Time is running out on an historic planning opportunity
By Mark PetersonMr. Peterson is Senior Vice President and Head of Brokerage Life Distribution, American General Life Companies. He spearheaded promotion of American General’s 2012 Gifting campaign and can be reached at email@example.com.
Time is running out on a historic opportunity to help clients gift more than ever to their beneficiaries while paying little, or even nothing, in federal taxes. When the New Year’s Eve ball drops at midnight to welcome in 2013, it may usher out the greatest estate planning opportunity we’ve ever seen. Keep reading for more on how we got to this point and what agents and advisors can do to help.
On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Tax Act”) into law.1 The 2010 Tax Act:
• kept the existing income tax rate structure intact through 2012
• temporarily fixed the alternative minimum tax (“AMT”)
• extended certain deductions and tax credits
• provided a one‐year reduction in Social Security taxes
• temporarily reformed gift, estate and generation‐skipping transfer (“GST”) taxes, and
• provided incentives for businesses to invest in equipment.
Let’s take a look at some of these changes in detail:
Gift Tax Changes
The 35% marginal federal gift tax rate was extended from 2010 through 2012, becoming a “three years in a lifetime” low rate. Perhaps more importantly, the federal gift tax exemption amount was again (after a seven-year hiatus) reunified with the federal estate tax exemption amount, and is now at more than 500% of its previously highest level.
In short, during 2012 an individual can make up to $5,120,000 of cumulative taxable gifts during his/her lifetime without incurring any federal gift tax liability. If a married couple agrees to treat 2012 gifts made by either of them as having been made one‐half by each, then up to $10,240,000 of taxable gifts can be made through 2012 without any federal gift taxes being imposed (the “joint marital lifetime federal gift tax exemption amount”).2
But if Congress doesn’t act before 2012 ends, then on January 1, 2013 the highest marginal federal gift and estate tax rates will revert to their 2001 level of 55%, the individual lifetime federal gift tax exemption amount will plummet to $1,000,000, and the joint marital lifetime federal gift tax exemption amount will decrease to $2,000,000. As this article goes to press, there is no firm, convincing indication that either the 35% gift tax rate or the $5,120,000 gift tax exemption will apply after 2012.
Estate Tax Changes
For a death occurring in 2012, an estate comprised of up to $5,120,000 in
assets (which includes the cost‐of‐living adjustment for 2012) will be exempt for federal estate tax purposes,3 and the highest marginal federal estate tax rate of 35% reflects a substantial decrease from the 2009 rate of 45%.
The federal estate tax exemption amount generally is reduced by taxable gifts made by the decedent during his/her life. Therefore, if an individual who passed away in 2011 or passes away in 2012 has already utilized all of his/her individual lifetime federal gift tax exemption amount, there would be no remaining federal estate tax exemption available. All assets in such decedent’s gross estate for federal estate tax purposes (as distinguished from lifetime taxable gifts that are part of the estate tax base but are not includible in the gross estate) would, as a general rule, be subject to a 35% federal estate tax except to the extent the marital deduction, charitable deduction, or some other federal estate tax deduction applies.4
Generation-Skipping Transfer Tax Changes
For 2011 and 2012, the generation‐skipping transfer (GST) tax rate is also pegged at 35%, and the GST exemption amount is $5,000,000 (inflation adjusted to $5,120,000 for 2012). It would be a mistake, however, to say that the generation‐skipping tax provisions have been unified with the estate and gift tax provisions. Instead, the remaining GST exemption may vary materially from the unused balance of the federal gift/estate tax exemption amount, even though these exemptions are set at $5,000,000 for 2011 and $5,120,000 for 2012. For example, outright lifetime taxable gifts to children during 2012 or outright bequests to children upon a death in 2012 would count against the $5,120,000 individual federal gift/estate tax exemption, but would not exhaust any of the $5,120,000 GST exemption.
Conversely, gifts that are excludable for federal gift tax purposes, and thus are not “taxable gifts” for federal gift or estate tax purposes, such as annual exclusion gifts to some generation‐skipping trusts, may count against the GST exemption. On January 1, 2013, the GST tax rate is scheduled to revert to 55% and the GST exemption amount is scheduled to drop to approximately $1,400,000.
The lower rates and larger re‐unified gift and estate tax exemption amounts in effect during 2011 and 2012 are not the only potentially favorable gift and estate tax provisions set forth in the 2010 Tax Act. So‐called “portability” provisions were made law for the first time in the 2010 Tax Act.
