Dear Clients and Friends: January 2012 – Client Update
On December 17, 2010, the Federal Government enacted what we know as the 2010 Tax Act changing the estate, gift and generation-skipping transfer (“GST”) tax regime once again. The 2010 Tax Act extended the “Bush Tax Cuts”, but only temporary for 2011 and 2012. Beginning January 1, 2013, the Bush Tax Cuts will expire and the Internal Revenue Code will revert to its 2001 status, unless there is further legislative action to make the 2010 Tax Act permanent or otherwise alter the transfer tax system again. Absent such legislation, (and in an election year, such legislation is unlikely) the gift and estate tax exemptions are both scheduled to return to $1,000,000 on January 1, 2013, and the maximum gift and estate tax rates will increase from 35% to 55%.
Last year we described various planning techniques for taking advantage of the 2010 Tax Act before its expiration on December 31, 2012. Clients would be best advised to take advantage of the 2010 Tax Act (lock in the $5,000,000 gift exemption before it is lost – “use it before you lose it”) while they still can and not wait until the end of 2012. This letter will discuss varies strategies that a client can embrace to lock in the use of their $5,000,000 gift exemption before it is lost. Depending on your financial circumstances, the nature of your assets and your intended beneficiaries, one or more of the techniques listed below may be an appropriate way to utilize this new gifting opportunity. All of these techniques will be discussed at our upcoming seminars. (see the attached schedule) For those of you who do not wish to attend a seminar, you can call any of our offices and schedule an appointment to meet with one of our attorneys. This appointment will be billed at our normal hourly rates.
ESTATE, GIFT AND GST RATES AND EXEMPTIONS UNDER THE 2010 TAX ACT
Under the 2010 Tax Act, the estate, gift and GST tax rates all were set at a maximum rate of 35%. This is a significant decrease from the 2001 rates of 55%. Furthermore, the 2010 Tax Act increased the amounts exempt from these taxes to $5,000,000, indexed for inflation. In addition, for the first time in a very long time, the IRS increased the gift tax exemption to the same amount as the estate tax exemption of $5,000,000. Under current law, at least until December 31st of this year, a client can make a gift of $5,000,000 without incurring any tax whatsoever. This creates several very attractive strategies for clients.
Also worthy of note is the fact that both the gift tax and estate tax exemptions increased to $5,120,000 on January 1, 2012 based on the inflation index.
For those clients who have not yet used their lifetime gift exemption of $5,000,000 this a good time to consider making lifetime transfers and lock in the use of all or part of that exemption before it expires the end of this year. This is especially attractive to clients who have real estate that has depreciated in value, or has seen a decline in the value of their portfolios.
There are a number of ways to take advantage of the increased gift and GST tax exemptions before they are lost.
GIFTS TO “SPOUSAL GIFT TRUST” FOR SPOUSE AND/OR OTHER FAMILY MEMBERS
A Spousal Gift Trust is an irrevocable trust created by you for the benefit of your spouse and/or other family members. Gifting assets to such a trust removes the assets and their appreciations from your taxable estate. If you are married, a gift to such a trust can be particularly attractive because your spouse can be the primary beneficiary of the trust. This allows the assets to be removed from your taxable estate while still being available to your spouse. (you do not benefit directly, but benefit indirectly thru your spouse) With careful planning and some restrictions, each spouse can create and fund his or her own Spousal Gift Trust so that each can use their respective $5,000,000 gift exemption. (“Reciprocal Trusts”) In addition, if you choose to allocate GST exemption to the gifts to a Spousal Gift Trust, the trust assets and their appreciation can also be removed from the GST tax system for as long as the trust exists, meaning that the assets will pass free of estate taxes for two or more generations. (Children and Grandchildren) This Trust also offers significant asset protection for a client and his or her family.
