New 2013 Gift Tax and Estate Tax Rates – Now What?

cash gift

Congress surprised us again and passed the American Taxpayer Relief Act (don’t you love the catchy name) on January 1 to temporarily avoid the fiscal cliff.

Overall, the new law is much better than the experts expected. It extends the estate tax and gift tax exclusions of 2012 and even indexes them for inflation. In 2013, you can gift $5,250,000 with no gift tax. In 2013, you can die with $5,250,000 with no estate tax. A married couple can double this amount. The tax rate for gifts or estates greater than $5,250,000 rose to 40% from 35%. But so long as your estate is less than $5,250,000, or $10,500,000 for a married couple, there won’t be a tax.

So what does this mean for you?

We will be telling our clients through our newsletter (you can sign up below) that the planning environment is very similar to what it was in 2012.

Consider gifting now.

Real Property. For most people, property values are still low from the long recession. Now is a great time to gift. By gifting now, you will remove assets from your estate at the low value. When the assets appreciate in value again, it will be outside your taxable estate. For example, gift a $1M property now and use only $1M of your gift exclusion. In 10 years, the property may be worth $2M, and it will be outside your taxable estate, and you only burned $1M of your gift exclusion.

Your Business. Gifting now is also a great strategy if you own a business. If you have a business that was hit by the recession, it might be a good time to gift all or some of the business while the value is low. Then the share gifted and all future appreciation will be outside your estate.

Investment Accounts. The same principle holds for investment accounts. If you believe the economy will rebound soon, your stock values may be lower now than in a few years from now. Why not consider gifting now at the low value?

How to Gift and Still Control and Use the Assets?

Ok, so you get the concept of gifting now at low values, but you can’t afford to gift because you need your assets. What can you do? Why not gift assets in a trust to your spouse? This type of gift trust is called a Spousal Lifetime Access Trust (SLAT) or a lifetime bypass or exemption trust.

If you set up a SLAT, your spouse can be the trustee and primary beneficiary. You would then gift assets to the trust for the benefit of your spouse. As trustee, your spouse would have control of the assets, i.e.  your spouse would be able to decide how to invest and when and how much to distribute out. If you have a solid marriage, you would have a say in those decisions and you would benefit from the distributions and growth of the trust assets.

Key Concept. If you have a solid marriage, you have amazing planning opportunities.

Key Concept 2. Jonathan Blatmachr, one of the top veteran estate planning attorneys in the country, likes to advise his clients to use tax deductions sooner rather than later because you never know when Congress will change the rules.

The 2013 American Taxpayer Relief Act has generous estate and gift exclusions. But will the generous exclusions last? We just don’t know. Historically, tax laws change. Favorable rates change to unfavorable rates and so it goes back and forth.

What we do know is that for many, asset values are lower than they will be in the future. Now may be the perfect time to remove assets from your estate to a trust for your spouse. You will continue to indirectly control and benefit from the assets while removing the assets and all future appreciation forever from your taxable estate.

How the Lifetime Bypass Trust Works: Attention CPAs

Cutting taxes

Many of my clients are interested in the Lifetime Bypass Trust. And some are vetting the concept through their CPAs. Here is an email (with the names removed) I have sent to several CPAs to clarify this amazing but simple planning strategy.

The structure we are proposing is a lifetime bypass trust. The concept is the same as used with an A/B trust, or bypass trust.

When a bypass trust is created upon the death of a spouse, it is funded with the deceased spouse’s share of property up to the then death tax exclusion amount. The surviving spouse is usually the trustee and the primary beneficiary of the bypass trust.

The benefits of the bypass trust are:

1) Assets in it (and all future growth) will not be subject to the death tax at the deceased spouse’s death or at the surviving spouse’s death because the trust was funded using the deceased spouse’s death tax exclusion, and

2) Assets in it will be significantly protected from lawsuits and divorce claims against the surviving spouse.

The use of a bypass (A/B) trust is a tried and true estate planning strategy.

