. McManus, trusts and estates planning attorney and founding principal of McManus & Associates, discussed the “Top 10 Topics on the $5MM Federal Gift Tax Exemption” below.
1. The propaganda – why is it called the “golden age”?
- Gift tax exemption was always $1.0MM, meaning any gift in excess of that amount was subject to gift tax at a rate of up to 55%.
- The exemption was increased to $5.0MM, dramatically increasing the ability to make tax-free gifts.
2. The deadlines – what actually happens on January 1, 2013?
- Exemption retreats back to $1.0MM.
- It will take an act of Congress to increase the exemption over $1.0MM.
3. Future tax rates – what is the new estate tax rate starting January 1, 2013?
- There will be a 55% rate for estates in excess of $1.0MM.
- This is an increase of 20% over the current 35% estate tax rate.
4. Future tax benefits – what about projected appreciation of the gift?
- Once transferred, it is not just the gift that enjoys the exemption, it is also the growth that is outside the estate.
- The entire amount is free from both federal and state estate tax.
- Depreciated real estate and securities enable a gift of underappreciated assets.
5. State Estate Tax – what is the net state tax benefit if the $5.12MM Federal Exemption Amount remains unchanged?
- NJ: 8-12% on average, with the top rate at 16% for an estate over $10MM.
- NY: 3.5% to 12.45% for estates from $1.1MM to $15MM.
- CT: over $2MM a 7.2% rate; up to 12% for estate over $10MM.
6. State gifting limitation – is Connecticut’s $2.0MM gift tax free limitation the beginning of a trend?
- CT was the first state to reduce its estate tax exemption and is the only state that currently imposes a gift tax.
- 7.2% rate on gifts over $2MM; up to 12% for estate over $10MM (same as estate tax).
- Of the states that impose an estate tax, CT was one of the more liberal with respect to estate tax exemptions. There is a concern that states with more confiscatory tax regimes will consider following suit, particularly if the federal estate tax exemption does not retreat back to $1.0MM.
7. Gifts transferred into trust – is there any opportunity to access the gift or to change the beneficiaries?
- Yes, the grantor can appoint the spouse as trustee and beneficiary, which we recommend.
- The grantor may retain the option to borrow from the trust.
- If drafted correctly and with precision, there can be an opportunity for the grantor to receive the assets back after the spouse beneficiary dies and if there has been dramatic reversal in his or her personal finances.
- For years, we have had clients who wanted to move $1.0MM out of their estate to take advantage of the exemption, but they were concerned about access to the trust assets. Now that the exemption is increased to $5.0MM, this concern is exacerbated. As a result, we have developed a structure that allows for significantly greater flexibility.
- We also support procuring an insurance policy on the life of the spouse who is the trustee and beneficiary of the trust. If the spouse dies, there are then meaningful liquid assets available to the grantor to replace the spouse’s access to the trust as trustee and beneficiary.
8. Asset protection – can the gift truly be protected from creditors and plaintiff’s lawyers?
- Yes, and the spouse can serve as the trustee.
- We favor institutional trustees to accomplish this aim, and, at a minimum, we must preserve the right to transfer the situs of the trust to another state with stronger asset protection statutes.
- The trust can protect the assets from attack for those in high-risk professions, such as physicians, or those in second marriages, where the spouse wants to ensure the assets pass to the children of the first marriage.
9. Planning limitations after the gift is made – are there any additional strategies or is it just “one and done”?
- No, additional gift tax-free funding can take place provided that there is an unused amount of credit available. For example, if the gift tax exemption settles at $3.5MM in 2013, and a $2.0MM gift was made in 2012, there would still be a $1.5MM gifting opportunity.
- The trust can also purchase certain components of the family wealth which exceed available credits using the assets of the trust as down payments. These more valuable assets may constitute the more aggressive portion of the overall portfolio, so all prospective growth is outside of the estate.
10. What does President Obama say about the exemption? What does Candidate Romney say about the exemption?
- Mr. Obama wants to return to the 2009 levels. That would mean an estate tax exemption of $3.5MM and a gift-tax exemption of $1.0MM. The proposed top tax rate for both would be 45%.
- Romney wants to eliminate the estate and gift tax all together. He is taking the Republican party line to broaden his appeal to conservatives, even though he comes from one of the most liberal states in the nation.
- We have a mounting deficit, which will need, in part, to be bailed out with taxes.
11. What assets you use to fund the trust and why now if you wish to gift only $1.0MM?
- Many of those that we represent who are rushing to get some assets into the trust are using their residence or cash and then determining their approach for investing the money later. The residence can also be sold and the cash used for other investments or to purchase another piece of real estate.
- Others are using cash to buy large life insurance policies to “supercharge” the trust, and guarantee a significant return or investment after they pass away.
- Clients who want to give $1.0MM may say that there is no rush, but we always believe in the merit of (i) getting assets off the balance sheet; (ii) having those assets protected in a trust; and (iii) enjoying future growth that avoids federal and state estate tax.
McManus & Associates would welcome further discussion as you consider taking advantage of the “golden age” by December 31, 2012.