GIFTS TO SELF-SETTLED TRUSTS
Generally, a client cannot create a trust for the benefit of himself, receive asset protection and lock in the use of his $5,000,000 gift exemption. However, under certain circumstances and in certain states (such as Nevada, as well as other states) it may be possible for you to make a gift to an irrevocable trust and include yourself as a beneficiary of that trust. (and still remove the assets from your taxable estate when you die and remove the assets beyond the reach of your creditors) Such a structure may be desirable if you want to maximize your gifting while the gift tax exemption is $5,000,000 but you are reluctant to part with assets due to future uncertainty. Making gifts to a self-settled trust can prove to be the tool to overcome these psychological barriers. The law governing both the ability to create such trusts and their effectiveness for tax purposes is still evolving. However, the IRS recently has given guidance on this planning. Generally, the donor cannot have a pre-arranged or underlying agreement as the as to the distribution of assets from the self-settled trust. Ultimately, the primary benefit of a self-settled trust is to allow you to make a tax efficient gift while providing distributions to you if circumstances warrant. This Trust also offers significant asset protection for a client and his or her family. Our firm has strategic business alliances with law firms in Nevada that will co-counsel with our firm to create these trusts in Nevada. Also, the fact that Nevada does not have a state income tax system makes Nevada a desirable jurisdiction to create a Trust. Plus, who wouldn’t want to go to Las Vegas on a regular basis to conduct some of your financial affairs. This Self-settled trust planning is available even if you are not a resident of these favorable states by selecting a Trustee who is a resident there.
GIFTS TO DYNASTY TRUSTS FOR CHILDREN AND GRANDCHILDREN
A dynasty trust is a trust that is designed to benefit multiple generations (children, grandchildren and great grandchildren) by continuing to hold property in trust for each generation with the assets in the trust not being subject to estate tax or GST tax. The increased gift tax exemption and GST exemption under the 2010 Tax Act present an excellent opportunity to fund a dynasty trust using your increased gift tax exemption and allocating GST exemption to such gift for the benefit of your descendants. These Trusts also remove the assets beyond the reach of creditors.
Most states still have statutes that require a trust to terminate within a specified period. Some states, such as Arizona, have modified or repealed these “rules against perpetuities” to allow a trust to continue either for a period significantly longer than the traditional time (21 years after the death of the last member in a named class of then living individuals) or even continue in perpetuity with no required termination. Establishing a dynasty trust in Arizona potentially enables three or more generations to enjoy the use and enjoyment of these assets without any estate tax consequences at any level.
QUALIFIED PERSONAL RESIDENCE TRUSTS (“QPRTS”)
A Qualified Personal Residence Trust is designed to be a tax-efficient means of transferring a personal residence to your intended beneficiaries. The concept of a QPRT is relatively simple: the owner of the personal residence transfers it to a trust but retains the right to live rent-free in the residence for a residence for a specified number of years. At the end of that period, ownership of the residence is transferred to the beneficiaries (or a trust for their benefit) and is removed from the estate of the original owner. At that time, the original owner can rent the property from the beneficiaries if he or she wishes to remain in the house.
The tax advantage of the QPRT comes primarily from the way in which the value of the residence is calculated for gift tax purposes. The value of the gift is not the full value of the residence on the date of the gift, but rather the gift is valued based on the beneficiaries’ right to receive the residence only after the specified number of years. The value is calculated based on a number of factors including the age of the door, the number of years the donor can remain in the house rent-free, the value of the residence at the time of the gift and the IRS prescribed discount rate required for the calculation. A higher IRS discount rate produces a lower gift tax value. Although the IRS rates have been at historic lows, suppressed property values may still produce favorable outcomes. Additionally, for clients over age 65, a low IRS rate has less of an impact on the gift tax value.
However, no matter how a QPRT is structured to reduce the gift, the gift will still be substantial. With the increased gift exemptions, QPRTs may be an appropriate gifting opportunity for people who otherwise would not consider such a gift because they did not have enough gift exemption remaining or did not want to use the more limited exemption on such a gift but now find themselves with “extra” exemption to spare.
GRANTOR RETAINED ANNUITY TRUSTS (“GRATs”)
Because of low interest rates, the use of Grantor Retained Annuity Trusts (“GRATs”) has become very popular. GRATs allow you to transfer certain assets to your beneficiaries at a discounted gift tax value. This is because you retain the right to receive payments from the GRAT for a certain number of years before the GRAT terminates in favor of your beneficiaries. The amount of the payments you can receive can be calculated so that you will be deemed to have made a “zero gift” upon funding of the GRAT. With the increased gift exemptions, GRATs may allow clients to design a GRAT with a lower annual payment, while using the gift tax exemption to cover the value of the remainder interest for your beneficiaries to avoid gift tax.