The Lifetime Bypass Trust is based on the same principal, except that we are creating and funding it now, to take advantage of the $5.12M gift exclusion available this year, rather than waiting until a spouse dies. One of my client’s calls it an “early bypass trust.”

Just like the at-death bypass trust, the lifetime bypass trust would name spouse as trustee and spouse and children as beneficiaries.

Just like the at-death bypass trust, the assets in the lifetime bypass trust would be exempt from estate tax when the grantor spouse dies, when the surviving spouse dies and, if generation skip exemption is used, even when their children die – two generations of no estate tax on the gifted asset and future appreciation.

Just like the at-death bypass trust , we can give the surviving spouse a limited power of appointment to change the remainder beneficiaries, limited to a certain class of people, like descendants. However, with the lifetime bypass trust, we could also include the grantor spouse as a permissible beneficiary. (Can’t do this with bypass trust created at death b/c the grantor spouse is dead.)

The grantor spouse, after the creation of the trust, can be named a remainder beneficiary if done correctly. This will not cause estate tax inclusion unless there is an implied understanding between grantor and trustee at the time the trust is created.

We recommend drafting the lifetime bypass trust to give an independent third party/trust advisor the authority to add and remove the grantor spouse as beneficiary.

The lifetime bypass trust uses the tried and true principles of a standard at-death bypass trust, but it uses the gift exemption now, while it is $5.12M, rather than at death, when the death tax exclusion is scheduled for a big drop (under current law $1M).

The downside to the lifetime bypass trust is the loss of step up in basis at death. But since the estate tax rate (35%-55%) has historically been a much higher rate than the capital gains tax rate (15%-20%) , most people would rather avoid the estate tax. In addition, the Democrats and the President have expressed their intent to do away with the step up in basis for inherited assets. So losing the step up in basis may happen anyway.

Finally, we may look back and realize 2012 was the best and easiest time in history to reduce or eliminate estate tax. If the estate and gift tax exclusions drop as scheduled on January 1, planning will get much more complicated and much more expensive.

Lifetime Exemption Trust

Forbes - Giving

Forbes has a great article on lifetime exemption trusts, aka spousal lifetime access trusts. This is a great trust strategy to gift assets to your spouse and children and remove the assets from your taxable estate, but still receive benefits from the assets.



Gift Now Before It’s Too Late


One of my clients send me a terrific article from Concannon Miller about the urgency to make gifts and how to make gifts before December 31. It is so good, I’m posting the whole article.

When it comes to making a decision about gifts and protecting assets, the main message is that, if appropriate for you, make gifts before the law changes in 2013; however there are many important nuances to the message that the media and many of the announcements for consumers have ignored.  A key message is that many people, not just the ultra-high net worth families, should consider the valuable 2012 planning options.

If you’ve tuned out these messages because you don’t believe your financial position justifies planning, reconsider and be certain. 

A critical issue that has been left out of the media blitz is that the large gifts that are being made should almost always be in trust. These trusts raise a host of issues, many of which have special implications to 2012 planning. This Alert will simply convey key points and hopefully you’ll be motivated to act now, act prudently and call your advisor.

Uncertainty: Uncertainty should not be the basis for inaction. Uncertainty may also mean opportunity. If you don’t act now, 2013 is scheduled to bring a $1 million gift, estate, and GST exemption and 55 percent tax rate. President Obama has continued to propose estate and gift tax changes that will undermine much of the planning arsenal, making his proposed 45 percent rate and $3.5 million exemption far more costly than most imagine.

True, the future is uncertain no matter who wins the election. At worst, if you don’t act and top rates go into effect, you and your heirs may lose out on tremendous opportunities. At best, you’ve wasted the cost of the planning, but have you? The trust planning that should be at the heart of 2012 planning will serve your estate planning needs and will provide asset protection benefits, divorce protection for your heirs, and better control and management of your assets. So the planning in the best tax case scenario (estate tax repeal) won’t be for naught, you’ll just have one less benefit. Even if the estate tax is repealed (which few if any believe likely at this point) the gift tax may remain intact with a $1 million exemption. Most simply don’t realize the importance of the gift tax is an integral backstop for the income tax, not only for the estate tax. If that occurred, transferring assets to protect them from lawsuits and claims would become incredibly difficult.

