Planning opportunities and considerations for high net worth clients.
Tax legislation passed in December 2010 included an unexpected estate planning bonus--a lifetime gift, estate, and GST tax exemption of $5,000,000 per person. Unfortunately this increased exemption applies only for 2011 and 2012, creating a short window of opportunity for high net worth clients to reduce their estates through lifetime gifts.
The changes in the lifetime gift tax exemption didn't change the basic gifting rules, nor did they change the rules relating to the annual gifts that can be made totally free of tax.
The annual gift tax exclusion is still in effect:
The lifetime gift tax exemption has been modified:
Gift Tax Return
A gift tax return needs to be filed only in years when taxable gifts are made. Gifts less than $13,000 per individual do not need to be reported. (However, if a couple makes a gift of up to $26,000 but splits the gift between the spouses, then a return does need to be filed so the spouse that did not own the assets can elect to use his/her exclusion.) All gifts over these amounts are recorded on the gift tax return. Over many years of gifting, the returns bring forward the cumulative taxable gifts that have been made. It is important to understand that, although they are called taxable gifts, there is no actual tax due as long as the lifetime gift tax exemption hasn't been exceeded.
The lifetime gift tax exclusion is a "unified" amount, meaning that you can use the $5,000,000 either for gift taxes or estate taxes, but not both. When the client passes away, the final gift tax return indicates the amount of the exclusion already used for lifetime giving, and only the excess can be used to pay estate taxes. For example, if John has a $7,000,000 estate and decides to make a gift of property worth $5,000,000 to his four children, the amount of the taxable gift will be $4,948,000 (the excess over four annual gift exclusion amounts of $13,000, or $52,000 total). When he dies several years later, only $52,000 of the exemption is available to offset the value of the remaining assets in his estate, with the excess subject to estate taxes.
You can make gifts of all types of property, including cash, securities, real estate, businesses, jewelry, and other personal property. You need a qualified appraisal for everything other than cash and publicly traded securities. And remember that the tax basis for the property carries over from the donor to the donee and is not stepped up to fair market value at the time of the gift.
Planning Opportunities for High Net Worth Clients
In order to benefit fully from the increased exemption, clients need a high net worth, as well as assets that will appreciate in value. It goes without saying that before making irrevocable gifts of this magnitude, clients need to understand the economics of the transaction and be assured that it doesn't reduce their net worth to an unacceptable level.
Most clients hesitate to make large outright gifts to their children and heirs, so you need to be familiar with sophisticated strategies to transfer assets. Most people want assurances that the funds will be available for several generations and protected from creditors or predators. With the GST exemption at $5,000,000, these multi-generational transfers are finally a possibility.
Some techniques to consider are:
Beware of Unanticipated Consequences
There are several unknowns that may come to play in the future, which makes the outcome of this type of gift planning uncertain. For one, the $5,000,000 lifetime exemption is set to expire at the end of 2012 and revert to $1,000,000. If you make a gift using the full exemption now, how will the excess $4,000,000 be treated for decedents dying after 2013? There is a possibility that the IRS could "claw back" the excess amount into the estate and tax it at current rates. Or it is possible that Congress will extend the $5,000,000 exemption to future years.
Less favorable outcomes will occur when gifts are made to trusts that have specified terms that the client does not outlive, or when the assets that are gifted do not appreciate in value. Consider the QPRTs that were set up and valued in 2007 with homes that have now lost 30% of their value.
Shifting a highly appreciating asset to the next generation by making a gift now to avoid paying tax on the higher value at the time of death can be a smart tax decision. Be sure, however, to run the numbers to determine if the tax benefits outweigh the cost of the transaction, and make sure your clients are aware of any potential pitfalls.
And, of course, gifts are irrevocable, so be sure clients don't give away assets they might need later in life.
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