United States: Going, Going, Gone? The Window Is Closing On Significant Estate Planning Opportunities

Private Client

If ever there was a good year to die, it was 2010 during which no Federal estate or gift tax was imposed. On the other hand, 2012 is the best year to make gifts to your loved ones because of a significant change to the Federal estate and gift tax that is scheduled to become effective on January 1, 2013.

In mid December, 2010 Congress enacted the Tax Relief, Unemployment Insurance Reauthorization and Jobs Creation Act of 2010 which granted a $5,000,000 exemption from Federal estate, gift and generation skipping transfer ("GST") taxes increased for inflation to $5,120,000 in 2012 and capped the maximum marginal rate at 35%. But these changes were granted only for a two-year period. Unless Congress acts again soon, beginning on January 1, 2013, the Federal estate, gift and GST tax law will revert to 2001 levels. As a result, taxable estates over $1,000,000 will be subject to estate tax, and the maximum marginal rate of 55% will begin at $3,000,000. Estates over $10,000,000 may be subject to a surcharge which can increase the marginal tax rate to 60%. In order to take advantage of the $5,120,000 gift exemption level ($10,240,000 for a married couple), gifts must be completed by December 31, 2012. Because many popular gifting techniques require the creation of trusts and the need for independent valuation reports, planning must begin soon so that the gift plan can be completed before year end.

Imagine a married couple with a combined estate of $15,000,000. If both spouses were to die in 2012, the total Federal estate tax payable would be $1,666,000 (($15M - $10,240,000) x 35%). If both deaths occur after 2012 (after the law reverts to 2001 levels as described above), the same couple would pay $7,150,000 in estate tax (($15M – $2M) x 55%) before imposition of the 5% surcharge on estates over $10,000,000.

If the couple were to make a $10,000,000 gift to their children in 2012, and then both of them die in 2013 or thereafter, (after the law changes as scheduled) the estate tax payable would be reduced to only $2,750,000 ($15,000,000 – $10,000,000) x 55%).

The 2012 gifts will reduce the estate tax payable in the future. In addition, the growth on the $10,000,000 gifted to the children will not be included in the couple's estates upon their future deaths. Since the current exemption amount may be applied to GST transfers, the parents could make the gift to a trust that benefits their children and their grandchildren, thereby extending the benefits of the tax-free transfer for another generation or more. These benefits may be further enhanced by transferring assets which are currently at reduced values, such as real estate or business interests.

There are many sophisticated techniques available for clients who are considering making large lifetime transfers in 2012, including grantor retained annuity trusts, qualified personal residence trusts, pre-funding of existing life insurance trusts, sales to intentionally defective grantor trusts, family limited partnerships and dynasty trusts. Many of our clients have already availed themselves of such techniques.

We have found, however, that many clients have substantial wealth (and realize that they should be taking advantage of this opportunity) but are concerned about making large gifts that will substantially diminish their liquid assets (cash and marketable securities) and cash flow. For clients in this position, there is another technique that is becoming increasingly popular as we get closer to the closing of this window of opportunity. This technique (a "spousal access trust") allows one spouse to create a trust which allows the other spouse to receive distributions of income and even principal while at the same time removing the trust assets from both of their taxable estates.

A spousal access trust enables one spouse to transfer up to $5,120,000 to a trust for the other spouse for his or her lifetime, and thereafter for the benefit of their children and/or grandchildren. The amount transferred (and any appreciation on such amount), to the extent retained in the trust, is no longer included in the couple's taxable estate, but at the same time, it can be made available to the spousal beneficiary if necessary in the form of a distribution of income (and in some cases principal) to the spousal beneficiary during his or her lifetime. In most cases, the distribution must be approved by an independent (but friendly) trustee. Upon the death of the spousal beneficiary, the trust assets pass to the children and/or grandchildren estate and/or GST tax-free, on the terms and conditions established by the spouse who created the trust.

With the presidential election in November looming, estate and gift taxes may figure prominently in the political conversation. If a change is made, it is impossible to predict what that change will be or whether the change will be made before the end of 2012. Even if the exemption levels are maintained at $5,120,000 beyond 2012, implementing a gift strategy now will enable more future growth on the gifted assets to escape federal transfer taxation. We are therefore urging our clients to consider these planning opportunities while they presently exist.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.