Planning Is for Many People, Not Only the Ultra-Wealthy: Planning is not only for the very wealthy. If you have a non-married partner, a $1 million gift exemption in 2013 will make it costly to shuffle ownership of assets between you and your partner. Everyone, not just surgeons, should be concerned about asset protection. Nothing anyone in Washington does will change the litigious nature of our society. About a score of states have decoupled from the federal estate tax system so that much lower amounts of wealth may trigger a state estate tax. A simple gift today might be all it takes in many situations to reduce or eliminate state estate tax. Use the current favorable tax environment to shift assets into protective structures before the ability to do so is sharply curtailed. A $1 million gift exemption will render much of this planning costly, impractical, or impossible.

Financial Planning Is Key: Start with a financial plan since that must be the foundation of any major 2012 wealth transfer. How much can you afford to give away and be really assured that you won’t have financial difficulties in the future? Which assets can or should you give away? Do you need additional life insurance for coverage in light of components of the plan? Might you need access in the future to the money you give away and if so how much? This analysis will support your position that you’re left with more than adequate assets for your lifestyle after the transfers. This can deflect an IRS challenge that you had an implied understanding with the trustees of a trust to which you make a gift to receive distributions, loans or other access to the assets you purportedly gave away. It can also make it harder for a creditor to prove at a later date that your transfers constituted a fraudulent conveyance, since you will have appropriate financial backing for your decisions.

Use Trusts: Make gifts to trusts not to heirs. Whatever amount you determine to give away, give it to one or more trusts, not directly to an heir. Trusts provide asset protection, divorce protection, preserve generation-skipping transfer (GST) tax benefits (i.e., they can keep the assets out of the transfer tax system forever). Trusts can be structured as grantor trusts so you can sell assets to them without triggering capital gains. When a trust is established to be a grantor trust you can pay the income tax on trust income thereby growing the value of the assets inside the trust faster while shrinking the assets left in your name to reduce assets reachable by creditors or subject to estate tax. Many of these benefits are on President Obama’s list of loopholes he hopes to close. So, these are benefits you might want to try to secure now, so that they will be respected even if the law changes in the future (they may be “grandfathered”). Perhaps the biggest benefit of gifting assets to a trust is that you can retain the ability to benefit from the assets in trust in the discretion of an independent (e.g., bank) trustee. For example, you can establish a trust for your spouse/partner and your descendants so long as your spouse/partner is a beneficiary you can indirectly benefit. But what if your spouse/partner dies before you? Instead, for more financial security, you can set up a domestic asset protection trust (DAPT) and be a beneficiary of your own trust. Even if you are wealthy, but much of your wealth is concentrated in a business, be very cautious about cutting off your access to trust assets. Don’t forget the harsh economic lessons of 2008-2009. You need to be assured of adequate resources even under adverse future economic conditions. If you simply make large gifts to your intended heir (e.g., child) it will be inexpensive and simple, but the many benefits that will be lost are substantial.

Consider Sales to Trusts: Depending on the size of your estate, the type of trust you might opt to use, your matrimonial considerations, and a host of other factors, it may be beneficial for you to sell some assets to a trust, instead of merely giving them to the trust. While so many people have focused on the importance of making gifts to use the $5 million exemption, the special 2012 planning opportunities go far beyond that. This is especially important for those wealthy enough that the $5 million exemption is not sufficient to address all of their tax exposure. Sales of assets to trusts that can provide a potentially substantial gift and GST benefit now, may disappear with changes in the law. This can be illustrated with a simple example. If you sell 45 percent of your interest in a family business to a trust, interest may be valued with a discount or reduction in value to reflect the reality that a 40 percent interest is not readily marketable, and it also lacks control. Discounts provide great leverage and there have been more than several proposals to restrict or eliminate them. So selling assets to the appropriate trust may lock in these significant discounts before the law changes and help leverage wealth out of your estate. Since few trusts will have sufficient cash to pay for these purchases they are typically structured as sales for an installment note. Since interest rates are at historic lows the interest payments on these notes will be modest. This note sale technique might permit you to transfer well beyond the $5.12 million in value.

