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Year End Gift Tax Planning

October 2012
Michael Durkin, John Hayes


Many of the existing Bush-era tax cuts are scheduled to expire on December 31, 2012. These expiring provisions will make significant changes to the federal gift and estate tax laws. In light of the changing landscape with respect to these tax laws, individuals may wish to consult with their attorney to review certain gift tax planning opportunities before the end of the year.

Under current U.S. gift and estate tax laws, individuals have a $5.12 million exemption from gift or estate (and generation skipping) tax. Husband and wife each have their own $5.12 million exemption. This exemption can be used to shelter taxable gifts (those gifts that exceed more than $13,000 per donee per year for 2012; $14,000 for 2013) from the imposition of gift tax cumulatively during the individual's lifetime, or, to the extent that that exemption has not been used to shelter lifetime taxable gifts, to reduce estate taxes at death.

On January 1, 2013, the gift and estate tax (and generation-skipping tax) exemption will be reduced from $5.12 million per person to $1 million per person, absent any further action by Congress. Because there is no assurance that there will be any action by Congress before year end, or at any time thereafter, we recommend individuals consult with their attorney and consider making taxable gifts in an amount sufficient to use some or all of their remaining gift tax exemption up to the $5.12 million maximum amount. By utilizing some or all of this larger expiring gift and estate tax exemption, individuals can be assured that they can pass at least that amount of assets to their descendants, free of any gift or estate tax.

The process for evaluating a gift includes selecting which assets would be best to transfer, selecting the recipients of the gift, determining whether to make the gift outright or in trust, and, if the gift is to be in trust, then whether to an existing trust or to create a new trust.

The best assets to transfer are those that are more likely to appreciate over time. Appreciating assets are, in effect, a leveraged gift because the appreciation on the asset from the date of the gift to the date of the donor's death will escape estate taxation. If an individual chooses to transfer non-marketable assets, such as a family business or real estate, an appraisal of the gifted asset is needed. If the appraisal cannot be accomplished prior to the time to make the gift, certain techniques, such as using a defined value formula clause in the gift, can minimize the risk of making a gift in excess of the available exemption amount. A significant advantage of gifting non-marketable assets is that the valuation will take into account certain valuation discounts, such as lack of marketability and minority interest discounts. Such discounts can have the effect of further leveraging the use of the donor's gift tax credit.

For most individuals, the logical recipients of the gift will be family members who are already designated to receive the estate on their passing. After 2012, individuals will continue to be able to make tax-free transfers to spouse and to charity, and, as under current law, transfers to them do not utilize available gift tax exemption.

An outright gift is the simplest way to use the gift and possibly generation-skipping tax exemption. A gift into trust may offer more advantages. For example, a gift into trust for the benefit of children or further descendants can be designed to protect those assets from claims of the individual's descendants' creditors or their spouses. In addition, the individual can control the terms of the trust and the timing and manner of distribution of the gifted funds to descendants.

In addition, a gift to trust may be more advantageous if the individual desires to use generation-skipping tax exemption, but wish to have the gifted assets initially available to children and then ultimately pass to future generations on the children's passing. Another advantage of gifting to a trust is created when the individual designs the trust to be a grantor trust for income tax purposes, and then the individual, not the trust, will pay the income tax on the income generated from the trust. When an individual pays the income tax on the income earned from the trust, the size of the estate is further reduced without having to make additional taxable gifts to the trust, and the assets gifted to the trust continue to grow tax free.

If an individual decides to make a gift in trust, consideration should be given to whether the individual wishes to create a new trust or use an existing trust. Whether a new trust or an existing trust is selected is a function of a number of considerations, such as whether the trust has already created the appropriate beneficiaries and whether the trust is a grantor trust for income tax purposes so the trust is designed to be a generation-skipping tax trust to utilize the generation-skipping tax exemption.

The following are some examples of gifting strategies that incorporate the above-mentioned considerations:

  • Direct gift of cash or securities to children or grandchildren.
  • Forgiveness of past loans, either made directly to children or grandchildren, or loans made to trusts. Many individuals have established intentionally defective grantor trusts and have leveraged the gifts they made to those trusts through an installment sale. If there is a balance due on the promissory note from the intentionally defective grantor trust to the individual, he or she may wish to forgive the debt to complete the transfer of the assets in that trust.
  • Life insurance strategies include prefunding premium payments in an irrevocable life insurance trust, or, alternatively, making a large gift to invest in new policies.
  • Gift of residences either outright to children or into a qualified personal residence trust. Great care must be taken if the individual intends to continue residing in the residence gifted.
  • A Spousal Lifetime Access Trust ("SLAT") is a trust that is designed to mirror, in many respects, the family trust that an individual may have created as part of his or her testamentary estate plan. Additional features include that the trust would be taxed as a grantor trust during the individual's lifetime. The primary beneficiary of the SLAT would be the spouse during his/her lifetime. On the spouse's passing, the SLAT would then be held or distributed to descendants. The SLAT is particularly attractive to married couples who wish to utilize their gift tax exemption but either are not comfortable with completely parting with such a sizeable amount of money or are uncomfortable with their children being current beneficiaries or having access to such a sizeable amount of assets.

Please contact John Hayes (312 261 2121) or Michael Durkin (312 261 2130) if you wish to discuss gifting strategies in greater detail.

This communication is provided as a general informational service to clients and friends of Pedersen & Houpt. It should not be construed as and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship. This material may be considered Attorney Advertising in some states. Please note that any prior results discussed in this material do not guarantee similar outcomes.

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