Bay Area families that have yet to take advantage of the current gift tax exemption are running out of time. As of midnight on December 31, 2012, the $5 million exemption disappears and will be replaced by a $1 million exemption. As it stands right now, gifts in excess of $1 million given after January 1, 2013, will be taxed at a whopping 55% top rate!
Last year, Congress raised the gift tax exemption from $1 million per year to a whopping $5 million per year ($5,120,000 per person, to be precise). In addition, the estate tax rate has been reduced from 55% to 35%. However, the increased exemption and reduced rates will last for only the 2011 and 2012 fiscal years, making it imperative to act now to create and revise estate plans to take advantage of these extraordinarily favorable terms.
According to the IRS, the gift tax occurs when a person or estate transfers money or property to another either for nothing or for something less than the full value of the property. Congress passed the tax specifically in response to wealthy individuals trying to avoid the estate or “death” tax by giving away their assets prior to death. Before this year, the relatively low threshold of the gift tax exemption discouraged large pre-death bequests.
I have previously said that those with a high net worth should do advanced estate planning beyond a basic will. The generous gift tax exemption currently in place makes now the best time to leverage any gifts into ones that hold greatly increased potential value for the recipients. Some strategies include:
LLC: Starting a LLC and then making a large gift to capitalize the company. It’s important to note that the process of creating an LLC takes time; all the necessary documents have to be drafted and then approved by the Secretary of State. A prudent planner would need to begin the process right away if he wishes to take advantage of the favorable exemption.
FLP: Related to starting an LLC is the pooling of assets into a Family Limited Partnership. I have previously discussed the benefits of such partnerships here.
Trusts: Another option involves placing certain gifts in trusts. We advocate using various kinds of trusts to protect assets from creditors and con artists alike. This article from the Wall Street Journal contains an excellent rundown of the various trusts one can create to take advantage of the gift tax exemption. Some trusts, such as the Grantor Retained Annuity Trust can be structured so that there are no gift tax consequences.
Real estate: Real estate, much like closely held businesses, is notoriously hard to value and can greatly increase in worth over time. One only needs to look at the massive increase in home values in the Bay Area over the past 25 years (or the dip for the past several) to know how volatile the real estate market can be. Home prices may be lower now, but can increase in value substantially over the next decade or two, increasingly the value of the gift for the recipient. The current economic environment, in which many asset values are depressed and interest rates are at historic lows, actually makes this a perfect time to make gifts, since these factors can really help maximize the benefits of gifting.
Even if you can only afford to give smaller gifts between $1 million and $4.999 million (small being a relative word), it would still be wise to take advantage of this generous exemption before the year’s end and the $5 million ceiling expires. If you have not yet tried to take advantage of the exemption, you need to act quickly. The likelihood of Congress extending this exemption is widely seen as unlikely given that it is an election year.
Creating a gift plan that will suit your individual needs takes time. Appraisals, business valuations, and trust documents must often be created in order to ensure the gift tax exemption is applied properly in your situation. Talk to your California gift-planning attorney right away if you want to take advantage of the exemption before it ends.
Source: “The $5 Million Tax Break,” by Anne Tergesen, published at WSJ.com.