For the balance of 2012, there are unique estate planning opportunities that we may not see again. This year, every individual may pass $5.12 million free of federal gift and estate tax to children, grandchildren, more remote descendants or other family members. Any transfers of wealth more than $5.12 million per person will be taxed at a 35 percent rate. In addition, if transfers are made to include grandchildren or more remote descendants, the $5.12 million will be exempt from the additional generation-skipping transfer (GST) tax.
This opportunity to make gifts of this significant size ($10.24 million for a married couple) is anticipated to expire on Jan. 1, unless Congress acts to extend it. If there is no congressional action, the federal estate, gift and GST tax exemptions will revert to their lower 2001 levels — that is, a $1 million exemption for estate, gift and GST taxes with the balance taxed at a 55 percent rate.
President Obama’s proposals for 2013 call for a 45 percent maximum estate, gift and generation-skipping tax rate. These proposals also call for disallowance of discounts on certain transfers between family members, longer minimum periods for GRATS and restrictions on the use of other now acceptable gift and estate planning practices commonly used by high net worth individuals.
There is much uncertainty in the matter of transfer taxes at this time. What appears to be clear is that what prevails throughout the balance of this year is the lowest transfer tax environment and largest credit amount seen in more than 20 years. As a firm, we urge that clients, who are able to do so, take advantage of some existing opportunities.
We recommend that our clients consider taking advantage of the benefits provided by the 2012 law, using one or more of the Estate Planning Strategies outlined below:
- “Capped” gifts to children. This strategy involves making current lifetime gifts to children, outright or in trust. The gift may be coupled with a “cap” in the parents’ will or revocable trust, which sets a limit on the children’s inheritance at a specified dollar amount (perhaps with an inflation adjustment). The balance can pass to charity, either a public charity or the family’s private foundation, or a donor advised fund.
- Gifts of the exempt amount (up to $5.12 million for individuals or $10.24 million for a couple) in trust to children, remainder to grandchildren or more remote issue. This strategy can be used to create the so-called “dynasty” trust that will remove the gifted assets from the gift, estate and generation-skipping transfer tax system for approximately 90 years.
- Family Limited Partnerships. Family Limited Partnerships (FLPs) are a strategy that can leverage the available gift and GST exemptions and permit the senior generation to continue to manage strategic family business or investment assets. If there is a sound business purpose for holding assets in a partnership with multiple family members as partners, and business formalities are strictly followed, the use of an FLP may allow families to pass non-controlling interests in an FLP at a substantial discount over the value of the partnership assets to the next generation and beyond. This strategy is also available for family limited liability company (LLC) assets.
- Loans and promissory notes. Outstanding loans or promissory notes from children, or trusts for children that were created in prior years, can be forgiven in 2012 using the gift tax exemption.
- Irrevocable life insurance trusts. Trusts holding life insurance policies (ILITS) can be given additional cash assets to provide for future premium payments by the ILIT trustee. Irrevocable trusts holding life insurance policies, if properly maintained, can pass insurance proceeds free of estate tax to the next generation and beyond.
- Intra-family loans. Interest rates are at historically low rates. This enables intra-family loans at very attractive rates. A loan at a low interest rate to a trust can be a good way to permit the trust to make investments yielding returns well in excess of the annual interest due. The so-called “spread” inures to the benefit of the trust and its beneficiaries. For example, the long-term Applicable Federal Rate (for a more than 9-year loan) in December 2012 is 2.4 percent.
- GRATS. A GRAT is a grantor retained annuity trust in which the grantor retains the interest for a number of years (usually 2 to 4 years), with the remainder interest passing to designated remainder beneficiaries at the end of the term. The gift to the remainder beneficiaries is calculated by reducing the value of property gifted to the GRAT by the value of the grantor’s retained interest (using IRS tables). The goal is for the gifted property to increase in value — which value inures to the benefit of the named remainder beneficiaries. The key to the GRAT is that the grantor survive the term so that the property passes to the remainder beneficiaries during the grantor’s lifetime. A GRAT formed in 2012 will fall under the current rules; if the minimum term of new GRATS created in 2013 is extended by statute, the use of the GRAT technique and its gift tax advantage will diminish or disappear.
- Spousal Lifetime Access Trusts (SLATS). A SLAT is an irrevocable trust that one spouse establishes for the primary benefit of the other spouse. In California, a SLAT would need to be established with the donor spouse’s separate property rather than community property. If such a situation exists, the assets of the SLAT are removed from the estate of both spouses. SLAT assets available to the beneficiary spouse during his/her lifetime can ultimately be distributed to children and grandchildren without further estate, gift or GST tax.
We want to remind clients that each of these planning techniques takes time to analyze and structure, as each family situation and gift opportunity is unique. It is still possible to create some of these structures in December. Please contact Miriam Golbert or Barry Fink for further details and analysis.