Plan the Trusts to Achieve Your Goals: The trust or trusts you’ll use should not be the simple children’s trust commonly used in estate planning. Some of the issues to consider include:

  • Should you be a beneficiary? If yes, there are precautions to take and only certain states in which the trust can be established.
  • Is there any reason the trust should not be a grantor trust? Unlikely, but ask your adviser. If it is a grantor trust, what happens if there is a large taxable gain you would have to report on your personal return even though the proceeds will remain in the trust? For example, assume you transfer your family business to the trust and five years from now sell out to a public company. You have to pay the gain but the proceeds are held in the trust. You might include a tax reimbursement clause in the trust. This would permit the trustee to reimburse you for the tax cost. But caution is in order. These clauses have to be handled correctly and the trust must be in a state with appropriate laws. What is worrisome is that if the trustee just so happens to reimburse you, the IRS might argue that you had an implied agreement with the trustee to reimburse you for the capital gains on a significant sale. There may be better approaches.
  • If you and your spouse/partner both set up trusts, the trusts need to be sufficiently different to avoid the IRS arguing what is called the “reciprocal trust doctrine” – that they are so identical that they should be “uncrossed” so that the trusts are included back in your respective estates. That would entirely negate the planning. Differentiate the trusts using different powers, different distribution standards, set them up in different states, sign them on different dates, etc.
  • If you own all the assets to be given, you can set up a trust and gift $10.24 million and have your spouse treat the gift as if it is ½ his thereby using up his exemption. While spouses can gift split, if your spouse is a beneficiary of the trust which is the recipient of the gift, that may negate the ability to gift split.
  • What if you gift $5.12 million to your spouse, and he then gifts it to his trust to avoid the gift-splitting issue? The IRS could attack that approach using the “step-transaction doctrine.” If the IRS wins this challenge they might treat your gift to your spouse and his gift to the trust, as really an indirect gift by you to his trust. Thus, you’d be treated as making two $5.12 million gifts and owe about $1.8 million in gift tax. If there was GST tax due as well, the bill would be even larger.
  • There has never been a time in history when so many taxpayers may feel so compelled to make so many large transfers in such a short time period. This is indicative of the tremendous planning opportunities that exist, but which may soon disappear. The IRS is keenly aware of this as well, so more caution then ever before should be exercised.
  • If you want to fund a family limited partnership (FLP) or a family limited liability company (LLC) with assets that make gifts and thereby secure discounts. Time is short. If the assets are not inside the entity long enough the IRS will argue that the gifts were of the underlying assets, not the FLP/LLC – no valuation discount would be permitted.

Operate the Plan and Trusts Right:  Signing a trust and consummating a transfer is only the beginning of the process. You need to administer and monitor the plan and trust in future years meeting not less than annually with all your advisers to assure that all formalities are adhered to. Be certain the administrative requirements of how the trusts are to be operated are adhered to. If differences were created to reduce the risk of the reciprocal trust doctrine applying, monitor to be sure they are not circumvented. Be sure the advisers are clear as to prepare the gift and income tax returns to report the planning transactions. You may have to revise asset allocation models to better coordinate asset location decisions. Be sure property, casualty, and liability coverage reflect the realities of trusts owning interest in entities or assets.

Act Now: Time is fleeting. Everyone should review planning options for themselves and their family/loved ones to ascertain what might be beneficial and how to expedite the process so planning is completed in advance of year end, preferably before the election.