April 1, 2011
By: Adam J. Poteracki

In December 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which, among other things, provided a temporary resolution to federal estate and gift tax uncertainty. Lee Poteracki discussed the general provisions of the 2010 Act in an article published in the January 2011 edition of this Newsletter. This article is intended to discuss opportunities for gift planning presented in the 2010 Act.

The 2010 Act re-unifies the Federal Estate and Gift Tax exclusion amount at $5 Million. As a result, an individual can make taxable gifts in 2011 or 2012 of up to $5 Million before incurring any gift tax.

Although the nominal rate of Estate Tax and Gift Tax are each 35%, making lifetime taxable gifts has the potential to avoid more taxes than waiting for property to pass at death. The following three considerations make planned lifetime gifting a valuable tool in constructing an estate plan that aims for tax avoidance.

First, the gift tax is a tax-exclusive tax, paid for out of money that is not being taxed. The estate tax is a tax-inclusive tax, paid for out of money that is being taxed. The following example illustrates the benefit of paying a tax-exclusive tax rather than a tax-inclusive tax:

A has $5 Million in assets and has already used the entire $5 Million exclusion on other lifetime gifts. If A chooses to not make any gifts, A’s estate will pay $1.75 Million in federal estate tax and $3.25 Million will be passed along to A’s beneficiary, B. However, if A chooses to make a lifetime gift of $3 Million to B, A will pay $1.05 Million in gift tax and the remaining $950,000.00 will be subject to estate tax at A’s death. A’s estate will pay $332,500.00 in federal estate taxes, leaving an additional $617,500.00 for B. By taking advantage of the gift tax, A will pass over $3.6 Million to B and only pay slightly more than $1.3 Million in combined federal estate and gift taxes.

Lifetime gifting allows A to pass more assets to B and pay less in taxes because A is taking advantage of the tax-exclusive nature of the gift tax.

Secondly, lifetime gifting allows you to apply the $5 Million exclusion to assets before the assets appreciate. Clearly, it would be preferable to use up part of the $5 Million exclusion on an asset worth $3 Million today rather than to use up the entire $5 Million exclusion and pay estate taxes on $1 Million on that same asset several years from now when it is worth $6 Million. Of course, it is important to first target assets that you expect to appreciate. You should be careful to plan your gifting, especially when attempting to take advantage of unappreciated assets.

A third benefit of gifting is that it enables the planner to make use of a certain exclusion. As we have previously advised, the 2010 Act is temporary. The current $5 Million exclusion is only in effect through the end of 2012. After 2012, there is no guaranty that a $5 Million exclusion will be available for federal estate and gift tax purposes. Gifting prior to 2012 ensures you will be able to take advantage of the $5 Million exclusion.

There are clear opportunities for tax avoidance by planned gifting from now through 2012. Non-tax considerations also must be taken into account. A planned gifting program should only be undertaken after careful consultation with our estate planning counsel.