The last three years have witnessed substantial changes in federal estate and gift tax laws and more changes are undoubtedly coming.  Such changes offer a number of opportunities for clients to achieve their estate planning goals at reduced or no transfer tax costs.

Where We Are Now on Transfer Taxes

The 2010 Tax Relief Act, for estates of persons dying in 2011 or 2012, increased the federal estate tax exemption for each taxpayer to $5 million for 2011 and $5,120,000 for 2012 and decreased the maximum federal estate tax rate to 35% on the value of the taxable estate above the exemption amount.  The Act also adopted a concept called “portability” for married individuals.  If the first spouse to die does not have sufficient assets to claim his or her entire estate tax exemption, then the unused exemption may be transferred to the decedent’s surviving spouse.  The portability concept currently only applies for decedents dying in 2011 or 2012.

The 2010 Act also increased the federal generation-skipping transfer (GST) tax  exemption to $5 million per taxpayer in 2011 and $5,120,000 in 2012; however the GST tax exemption is not portable between spouses.

The lifetime federal gift tax exemption was also increased to $5 million per taxpayer for gifts made in 2011 and $5,120,000 for gifts made in 2012, and is portable between spouses.

Changes in Transfer Taxes if No Action by Congress

As discussed below, there are several proposals made by the President and members of Congress for changes to the transfer tax laws.  However, it is not clear whether Congress will agree to any changes before the laws put into place by the 2010 Tax Act expire at the end of 2012.  If the laws under the 2010 Tax Act do expire without action by Congress, the laws as they were in effect prior to the 2001 Tax Act will become applicable again. The estate and gift tax exemptions will revert to $1 million with a maximum tax rate of 55% on the excess over the exemption.  The GST tax exemption will also revert to $1 million (adjusted for inflation).  Also, the concept of portability for estate and gift tax exemptions between spouses taxes will no longer be available.

President’s Proposals

The Administration’s 2013 budget proposals include a number of provisions related to estate, GST, and gift taxes.  If these proposals should be adopted, beginning on January 1, 2013:

• The exemptions for federal estate and generation-skipping transfer taxes would be $3.5 million and the gift tax exemption would be $1 million.  The top estate, gift, and GST tax rates would be 45%.
• The portability concept for estate and gift tax exemptions between spouses would be made permanent.

The President’s Budget proposals also include changes in popular strategies presently used in estate and gift tax planning:

• Certain discounts in the valuation of interests in family limited partnerships and limited liability companies (LLCs) would no longer be allowed.
• A minimum term of 10 years would be required for grantor-retained annuity trusts (GRATs).
• The attractiveness of the use of intentionally defective grantor trusts in estate planning would be reduced by requiring that the grantor trust be included in the deceased grantor’s estate for estate tax purposes, and gift taxes would be imposed on the grantor on distributions made by the grantor trust to other persons.
• The allocation of the GST tax exemption to a transfer to a perpetual or “dynasty” trust will protect that transfer from GST taxes for no more than 90 years.

Republican Proposals

Presidential candidate Mitt Romney’s position is that the estate tax, GST tax, and likely the gift tax should be repealed.

Year-End Planning

As indicated above, it is not clear whether (i) transfer taxes will be retained, exemptions lowered to $1 million, and rates increased if there is no action by Congress; (ii) an “intermediate” law will be adopted  by Congress with a $3.5 million exemption and a 45% tax rate, or (iii) there will be an outright repeal by Congress of the estate, GST, and gift taxes.  What is clear now is the status of the tax law for the remainder of 2012.

Strategies and Issues to be Considered for the Remainder of 2012

For clients with potential taxable estates in excess of $5 million and who can afford to make larger gifts, serious consideration should be given to making such gifts before year end.  Issues to consider include:

Should the gift be made outright, or in trust? 

What would be the terms of the trust? 

Who would be named as Trustee?

What is the appropriate asset to give?

• Real estate values are still depressed and may make an attractive asset for transfer, but consider if there is debt on the real estate.  The creditor may require such debt to be paid.  The property would have to be appraised; and if only a fractional share is given away, a valuation discount may be available.
• Business interests may be attractive assets for gifts.  If the asset to be transferred is an interest in a closely-held entity, an appraisal of the value of the interest to be transferred and applicable valuation discounts for lack of control and/or marketability will have to be obtained before the gift may be made. Action on obtaining an appraisal will have to be taken soon in order for the gift to be completed before the end of the year.  If the corporation has both voting and non-voting classes of stock, one question to consider is whether voting interests or non-voting interests should be transferred. 
• Marketable securities are typically the easiest asset to give, but consider whether the donor can afford to give up the income from such assets.
• Gifts may be outright, or in trust.  If the donor desires to retain an income stream from the assets transferred to a trust, it could be structured as a GRAT under which an annuity is paid to the grantor for a period of time and the remainder passes to the beneficiary.  Such trusts are often funded with marketable securities.  The donor could also transfer assets to a trust to benefit multiple generations of his family.  A GST trust would reduce total transfer taxes for the donor’s family on the assets transferred to the GST trust.  The GST trust would also provide protection from creditors and others (such as a divorcing spouse) who may attempt to reach the beneficiary’s assets.

Revision of Estate Plan Documents

Once the estate, GST, and gift tax laws for 2013 and beyond are determined, clients should consult with their advisor whether changes should be made in their estate planning documents.