Estate Tax Planning 2012
Potential Missed Opportunities
There is considerable uncertainty in today's tax planning environment. This is especially true in the area of estate and gift tax planning. Thanks to legislation passed by Congress in 2010, the gift and estate tax exemption are both $5.12 million and both rates are currently 35%. In addition, the unused exemption of a deceased spouse may carry over and increase the surviving spouse's unused exemption resulting in a surviving spouse's estate tax exemption that can total up to $10 million. In other words, an estate up to $10 million may be passed to surviving beneficiaries (e.g., children) intact without any federal estate tax. However, without Congressional action, gift/estate tax rates and exemptions will revert to pre-2001 levels of 55% and $1 million, respectively, in 2013. This makes 2012 a critical year to consider planning techniques that also may not be around after 2012. The following is a brief discussion of a few of these techniques.
Estate Value Freezing
One of the important elements of estate tax planning is freezing the value of property such that future appreciation is not subject to estate tax. Such value-freezing techniques include maximizing the use of the annual gift tax exclusion. Currently, an individual's annual gift tax exclusion per donee is $13,000. In other words, an individual may make a gift to a donee free of any gift tax up to $13,000 without incurring a gift tax. If the individual is married, an election is available to a husband and wife to treat the gift as having been made by one-half each resulting in an annual gift tax exclusion of up to $26,000 per donee without using any of their exemption. The gift plus any subsequent appreciation escapes future estate tax. Over a period of time this can be a very efficient strategy in passing value to family members free of estate tax.
Gifts in excess of the annual exclusion should also be considered. As the gift tax exemption may drop to $1 million in 2013, taking advantage of the present $5 million exemption may make sense in 2012 especially where gifts of this magnitude are planned for in the more immediate future. Any future appreciation of such gifts will also avoid estate tax.
grantor retained annuity trust (GRAT)
Certain estate/gift tax planning techniques are currently available but may soon become obsolete based on certain proposals. One such technique is the grantor retained annuity trust, otherwise known as the "GRAT.” With interest rates being at all time lows, the GRAT can be an effective means of transferring substantial wealth at a relatively low gift tax. This technique involves transferring property to a trust with intended heirs as beneficiaries. During the term of the GRAT the grantor receives an annuity interest. The gift is based on the value of the property going into the trust less the present value of the annuity interest. The lower the interest rate the higher the present value of the annuity interest and, therefore, the lower the value of the gift. The property passes to the trust beneficiaries at the end of the trust term. A tax free transfer to the trusts beneficiaries occurs where the property appreciates at a rate greater than the present value rate.
The longer the GRAT term, the greater potential of tax-free value transfer. However, a long term GRAT creates a dilemma in that the GRAT technique fails if the grantor dies during the GRAT term (the "mortality risk"). Specifically, the remaining property in the GRAT at date of death is included in the grantor's estate at date of death value. The longer the GRAT term the greater potential appreciation can be transferred estate tax free but also the greater the mortality risk. In many cases, a shorter term GRAT is created to minimize the mortality risk. Such shorter term GRATs can be structured as "laddered GRATs," where multiple trusts with different terms are set up, thus reducing the risk of an all or nothing inclusion in the grantor's estate upon death during the GRAT term.
There is a proposal in the Obama budget that would provide for a 10 year minimum GRAT term thus increasing the mortality risk. In view of this possibility, taxpayers who are considering the use of a GRAT may have a short term time horizon. The Obama budget would also retain the "portability" between spouses of unused exemptions but would also roll back to 2009 exemption amounts and rates of $3.5 million and 45%, respectively.
intentionally defective grantor trust (idgt)
The intentionally defective grantor trust, otherwise known as an "IDGT,” has many of the advantages of the GRAT without the mortality risk. This technique involves the grantor selling property (e.g., corporate stock) to the trust. The sale is ignored for income tax purposes but is recognized for estate and gift tax purposes. Thus, similar to the GRAT, subsequent appreciation in the property escapes estate and gift tax. Unlike the GRAT, there is no mortality risk. However, the IDGT has its own set of complexities such as a requirement to contribute seed money to the trust (generally 10% or more of the value of the property sold to the trust). The IDGT should be carefully considered under the right circumstances.
These are only 3 of many tax planning techniques that may have a short shelf life. Of course, all of these tax planning techniques should be considered in the context of non tax considerations such as the taxpayer's future cash flow needs and the comfort of transferring wealth to certain family members prematurely as well as many other personal and financial considerations.
With all of this uncertainty and 2012 possibly being a transition year into a much less tax friendly environment in 2013, it is a good idea to review your estate and gift plans with a qualified advisor.
Please contact Feeley & Driscoll's Boston Accounting team by Email or call us at 1 (888) 875-9770.
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