The 2010 Tax Relief Act, signed Dec. 17, temporarily raised the tax-exemption threshold for gift and estate giving.
The law was set to revert to a $1 million threshold this year, with a maximum tax rate of 55 percent.
Instead, the estate tax exemption was increased, during 2011 and 2012, to $5 million for individuals and $10 million for married couples.
Since 2001, the two exemptions slowly changed. People could give away $1 million during their lifetime, but after death that amount increased to $3.5 million, said Kate Carr, tax manager at BKD’s Colorado Springs office. The recent law also unified both the gift and estate tax exemptions to the same threshold.
“Usually, it’s much better to make gifts during your lifetime because the effective tax rate is less than if you die with the money,” Carr said.
That’s because gift tax is calculated differently than estate tax.
“It just makes a lot more sense to try and give it away during your life time, if you can,” she said. “It lowers your out-of-pocket tax cost.”
The law also makes the exemption portable between spouses. When one spouse dies with an unused portion of his or her lifetime exemption, the surviving spouse’s estate can use that portion.
Carr advises clients to look at their current wills and trusts to make sure they’re taking advantage of the increased exemption and portability.
The clock is ticking in more ways than one. There’s a strong possibility that the $5 million exemption will be lowered in 2013 or thereafter. And no one knows whether the change will be retroactive.
For instance, if a woman gives the maximum $5 million to her children this year, and the lifetime amount is decreased to $3.5 million before she dies, her estate may be subject to tax on the $1.5 million difference.
Even so, there’s still an advantage to giving away the maximum amount this year or next before the law changes, because if that money is invested, the future gains are in the children’s accounts.
“If you didn’t use your money while alive to pay tax — then you’ve still won on that one,” Carr said. “If you’d kept the money, you would have been paying taxes on the growth that whole time.”
For similar reasons, this is a good time to make generation-skipping transfers, which allow people to give money to their grandchildren, because that lifetime exemption was also raised to $5 million.
Another two things she advises clients to do, while the opportunity still exists, is to make gifts via family entities and short-term grantor retained annuity trusts. The Internal Revenue Service is likely to take away those options, Carr said.
“It’s been in their budget proposals for awhile,” she said.
GRATs are one way to retain most of the income — from a high-yielding and rapidly appreciating property — and transfer that property to a child or someone else and save considerably on federal taxes and probate costs, Carr said.
For those able to sell stock, that’s another good option for gift-giving because the long-term capital gains tax, at 15 percent, is much lower than the gift and estate tax rate.
From the investment side, Susan Davis, VP and trust officer at Wells Fargo’s Private Bank, said her office has focused on the gift tax exemption with their clients.
“It makes sense for high-value clients. They respond to it,” Davis said. “We’ve been successful in having people take advantage of this particular aspect of the change.”
Increasing the exemption has given clients more flexibility to reduce their estate size and pass it down to next generation.
“They understand it,” she said. “(Clients) say, ‘I want to do that for my children. I want to do it now.’”
Estate tax planning tips
Several vehicles can help investors take advantage of the temporary increased estate- and gift-tax-exemption thresholds:
Sales to “defective” trusts, which allow the tax-effective transfer of assets to multiple generations
Grantor retained annuity trusts, or GRATs, which allow asset transfer to the next generation in a short-term vehicle
Charitable trusts, such as a CLAT, or charitable lead annuity trust, or a CRUT, a charitable remainder unitrust, to leave assets for multiple generations and provide for charities
Cash management of irrevocable insurance trusts, which reduces the amount of notification letters that must be sent each year
Generation-skipping transfer, or GST, tax exemption planning to increase the after-tax amount of gifts to future generations