Don’t Let This Golden Window of Opportunity Close Before You Take Action

Denis P. Dillon
Director, Trusts & Estates Department
Published: Portsmouth Herald
March 1, 2011

In December 2010, President Obama signed a new federal tax act known as The Tax Relief, and Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the Act).  The Act substantially changes the federal estate and gift tax laws providing unique estate planning opportunities over the next two years.  The gift tax exemption jumped to $5,000,000 from $1,000,000 for individuals and to $10,000,000 from $2,000,000 for couples, allowing people to give away these amounts without paying gift tax.  The tax rate on gifts above those amounts plummeted to 35% from 55%.  The Act expires on December 31, 2012, unless Washington reauthorizes it, and this golden window of opportunity closes as well.

The Act “reunified” estate and gift tax exemptions. Thus, the Act also raised the estate tax exemption to $5,000,000 and lowered the estate tax rate to 35% for two years.  In prior years the gift tax exemption was significantly lower than the estate tax exemption, hindering gifting before death to reduce estate taxes.  This discouraged people from making large gifts. The significant increase in the gift tax exemption offers exciting new gifting opportunities for those wishing to make large lifetime gifts to family members, or others.

The Act increased the exemption for the generation skipping transfer tax (“GST”).  The GST tax is a tax on gifts from a donor or decedent to “skip persons” (e.g., in most cases the donor’s grandchildren would be skip persons).  The Act also sets the GST tax exclusion for 2011 at $5,000,000 indexed for inflation in 2012.  The GST tax rate for transfers made in 2011 and 2012 is 35%.  The GST tax exclusion is scheduled to drop to $1,000,000 on January 1, 2013.  There is a golden window of opportunity to make significant gifts to grandchildren over the course of the next two years.

The two year window provides an excellent opportunity for taxpayers to significantly reduce the value of their estates without incurring gift tax.  By making the gift now future appreciation on the gifted assets will also escape gift and estate taxation. Individuals and couples with assets exceeding $4,000,000 and $8,000,000 respectively should seriously consider taking advantage of this golden opportunity.  Individuals and couples with assets in excess of $1,000,000 and $2,000,000 respectively may want to consider gifting as well.

Assets having the greatest potential to significantly increase in value such as vacation homes, expensive art, furniture, jewelry, and closely held business interests offer the best gifting potential.  Real estate is exceptionally well suited for gifting.

Gifting may be done in several different forms, ranging from direct gifts to individuals to gifts occurring through trusts.  Trusts allow the gift giver (“donor”) to maintain control and provide direction with respect to the distribution of the gift.  The donor must consider that gift cannot be returned.

The recipient of the gift will have the donor’s tax basis for income tax purposes.  A gift left to an individual as a result of death will generally receive a step up in cost basis to fair market value at date of death, resulting in less income tax to pay when such an asset is ultimately sold.  Trusts pay income tax at the highest rates beginning at a very low level of income.  For these reasons it is critical to analyze the gifting decision from an income tax point of view as well.

Even if you can’t or don’t want to make large gifts now, as a result of the changes in the law you should review your estate plans with your advisor.  Over the past few years, several changes occurred in the estate tax rules.  The exemption bounced from $2,000,000 in 2008 to $3,500,000 in 2009 to an unlimited exemption in 2010 to $5,000,000 in 2011 and back to $1,000,000 in 2013.  Planners drafted trusts and wills to utilize the maximize estate tax exemption using what are known as formula clauses.  These clauses allow the decedent’s estate to pass the maximum amount of the exemption to the next generation. The formula clause could be written in such as way to maximize benefits for trust beneficiaries other than the surviving spouse.  Because of the shift in exemption amounts, it is a critical to review your estate plan.

Whether you are interested in taking advantage of the golden opportunity to make tax free gifts or need to review your estate planning documents in light of the ever changing tax landscape, now is the time to make an appointment with your tax advisors to determine next steps.