A Gift from Congress: Gift Up to $10 Million Tax-Free
Posted on Mon, Dec 12, 2011 @ 01:37 PM
By Stephen Colella, CPA and Sarah Wulf, CPA
For a limited time, married taxpayers can make lifetime gifts of assets worth up to $10 million without paying federal gift taxes or other transfer taxes.
The exemption for gift taxes, estate taxes, and generation skipping transfer (GST) taxes was fixed at $5 million per taxpayer when Congress extended the Bush-era tax cuts through 2012. Married couples can now give away up to $10 million and single people can give away up to $5 million without incurring gift or GST taxes, as adjusted for prior taxable gifts, which is a pretty powerful planning opportunity.
While the estate tax currently offers the same exemption, one needs to pass away in order to take advantage of this $5 million exemption. With the exemption for gift tax, estate tax, and the GST tax decreasing when the current Bush Tax Cuts extension expires, one may lose the opportunity to take advantage of the $5 million estate tax exemption, whereas the $5 million lifetime gifting and GST planning opportunity can be done now.
The gift and estate tax exemption amounts will revert to $1 million per taxpayer on Jan. 1, 2013, with the GST exemption amount reverting to an inflation adjusted $1 million per taxpayer, if Congress takes no action between now and December 31, 2012. There are many practitioners who feel Congress will take action before then, and most predict that Congress is likely to decrease the exemption below $5 million. As such, it would be best to act now.
Other reasons to act now include:
- The estate tax rate may be higher and the exemption may be lower when you die.
- You can benefit your heirs while you are still alive.
- Future appreciation of the gifted assets will take place outside of your estate.
- Most states do not tax gifts, but most states do tax estates. In Massachusetts, an estate tax of up to 16% applies to estates exceeding $1 million in value.
- Some states, such as Florida, do not have an estate tax, but may decide to add one at some point. Transferring assets now will ensure that they are not subject to a future state estate tax.
Taxpayers can also take advantage of annual exclusion gifts, which allows gifts valued at up to $13,000 a year per beneficiary without being subject to gift taxes and is a way of transferring wealth without incurring gift tax that can be done in addition to gifts that take advantage of the lifetime exemption. There are also opportunities to make gifts that are not treated as gifts for gift tax purposes, such as making payments directly to qualified education institutions for tuition or to a provider of qualified medical expenses.
Congress also decreased the tax rate on gifts exceeding the exempt amount from 55% to 35%. For some ultra-wealthy clients who have already taken advantage of the $5 million lifetime gift exemption, paying gift tax at a 35% rate on gifts that exceed the lifetime exemption may still be a valuable planning opportunity given that such rate may be higher at a later date.
For several reasons, trusts are commonly used when structuring lifetime gifts. When a gift is made to a trust that is treated as a grantor trust to the donor for income tax purposes, the grantor, instead of the trust or beneficiary, is taxed on the income. This can preserve more assets for the next generation since the trust retains the assets that would otherwise be needed to pay the income tax. It is also not a gift to the trust for gift tax purpose when the grantor pays the income taxes. In effect, the payment of the income taxes on behalf of the trust is a tax free gift.
A married couple can retain limited access to the gifted assets without retaining the assets in their estate if the grantor’s spouse is a beneficiary of the trust, which will help ensure that they have enough assets to live on, as long as such spouse is alive.
Some Issues to Consider
When structuring a lifetime gift, one unknown that should be considered is whether Congress will include a “claw back” in future legislation. A claw back would tax gifts made during the $5 million exemption period based on the exemption level that is in effect at the taxpayer’s death, which could be much lower ($1 million for example) if Congress reduces the $5 million exemption,.
The estate’s beneficiaries would bear the tax liability from both the lifetime gifts and their transfer at death, if there is a claw back. Currently, when a taxpayer dies, lifetime gifts are included when calculating the estate tax exemption. Estate taxes are owed on any amount that exceeds the unused portion of the exemption.
This issue is especially important to consider when the lifetime beneficiaries are different from the remainder beneficiaries. Regardless, any appreciation in value between the date of the gift and the date of death remains outside the estate and is not subject to estate or gift taxes, even if there were a claw back. Prudent practitioners are therefore structuring estate plans to take advantage of the huge increased gifting and GST opportunities before they expire in the event there is no claw back, which many believe will not happen, and to also include flexibility in the plan to minimize or eliminate any negative tax impact in the event a claw back does occur. This type of planning gives taxpayers the ability to benefit greatly from this opportunity given that they will at least remove from the taxable estate what could be significant appreciation on such large amounts gifted, and reap more savings in the event there is no claw back.
Another important consideration when shifting ownership of assets that are likely to appreciate is whether the taxpayer is expected to have a long or short lifespan after the transfer. When a taxpayer passes an asset to a beneficiary during his or her lifetime, the recipient takes over the original person’s holding period and cost basis assuming such is lower than the fair market value of the assets at the time of the transfer. That could mean a significant tax liability to the recipient upon realization of the gain.
Under current law, when a taxpayer passes an asset to a beneficiary upon death, the asset receives a step-up in basis to its fair market value at the date of death. As such, it may be best for the taxpayer to continue to hold onto assets that have already appreciated significantly and to allow the recipient to receive the increased basis upon the taxpayer’s death, particularly if the taxpayer has a short life expectancy and does not expect significant appreciation between now and when he or she passes away.
Conclusion
It is important to discuss the current gift, estate and GST planning opportunities available with your advisors to make sure that your overall estate planning goals will be met, and that you plan as flexibly as possible to avoid potential pitfalls, based on the huge potential tax savings and limited time offer.