The 2010 Tax Relief Act has provided a great opportunity for lifetime gifts to family members with a temporary increased estate and gift tax exemption of $5.12 million making these gifts potentially free of ever incurring gift or estate tax. The exemption will return to $1 million on January 1, 2013 unless Congress acts, and although most commentators think a return to $1 million is unlikely, there is a good possibility the exemption will be reduced.
Despite this great gifting opportunity for wealthy individuals, many people are reluctant to make use of the exemption for many reasons. Some of the many reasons are:
(1) The economy. While the markets have improved since the lows of 2009, many people are worth less than before the market crash and they have less confidence in their holdings due to the volatility of the market.
(2) Clawback. Clawback is the term given to a concern that the gifts will be included the donor’s taxable estate. This concern is based on the way the estate tax is calculated, which includes all gifts made by the donor and then gives a credit for any tax paid at the time of the gift. The exemption has never been reduced, so clawback has never been an issue before. If the exemption is reduced and clawback does not apply, all amounts given over the new exemption amount will stay free of transfer tax. If clawback applies, the donor’s estate tax liability will be the same as if the gift had not taken place, but the donee will not receive a step-up in cost basis and thus, may have increased income tax liability upon the eventual sale of the asset. However, all appreciation from the time of the gift will be excluded from the donor’s estate, which could exceed the negative impact of the income tax consequences. Thus, anyone contemplating a large gift in 2012 should evaluate each asset to determine the potential pros and cons related to the clawback issue.
(3) Future of the estate and gift tax. If Congress makes the current exemption permanent or extends it for a number of years, the potential donor can wait to make a large gift. Thus, many people want to wait until later in the year to see if there is any evidence Congress will extend the current exemption.
Regardless of the concerns, some want to take advantage of the high gift tax exemption amount, but also want to wait until the end of 2012 before making the gift in case an action by Congress or change in the economy affects the decision to make the gift. It is smart to wait to make the gift, but the danger lies in waiting to plan for the gift because most large gifts require plenty of planning. The asset may need to be appraised to obtain the market value of the gift, the donor often wants to place the asset in a trust to benefit the children or more remote generations, often transfer documents must be prepared to make or approve the transfers and the actual transfer must be complete by December 31, 2012. All of this takes time and the use of advisors who are likely to be inundated toward the end of 2012 with many potential donors waiting until the last minute.
Thus, any potential donor should begin preparing for the gift so everything is in place to make the gift at the end of the year. Some options for planning are:
(1) Revocable Trust. The donor can establish and fund a revocable trust with the asset the donor is considering for a potential gift. This will allow the donor to develop a plan for how the trust should benefit his/her children or more remote generations, obtain any needed appraisal for the asset and transfer the asset to the trust. Once the donor decides to make the gift, the donor can execute a previously drafted irrevocable waiver of the power to revoke document, which will make the trust irrevocable and result in a gift of the assets in the trust. This plan has the advantages of making a gift at the last minute without the need to transfer the asset or wait for advisors to prepare a document or make a transfer on the donor’s behalf. If the donor decides to reduce the size of the gift, he/she can withdraw assets prior to making the trust irrevocable, but this may require additional time for the donor’s advisors.
(2) Irrevocable Trust. The donor can establish an irrevocable trust and establish an account with a minimal amount of funds. This will allow the donor to develop a plan for how the trust should benefit his/her children or more remote generations, obtain any needed appraisal for the asset and prepare for the transfer of the asset to the trust. Once the donor decides to make the gift, the donor can execute a previously drafted transfer document or request any needed transfer from the donor’s advisors. If the asset requires recording (like a real estate transfer), the attorney will need to be involved to make sure the transfer is properly recorded. This plan has the advantages of arranging for most of the planning prior to the date of the gift and leaves additional flexibility in the amount of the gift. However, this plan requires additional assistance from the donor’s advisors and thus, the donor should make the decision sooner to give the advisors sufficient of time to make the transfer before December 31, 2012.
(3) Outright Gift. The donor can develop a plan to make an outright gift of the asset. This will allow the donor to obtain any needed appraisal and prepare any needed transfer documents. Once the donor is ready to make the gift, the donor can execute the transfer document and have the asset transferred to the donee. This may require additional communication with advisors upon making the gift, and if the transfer requires recording, the attorney will need to be involved to make sure the transfer is properly recorded. Thus, the donor should make the decision sooner to give the advisors sufficient of time to make the transfer before December 31, 2012.
So, if you are considering a large gift to take advantage of the current favorable gift tax exemption, you should start by discussing the potential gift with your advisors over the summer so the majority of the planning can be in place in time for a completed gift to be made sometime in December 2012. And, you can write your Congressman to ask for more permanence and certainty in future estate and gift tax legislation to avoid the need for these sorts of contingent plans.