For 2012, the federal exemption from all three transfer taxes is $5,120,000 ($10,240,000 for married couples). The gift and estate tax exemptions are each scheduled to revert to $1,000,000, and the generation skipping transfer tax exemption (GST) is scheduled to revert to $1,390,000 on January 1, 2013. No one really expects a complete reversion, but it is highly unlikely that that all three types of transfer taxes will be sustained at the current, historically high, levels. Here are a few reasons why a great deal of wealth will be transferred between January 1 and December 31, 2012, in variety of ways.
Introduction
The Gift tax is a tax on lifetime transfers above the exemption limit. The Estate tax is a tax on what is left over at death. Lifetime gifts have a basis carryover, and as a result, a sale or disposition of the asset will generate income or capital gain tax. Common types of asset transfers include high basis assets, and highly appreciating assets.
The GST tax is imposed whenever there is a transfer of an interest in property by gift or at death to a person who is two or more generations below that of the transferor. The GST is a standalone exemption. GST transfers are generally designed to “skip” estate tax in the generation below the Donor.
Of the three transfer taxes, the gift tax exemption is the exemption most likely to go down, and if this happens it will become harder to use the GST exemption, irrespective of its size, or to remove appreciation in assets from the taxable estate for estate tax purposes.
Even though, a married couple can make cumulative gifts through 2012 of $10.24 million there are estates where gifting of that magnitude is not financially feasible. If the right size gift is $5.12 million or less, one spouse could make the gift (without gift-splitting), and the non-Donor spouse will then have preserved the full gift tax exemption for future use (at whatever amount it may then be).
Hedging Your Bets
It is possible to buy some additional time to see what might happen with the gift tax and the GST tax by making a gift to a lifetime trust for a spouse (QTIP) in 2012. This transfer will be treated as a gift qualifying for the marital deduction only if an election is made on a timely filed gift tax return (April 15, of the year following the transfer). The Donor will have until the following April 15, to decide whether or not to elect to qualify for the marital deduction or use his or her gift tax exemption for 2012. Alternatively, the spouse may waive all or a portion of the spouse’s income interest and the trust could continue as a GST exempt trust.
Another type of hedge is a revocable trust that has already been drafted as a type of stand by gifting trust. Generally, all that is needed to complete the gift would be for the Donor to relinquish his or her power to revoke, or the trust may contain a provision that automatically makes the trust irrevocable on December 31 unless revoked prior to that date.
In some case, the gift may be structured in a fashion that may allow a return of some or the entire gift to the Donor, if financial circumstances change. A Spousal Lifetime Access Trust (SLAT) is such a structure.
Life insurance Transfers
The gift tax and/or GST exemptions may be used for transfers to a life insurance trust to acquire new life insurance, purchase policies from the Donor or his or her spouse, or prefund premium payments. Even if no gifts can, or will, be made in 2012, it is important to review all previous allocations and potential automatic allocations of GST exemption, and consider a possible allocation of the GST exemption to trusts that may not be fully GST exempt.
Valuation discounts
Valuation discounts are a way to leverage the gift and GST exemptions. These types of transactions are more complicated and time consuming, and there is probably not sufficient time left this year to properly structure a transaction of this type. However, all is not lost. A transfer of cash, or other high basis property may be made this year, to a properly drafted trust, and later used to purchase the discounted interest after the valuation discount planning is implemented.
Finding Assets to Transfer
In some cases, cash may not be readily available for transfer, but there may be other sources for the gift. For example, a gift may include the exercise of lifetime general power of appointment over an existing trust; relinquishing a surviving spouse’s interest in a QTIP trust, forgiving a promissory note; forgiving past indebtedness; or establishing a qualified personal residence trust (QPRT).
Dealing with Uncertainty
It is difficult to plan with any degree of certainty. Planning through the end of this year may not gain anything, yet failure to plan properly may prove quite costly. It is not too late to “have your cake and eat it too,” provided you dine before January 1, 2013.
If you would like more information on this subject, or have a client who might benefit from a discussion about it, please contact Barry Koslow at bkoslow@mkaplanners.com or (781) 939-6050.
Securities offered through Advisory Group Equity Services, Ltd., Member FINRA/SIPC. 444 Washington Street, Woburn, MA 01801 (781) 933-6100.
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