Client Alert!
Take advantage of family wealth transfer planning opportunities before the sun sets
By Elizabeth K. Brown | March 4, 2011
THE TAX RELIEF ACT OF 2010 CREATES PLANNING OPPORTUNITIES
Just before the end of 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The Act primarily provides for a two-year extension of the Bush income tax cuts, but it also provides a significant but temporary reduction in estate and gift taxes. Without the enactment of the new law, estates and gifts valued above $1 million would have been subject to a tax, effective January 1, 2011. Additionally, the maximum tax rate on the amount of the estate or gift over the exemption amount would have been 55%.
The good news is the Act provides for generous estate and gift tax exemptions and rates for 2011 and 2012. The bad news is the Act is only a temporary measure, sunsetting January 1, 2013. Absent new legislation, the lower estate and gift tax exemptions and higher tax rates will return in 2013, resulting in a much greater tax burden on estates and gifts. During that two-year window, though, the Act has created a surprisingly generous gift tax exemption never available before. Following is a summary of the provisions of the new Act and a discussion of the planning opportunities available during that two-year window.
OVERVIEW OF ESTATE AND GIFT TAX CHANGES
Increase in Estate Tax Exemption. For decedents dying in 2011 and 2012, the Act greatly reduces the reach of the estate tax by granting estates a $5 million exemption for property subject to the tax. The $5 million exemption in the 2010 Act is a significant increase from the exemptions available in prior years. Under prior law, the highest estate tax exemption ever available was in 2009 when the exemption was $3.5 million.
Reduced Tax Rates. Estates that exceed the exemption amount will be subject to a new 35% tax rate, which is 10% lower than the rate that was in effect before 2010.
Exemption Portability. Under the Act, if one spouse does not use all of his or her $5 million exemption, it may be used in the estate of the surviving spouse. This concept, called "portability," is a new concept introduced by the Act. The portable exemption makes it easier for a married couple to take full advantage of their combined $10 million exemption.
Estates of Decedents Dying in 2010. The Act has reinstated the estate tax for 2010 but with the $5 million exemption and the 35% tax rate, as is the law in 2011 and 2012. The new law also provides that estates of persons dying in 2010 can elect out of the estate tax, provided that the heirs of the decedent use the decedent's tax basis, known as carryover basis, for their inherited property. For estates of decedent's dying in 2010, the Act extends the filing date for the estate tax return (usually due nine months after the date of death) to September 17, 2011.
Generation-Skipping Transfer Tax. The generation-skipping transfer (GST) tax is imposed on gifts and bequests to grandchildren and great-grandchildren, which is in addition to the estate and gift tax. Under prior law, the GST was also repealed for 2010 and reinstated in 2011 at the lower $1 million exemption and higher 55% maximum tax rate applicable to estates and gifts. However, like the estate and gift tax changes, the GST exemption is increased to $5 million and the tax rate is 35% for 2011 and 2012. In 2013, the GST tax, also like the estate and gift taxes, will revert to a $1 million exemption and a 55% maximum tax rate.
Increase in Gift Tax Exemption. For gifts made in 2011 and 2012, the gift tax exemption has been increased to $5 million, and the tax rate on gifts in excess of that amount is 35%. Since 2001, taxpayers have had only a $1 million lifetime exemption for gift tax purposes.
PLANNING OPPORTUNITIES WITH INCREASED GIFT TAX EXEMPTION
Make Tax-Free Gifts Before Sunset. For 2011 and 2012, business owners and other high-net worth individuals should consider taking advantage of the newly-created opportunity to make larger gifts to their children and descendants without estate, gift or generation-skipping taxes. Instead of being limited to making only $1 million of tax-free gifts, as under prior law, business owners and high-net worth individuals can now give up to $5 million to their family members – tax-free. In 2013, the estate and gift tax exemption is to revert back to $1 million, so it makes sense to make gifts between $1 million and $5 million during this two-year window.
Gifts of Interests in Family Business Entities to Dynasty Trusts. Under the Act, a married couple may now gift up to $10 million of property, gift tax-free. If the gifts are made to a dynasty trust for children and descendants, the gifts can be made without the imposition of any gift, estate, or GST tax at the time of the transfer or at any point in the future. If the gifted property is a minority interest in a family business entity, the business owners can still retain control of the family business while utilizing discounts in gift valuations for lack of marketability and minority interest. The discounting techniques further leverage the gift tax exemption. Growth of dynasty trust assets without the imposition of transfer taxes can lead to some truly astonishing appreciation in the value of the gifted assets over time.
Sales to Grantor Trust. If the business owners or high-net worth individuals wish to leverage their gift tax exemption even more, they may structure the dynasty trust as a "grantor trust," gift some cash into it and then sell the minority interests in the family business to the dynasty trust on the installment basis. The "grantor trust" status allows the business owners to pay the tax on the income from the gifted interest as though the gift was not made. While that may not sound like a good thing, it actually is! It allows the business owner to pay the income tax – that otherwise would have to be paid by the children's dynasty trust – with no gift tax consequences. The result is that more assets are available for the business owners' children, and the transfer taxes are minimized.
Transfers to Irrevocable Life Insurance Trust. Another option for making tax-efficient gifts is to gift cash to the dynasty trust for the payment of premiums on life insurance on the lives of the business owners. Upon the death of the business owners, the policy's proceeds paid to the dynasty trust are estate, income, and GST tax-free.
Discounts and Other Planning Techniques. At year-end, Congress again considered eliminating other family wealth transfer tax strategies, including the use of certain grantor retained annuity trusts and valuation discounts for gifts of minority interests in family business entities. Fortunately, those proposals did not get included in the Act, and those strategies can still be used as appropriate.
The Act created some much needed certainty in the world of family wealth transfer taxation. Unfortunately, this Act, too, has a sunset – December 31, 2012. With the increased gift tax exemption temporarily available, the time for making gifts to family members is now.
To learn more, contact Elizabeth K. Brown: (405) 235-4100.
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