Two Year Tax Planning Window of Opportunity for Large Gifts

Estate and Gift Tax Opportunity

As a result of legislation enacted by Congress in December, the current (but temporary) estate and gift tax exemption is increased to $5,000,000. The $5,000,000 exemption applies to the estates of those who die in, and to gifts made in, 2011 and 2012.

In addition, the highest estate and gift tax bracket applicable in 2011 and 2012 has been reduced to 35%.

In 2013, however, the old $1,000,000 estate and gift tax exemption is scheduled to return along with 55% as the highest estate and gift tax rate.

In light of such compelling tax facts, high net worth clients may be highly motivated to make large gifts before 2013.  If clients delay making such gifts until after 2012, and if Congress does not act to change the current law, the estate and gift tax exemption will revert to $1,000,000. The opportunity to transfer an additional $4,000,000 free of estate and gift tax will be lost.

The estate tax that may be saved as a result of making large gifts in 2011 and 2012 can be significant. For example, assume that an unmarried client has an estate with a value of $10,000,000. If he makes no gift and if he dies in 2013 when the $1,000,000 exemption and higher tax rates apply, the U.S. estate tax would be approximately $3,727,000 and the state estate tax (we are using New York tax law for this article)  would be approximately $1,068,000 for a total estate tax obligation of approximately $4,795,000.

If the client believes he needs no more than $5,000,000 for himself, however, he might be inclined to make a gift of the rest ($5,000,000) to his children (or in trust for them). If the client were to make a gift of $5,000,000 in 2012 and die in 2013, there would be no U.S. gift tax to pay and the total estate tax would be $2,750,000 (federal, $2,359,000, and state, $391,600). The estate tax saved would be more than $2,000,000.

You can find details regarding how the gift and estate tax is calculated here: No Tax Clawback Pursuant to Section 304 of TRUIRJCA.

In Connecticut, the gift of $5,000,000 in 2012 would result in a gift tax of approximately $122,000. Although the $122,000 gift tax obligation would represent an upfront cost, the overall tax benefits would still be substantial and would not be materially different. Keep in mind that in Connecticut a gift tax is incurred only when cumulative taxable gifts exceed $3,500,000.

Generation Skipping Tax Opportunity

The generation skipping tax exemption has also been temporarily increased to $5,000,000. This means that, if your gift of $5,000,000 is to a generation skipping trust, you can allocate your $5,000,000 generation skipping tax exemption to the trust and, as a result, shelter the trust assets (including all appreciation) from estate, gift and generation skipping tax for many generations.

Other Advantages

Keep in mind that the opportunity to make larger gifts of income producing property free of gift, estate and generation skipping taxes includes the opportunity to shift income, which is generated by the assets you give away, to lower-income tax bracket taxpayers.

It is also an opportunity to protect assets from the claims of creditors, whether your own future creditors or the creditors of your beneficiaries.

If you are married, the gift could be to a trust which includes your spouse (as well as children, grandchildren and even younger generations) as a beneficiary. As a result, the income need not be totally lost to your household (at least as long as your spouse is living).

You can find more information about what a trust is, and common terms included in a trust, here: The Benefits of Trusts.

What Is the Down Side?

The motivation to make large gifts now is partially the result of an expectation that the old estate tax rules may return in 2013 with a $1,000,000 exemption and a 55% estate tax rate. What if Congress makes the current, more generous rules permanent so that, if death occurs in 2013 or later, the $5,000,000 exemption will apply?

Assuming no significant appreciation in the value of the assets after the time the gift was made, there would be no estate tax cost or benefit associated with making the gift now instead of waiting to do so at the time of your death through the terms of your Will.

By making the gift now, however, your cost basis (for capital gain tax purposes) would be carried over to the donee of the gift. If the donee of the gift sells the donated asset, a capital gain tax could result based on the difference between the sale price and the carryover basis.

On the other hand, if you were to retain the assets until your death, the cost basis would be adjusted to the date of death value. As a result, the capital gain tax upon the subsequent sale of the assets by the beneficiaries who inherited the assets might be significantly reduced.

Accordingly, even though there would be little difference in the estate tax result, if a large gift is made, the opportunity to obtain a beneficial adjusted cost basis could be lost. Keep in mind, however, that careful tax planning can defer and minimize the capital gain tax to some extent. As a result, the capital gain tax risk is speculative and difficult to value.

The discussion above assumes that there is no increase in value after the gift is made. Keep in mind that, if the assets, which were the subject of the gift, increase in value, the increase would escape estate and gift taxation.

Fear of the “Tax Clawback”

Estate planners have expressed concern that, if death occurs in 2013 after a large gift has been made in 2011 or 2012, and after the U.S. estate tax exemption of $1,000,000 is reinstated, the estate tax would be calculated in a manner that, in effect, subjects the large gift made in 2011 or 2012 to an additional tax.  Commentators have referred to this as a “tax clawback.”  

The consensus among tax experts, who have looked at the issue closely, however, seems to be that the calculation which results in the tax clawback is incorrect.

Tax professionals who are reading this blog may want more details regarding the tax clawback issue. For details, go here:  No Tax Clawback Pursuant to Section 304 of TRUIRJCA.

What if there is a tax clawback? In the example above, if the Will includes a common type of tax clause, the estate, which consists of only $5,000,000 (what remains in the client’s estate after the gift is made), would bear a total estate tax burden of more than $4,135,000. If the beneficiaries under the Will are different from the donees of the gift, the beneficiaries under the Will would no doubt be extremely disappointed and would likely be looking for someone to blame for such an “unfair” result.

It is not difficult to imagine a situation where the estate tax due would actually exceed the value of the probate assets that would commonly bear the burden of the tax.

To recognize the issue is to reinforce how important it is to carefully allocate tax burdens among beneficiaries. Although we are confident that a proper interpretation of the most recent tax legislation removes the prospect of the tax clawback, until the IRS acknowledges that view, we cannot be certain that the IRS will agree.  As always, it is best to take great care in allocating tax burdens by properly crafting tax clauses in your Wills and other estate planning documents. 

Posted on 2/9/2011 by Richard S. Land, Member, and Kasey Galner, Associate, Chipman, Mazzucco, Land & Pennarola, LLC.


We frequently post articles relating to estate planning, estate settlement and elder law issues to this blog. We also post notices about our client seminars here. When we do, we send out notices to clients and friends of the firm. If you would like to get our notices, please join our mailing list by clicking below.

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Notice: To comply with U.S. Treasury Department rules and regulations, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction, tax strategy or other activity.

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