During calendar 2012, individuals can gift, or give away, as much as $5.12 million and pay no federal gift taxes on the gifts, although this amount is reduced by the amount of any taxable gifts made in prior years. In the absence of a Congressional change in the law, however, the gift tax exemption will be reduced to $1 million on January 1, 2013. More current perspective is provided from three leading estate planning attorneys:
- Charles A. (Clary) Redd. Clary wrote an article titled “The Perfect Storm“ in the January 2012 issue of Trust & Estates (subscription required so contact Clary or me for further details).
- Bryan Howard. Bryan is the author of the blog, Tennessee Estate Planning Law. Over the past few months, he has written a series of posts on “The Great 2012 Gifting Opportunity.” The following link is to the fifth post in the series, which provides direct links to the previous four posts. Link to Bryan Howard’s posts here.
- Harris H. (Trip) Barnes, III. Trip wrote a letter to his clients in February 2012 talking about what to consider on the gifting and estate planning front for the remainder of 2012. He has given us permission to excerpt from that letter.
The Perfect Storm
Clary Redd’s article describes the current environment as a “perfect storm” for clients who may want to take advantage of the current situation to achieve “thunderous” results. Clary is careful to state that he rarely uses such superlatives in his writing and reads their use by others with skepticism. However, he highlights the elements of this perfect storm:
- High Applicable Exclusion Amount. As noted above, the gift tax applicable exclusion amount and the generation-skipping transfer (GST) exemption are both $5.12 million for an individual and double that for a married couple. Absent a conscious change by Congress, these amounts drop to $1 million at the stoke of midnight December 31, 2012. The current exemption amount has never been higher.
- Low Marginal Estate and Gift Tax Rate. The current rate is 35%, which many believe is as low as will be seen for the foreseeable future. Any increase in the marginal rate will increase the cost and reduce the attractiveness of many gift and estate planning techniques.
- Extremely Low AFRs. The long-term AFR (annual basis) has risen from 2.60% in January 2012 to 2.89% in May 2012. While rising recently, the rates remain quite low relative to historical levels.
- Depressed Asset Values. While Clary’s article did not anticipate the strong start to the year seen in the stock markets, many stocks and assets in other classes remain depressed in value relative to historical levels.
- Defined Value Clauses. Clary suggests that now is a great time for charitably inclined folks holding hard-to-value assets to make gifts and sales of the property. In doing so, a stated dollar amount would be allocated to a trust for the benefit of descendants, with the remainder being allocated to charity. He notes that this technique has been upheld in several courts, but that the IRS may promulgate contrary rules in the future.
- Valuation Discounts. Taxpayers have been giving nonvoting minority interests and voting minority interests in businesses for many years, taking advantage of allowable minority interest (if applicable) and marketability discounts. Other taxpayers have placed such assets into FLPs (or LLCs or other asset holding entities) and achieved reasonable discounts at the level of the holding company, as well. Clary warns about insuring proper business reasons for formation of such entities. From my experience, it is also necessary and appropriate to run them as businesses to avoid many other issues related to Section 2703.
- Very Long Trusts. Per Clary: “It is legally permissible in many states to establish trusts that are designed to exist longer than permitted under the common law rule against perpetuities.” Be sure to talk to an experienced planner about these trusts.
- Grantor Trusts. Read Clary’s article to learn about a twist enabling individuals to set up trusts where the value of the trust’s assets will not be includable in the estate and all income and expense items belong to the grantor. Again, this is an area where expert planning advice is essential.
No wonder Clary Redd refers to the present time and the remainder of 2012 as a “perfect storm” for gift and estate tax planning.
The Great 2012 Gifting Opportunity
Bryan Howard discusses some of the same issues, but from a different viewpoint. While Clary talks about the “perfect storm” that exists in some detail, Bryan assumes that the benefits of doing something should be apparent to most. He poses several questions in discussions with clients as they talk about what actions to take during the remainder of 2012. The questions are instructive:
- Can you afford to make the gift? Said differently, is there a chance that you will run out of money if you make the gift?
