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Window Closing On Gifting to Reduce Estate Taxes

Lee Poteracki

Over the years, the federal estate and gift tax laws have featured a once-in-a-lifetime exemption enabling taxpayers to make tax-free gifts to reduce their estate tax liability in varying amounts. While the exempt amount was once as little as $60,000, and for quite a few years has been pegged at $1 Million, the gift tax exemption has recently risen dramatically so that, in 2012, the exempt amount (“Exemption”) is $5,120,000 for each taxpayer, meaning a married couple together can gift or leave their beneficiaries up to $10,240,000 without gift or estate tax exposure. Unfortunately, it is highly likely that this opportunity is soon to be drastically curtailed.

Unless Congress acts to provide otherwise, the estate and gift tax laws will automatically and dramatically change effective January 1, 2013. Not only is the Exemption scheduled to shrink from $5.12 Million per taxpayer to $1 Million, but also the estate tax rate is scheduled to increase from 35% to 55% of each taxpayer’s taxable estate assets.

Estate taxes are not typically paid by surviving spouses due to an unlimited marital deduction. However, when there is not a surviving spouse, the decedent’s assets above and beyond the Exemption are subject to estate tax. Due to the impending tax law change, a husband and wife whose estates total $10.24 Million who died prior to 2013 would pay no federal estate or gift tax, while the same family dying after 2012 would incur estate taxes of over $4.5 Million. The immediate reaction of many of our clients to this development is to: (i) become irate and (ii) ask how to avoid this result.

Whether any action should be considered naturally depends upon the size of our clients’ estates, their age, earning expectations and anticipated family and retirement expenses. If it can be projected with confidence that well over $2 Million will remain after both spouses have died, their beneficiaries are faced with the estate tax issue. Because our clients are able to gift up to $5.12 Million at any time prior to December 31, 2012, it may be wise to gift assets to their beneficiaries this year in order to reduce their taxable estates before the gifting window closes on January 1.

The primary consideration for our clients as to whether they should gift substantial amounts in 2012 is whether they foreseeably might need the gifted assets in the future. Such gifts are not reversible, so access to the gifted assets is lost. Appreciated assets often are not the best types of assets to gift for these purposes because the donee is limited to the basis of the donor rather than receiving the step-up in basis as with an inherited appreciated asset, and the gift will require a full appraisal of the asset at the time of gift, which can be costly. Thus, it is often wise to use cash or cash equivalents for gifting purposes.

Clearly, our clients who have net worth well over $2 Million, and especially if they are older, are more likely to be able to safely gift to their beneficiaries. If any gifts to a single donee exceed the annual exempt amount of $13,000, then a gift tax return must be filed by April 15 of the next year.

Some of our clients have taken advantage of a technique which allows them to “give away” their cake and “have it, too.” A spouse can gift assets of up to $5.12 Million into an irrevocable trust for the benefit of his or her spouse and family for the life of the spouse, at which time the trust would be distributed to the family. Because the donee spouse only has a lifetime interest in the trust which expires at his or her death, and because the donor spouse has no further interest in the donated assets, they are not taxed upon the death of the surviving spouse. These Spouse and Family Exempt (“SAFE”) trusts can be very effective in reducing taxable estates. The only downside is that, upon the death of the donee spouse, the assets must stay with the family, and the donor loses the informal enjoyment of the assets he or she once had with the donee spouse.

The upcoming estate and gift tax law changes and the startling difference in the potential amount of death taxes make the evaluation of gifting opportunities quite important for our higher net-worth clients. If your circumstances fit into the categories mentioned in this article, please contact your Di Monte & Lizak, LLC attorney soon, as the gift transfers must be made prior to January 1, 2013 in order to take advantage of this expiring tax-reduction opportunity.

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