Gift Now and Avoid Estate Tax

Grim reaper

If you have a net worth of $1M or more (or as a couple, $2M or more), and act now, you could forever remove the threat of estate tax. But if you don’t act by the end of the year, you will miss a historic opportunity.

The 2012 estate tax exclusion and gift tax exclusion are both $5,120,000 – way higher than they have ever been. But unless Congress and the President act, both will crash to $1M on January 1, 2013.

If you die with more than $1M after December 31, 2012, every dollar over $1M will be taxed at 55%. If you die with a $2M estate, your children will get $1,450,000 and the government will get $550,000.

But here’s your big chance: If you gift assets out of your estate before December 31, you can remove up to $5,120,000 (double that for married couples) from your taxable estate.

Don’t think this opportunity is only for rich people. If you have assets that will appreciate – like real estate, business interests, or other investments, you should take advantage of this historic opportunity to remove assets and all future appreciation from your taxable estate.

I know what you are thinking – ok, I get it, I should remove assets from my estate to avoid a future estate tax, but I need those assets. Can I gift them, but still benefit from them? The answer is YES.

A lifetime exemption trust, sometimes called a spousal lifetime access trust, can remove the asset from your estate and give you indirect access to the income. Here’s how it works:
* Create an irrevocable trust which names your spouse and children as beneficiaries.
* Your spouse can be the trustee and direct the investments and distributions.
* Transfer assets to it before the end of the year.
* Your spouse, as trustee, can distribute income from the trust to herself and deposit it in your joint account – which means you will have access to the trust income, even though you gifted away the assets.

Your spouse can also create a lifetime exemption trust which names you and your children as beneficiaries. However, this second trust must be drafted very carefully with different provisions than the first one to avoid the reciprocal trust doctrine. If the IRS determines the two trusts are identical, it will pull the gifted assets back into your estate.

This is just one of many gifting strategies available.

If you would like to leverage this historic gifting opportunity, you need to act now. Planning will most likely take a several weeks and time is running out.

10. Estate and Gift Tax – Part 1

This is part 10 in my series, Estate Planning – What You Need to Know.

Part 10. Estate and Gift Tax – Part 1

The estate tax, aka the death tax, and the gift tax are separate but related. Let’s start with the estate tax.

Estate Tax

The estate tax is the tax the federal and state government levies on your estate when you die. The tax is based on the value of your estate. Each state handles its estate tax differently. It’s beyond the scope of this chapter to explain each state’s tax. I will focus on the federal estate tax.

California doesn’t levy a separate estate tax on the estate. It takes its tax out of the federal estate tax. So if you live and die in California, you really only have to consider the federal estate tax.

Not every estate will have to pay taxes. There is no tax if your estate is below the exemption amount. Here are the exemption amounts and tax rates since 1997:

Year

Estate Tax Exemption

Top Estate Tax Rate

1997

$600,000

55%

1998

$625,000

55%

1999

$650,000

55%

2000

$675,000

55%

2001

$675,000

55%

2002

$1,000,000

50%

2003

$1,000,000

49%

2004

$1,500,000

48%

2005

$1,500,000

47%

2006

$2,000,000

46%

2007

$2,000,000

45%

2008

$2,000,000

45%

2009

$3,500,000

45%

2010

No Tax

No Tax

2011

$5,000,000

35%

2012

$5,120,000

35%

2013

$1,000,000

55%

Notice it changes. In 2012, the exemption amount is $5,120,000. Unless Congress and the President do something, it will drop to $1,000,000 next year.

If you die on December 31, 2012, with a $5,000,000 estate, your family won’t have to pay an estate tax. If you die, one day later, January 1, 2013, your family would have to pay roughly $1,400,000. Isn’t this ridiculous?

For more craziness, look at 2010. There was no estate tax that year. George Steinbrenner, owner of the Yankees, died that year with a $1.2 billion dollar estate, and his family did not have to pay federal estate taxes. Lucky for them. Good timing George.

I could write a whole book on the capricious nature of the tax code, but I will keep to the topic.

Don’t Forget Life Insurance

You should also know that for estate tax purposes, your estate includes life insurance. If you were wiped out in the great recession but maintained a life insurance policy, you may have a taxable estate. Let’s say your house is underwater, you have $50,000 in savings and you have a $1,000,000 term life insurance policy. Your taxable estate would be $1,050,000.

Gift Tax

If you have an estate large enough to be taxed, couldn’t you simply gift your assets to your children before you die to avoid the estate tax? Unfortunately no. The government is on to that trick, which is why there is a gift tax.

Yes. There is a tax when you make gifts.

There are two parts to the gift tax. The Lifetime Gift Exemption and the Annual Gift Exemption.

The lifetime gift exemption is the amount you can gift during your lifetime without incurring a tax. Like the estate tax, the lifetime gift exemption has changed over the years.

Year

Estate Tax Exemption

Top Estate Tax Rate

1997

$600,000

55%

1998

$625,000

55%

1999

$650,000

55%

2000

$675,000

55%

2001

$675,000

55%

2002

$1,000,000

50%

2003

$1,000,000

49%

2004

$1,000,000

48%

2005

$1,000,000

47%

2006

$1,000,000

46%

2007

$1,000,000

45%

2008

$1,000,000

45%

2009

$1,000,000

45%

2010

$1,000,000

35%

2011

$5,000,000

35%

2012

$5,120,000

35%

2013

$1,000,000

55%

The lifetime gift exemption is tied to the estate tax. The lifetime gift exemption you use will be subtracted from your estate tax exemption. Let’s say you gifted $250,000 during your lifetime. If you pass away in 2013, your estate tax exemption would be deducted by $250,000.

2013 Estate tax exemption:                        $1,000,000

Lifetime gift exemption used:                        -$250,000

Remaining estate tax exemption:                  $750,000

Your estate tax exclusion will be reduced by the amount of the lifetime gift exemption you have used.

The second part of the gift tax is the annual gift tax exemption. This is the freebie gift.  The annual gift tax exemption has also fluctuated over the years.

Year

Annual Exclusion Amount

1997

$10,000

1998

$10,000

1999

$10,000

2000

$10,000

2001

$10,000

2002

$11,000

2003

$11,000

2004

$11,000

2005

$11,000

2006

$12,000

2007

$12,000

2008

$12,000

2009

$13,000

2010

$13,000

2011

$13,000

2012

$13,000

2013

TBD – indexed for inflation

In 2012, the annual gift tax exemption is $13,000. You can gift $13,000 to as many people as you want this year and the gifts won’t be taxed. If you are married, you and your spouse can each give $13,000 per person, or $26,000 per person.

In addition, the gift amount will not count against the lifetime gift exemption.

Let’s say you have three children and six grandchildren. You could gift each $13,000, for a total of $117,000 ($13,000 x 9) without using any of your lifetime gift tax exclusion.  And you could double the gift if your spouse does the same.

When you use the annual gift tax exemption, you will not dip into your lifetime gift tax exclusion, it is a freebie.

Next, I will discuss the opportunities and pitfalls of making gifts in 2012.