- Are you prepared to pay Tennessee gift taxes? There are several ways to make gifts without paying Tennessee gift taxes; however, these techniques are often impractical.
- What impact will the gift have on your children?
- What assets should be given?
- Are you willing to give up control of the assets you are transferring?
- Should you transfer “discounted” assets such as fractional interests in real estate or interests in corporations, LLCs, or limited partnerships?
- Should you make the gift to a trust rather than directly to the recipient? Most of our clients have decided to use a trust.
- If you use a trust, what are the provisions regarding trustees and distributions?
- If you use a trust, should you allocate generation-skipping transfer tax exemption to the trust? The answer is usually yes.
- How will the gift impact your overall estate plan?
- When should the gift be made?
Bryan’s questions put the decision-making process into quite human terms. During 2012, the repeal of the estate tax in Tennessee has been introduced and passed. A portion of Bryan’s posts deal with this issue, which is of obvious interest to Tennesseans. I encourage readers to read this series in Tennessee Estate Planning Law. Link to Bryan Howard’s posts here.
The Dirty Little Secret
Trip Barnes, in a letter to clients earlier in the year, made some of the same points about the obvious benefit of the high current exemption. While Clary and Bryan have focused on individuals and couples who have the ability to make large gifts, Trip discusses issues that relate to smaller estates. Two paragraphs (broken into four to promote readability here) are of particular note:
What sort of WILLS should be “drafted”? Currently, if you have an estate that between husband and wife exceeds $5 million you could have an estate tax problem. (? I thought the combined exemption was $10 million — read on). You say, if I have $3 million and my spouse has $3 million that is only $6 million, and the total exemptions are $10 million; thus no estate tax. This is true.
However, the dirty little secret is at death of the first spouse, you must file a Form 706 (Estate Tax Return) to transport the exemption from the first spouse to the second spouse. If you don’t do this, you lose it. Thus, the question is how many people are going to go through the time and expense of hiring lawyers, and appraisers to appraise properties, review those properties, and then create an estate tax return? I predict not that many, and thus, the exemption will be lost.
Three, if the surviving spouse remarries, and the spouse to whom he/she is currently married at death has used up his or her exemption, then the exemption of the first spouse did not transport. Thus, there are lots of reasons to still use the traditional estate planning and the credit shelter trust/by-pass trust to capture the exemption amount and to negate the need of a Form 706. (Even in estates of less than $10 million fair market value.)
One other hazard to consider is that if you are filing a Form 706 you are now giving some IRS estate tax examiner the opportunity to review your 706. He or she may disagree with your value, thus, you could easily find yourself with a 706 showing an amount less than $5 million increased to amounts substantially more than $5 million and potentially generating estate tax. (Thus, the need for really good appraisals!) Thus, the law is not quite as benign as one would think and is certainly not as “user friendly” as one would think.
There is truly a great gifting opportunity in 2012. In fact, there is a perfect storm for such gifting. However, taxpayers and planners need to be careful of the dirty little secret about smaller estates and protect themselves or their clients.
For a number of years prior to 2001, many taxpayers formed FLPs (or LLCs) to hold relatively small or relatively large asset holding entities, and then made gifts of discounted holding entity interests. At Mercer Capital, we often provided 100-200 asset holding entity valuations per year, with the majority being conducted later in the year. This timing places a strain on taxpayers, their advisers, and the valuation firm.
If you are considering making a substantial gift this year, or if you have clients who are contemplating the same, it is better to act sooner rather than later. You will want to be sure that there is sufficient high quality appraisal expertise available to accomplish your objectives in a timely manner.
Be sure to read Clary’s article and Bryan’s blog and familiarize yourself with this topic. Always consult an estate planning professional when contemplating such transactions. When seeking high quality valuation expertise, please give the professionals of Mercer Capital a call. We have the expertise, experience, and depth of resources to help you in a timely fashion.