Under the portability provisions, if and to the extent the taxable estate for federal estate tax purposes of the first spouse to die is less than the federal estate tax exemption amount, that first Deceased Spouse’s Unused portion of the federal estate tax Exemption Amount (“DSUEA”) can potentially carry over and be available for use by the surviving spouse’s estate on top of the surviving spouse’s own federal estate tax exemption amount, subject to limits imposed under law. Both spouses must die prior to the end of 2012, however, for the federal estate tax portability provisions to apply under the terms of the 2010 Tax Act. Portability only applies between spouses legally married at the time of the first spouse’s death.
Although the portability provisions provide only limited opportunities in the context of estate planning, they may present unique opportunities from a federal gift tax planning perspective if the first spouse died in 2011 or dies in 2012 and does not fully utilize his/her federal estate tax exemption amount. That DSUEA can be carried over to the surviving spouse and in effect can be added on top of the surviving spouse’s $5,120,000 individual lifetime federal gift tax exemption.
Putting the Changes Into Action
Assembling the Estate Planning Team
Generally, a qualified team should consist of an attorney who can provide qualified legal advice in the areas of tax and estate planning, produce applicable documents and follow through on their execution; an accountant familiar with the client’s financial condition, business interests and earnings history; the professional managing the client’s investments; and a life insurance professional capable of working with the other team members and obtaining needed coverage. For several steps involved in executing lifetime gifts, the expertise of one or more qualified appraisers may be required. In cases where the client has created a trust, it is certainly advisable to include the trustee as a peer member.
Implementing a Cohesive Gifting Process
Planning and executing large gifts dictates the need for a cohesive process. Give careful consideration to the following sequential steps:
Determine an approximate value of the estate
- Approximate value of estate and resulting optimal value of assets to transfer outside of estate
- Basis for estate valuation is fair market value
- Advisors: Accountant, sometimes a qualified appraiser
Determine which assets would be most advantageous to gift
- Asset selection is situational; appreciating property; life insurance; high cost basis property; and income producing property frequently considered
- Loss property and gifts of property that unreasonably impact donor’s income or capital needs not recommended
- Advisors: Accountant, estate planning attorney, life insurance professional
Determine the value of the assets to be gifted
- If accountant can’t determine fair market value, qualified appraiser needed. Certain types of property are subject to special valuation rules
- The value of any property that is not readily ascertainable and not appraised by a qualified appraiser must be justified by other means acceptable to the IRS
- Advisors: Accountant, often a qualified appraiser
Transfer ownership of property to trusts or individuals, directly or indirectly
- Gift complete when donor gives up ability to control disposition of property
- Present interest gifts qualify for annual exclusion amount ($13,000 per done in 2012); future interest gifts do not
- Advisors: Estate planning attorney
Report gifts and file a gift tax return for transferred property
- Form 709 generally required by April 15th following the year taxable gifts made to determine gift tax liability
- Must report all gifts except: Gifts that qualify for annual exclusion or marital deduction; gifts that qualify for charitable contribution deduction
- Advisors: Accountant, estate planning attorney
Insure against potential estate tax inclusion of transferred property
- Certain transfers made by the decedent within 3 years of death included in the amount of the estate for estate tax purposes
- Examples: life insurance; life estates; transfers with retained rights to alter or revoke
- Advisors: Accountant, estate planning attorney, life insurance professional
Determine remaining potential estate tax liability and ensure estate retains sufficient liquidity for this and other non-tax liquidity needs
- If potential estate tax liability still remains after gifting, or if non-tax needs for liquidity exist, consider purchase of ILIT-owned life policy
- Potential sources of funding include direct gifts subject to “Crummey” provisions, previously transferred income-producing property and private or commercial premium financing
- Advisors: Accountant, estate planning attorney, life insurance professional, qualified appraiser
The clock is ticking on the window of time to motivate clients with a net worth of $1 million or greater to engage in strategic gift-giving. While planning for relatively simple estates requires sufficient time for valuation, drafting and completed transfers, exotic assets and complicated estates are even more time-consuming. Whether gifting is right for a client or not, the exploration phase should have already begun. To move the process along, consider utilizing carrier-produced, comprehensive online tools created specifically to help advisors and their clients navigate the gifting process.
1 P.L. 111‐312, 124 Stat. 3296 (2010) [H.R. 4853]
2 A married couple may not file a joint gift tax return. However, if two spouses agree to split a taxable gift, they must both file a gift tax return (IRS Form 709) in the year that the gifts were made. It is typical that the spouses’ individual gift tax returns be filed together for administrative reasons.
3 Like the $5,000,000 lifetime federal gift exemption, the federal estate tax exemption is also subject to a cost‐of-living adjustment factor applicable in 2012, increasing the exemption to $5,120,000.
4 Note: Upon examination of the current federal estate tax return form (IRS Form 706), if an individual fully utilizes his/her $5,000,000 individual lifetime federal gift tax exemption amount during 2011 and 2012 and then passes away in 2013 when only $1,000,000 can pass estate tax free, the $4,000,000 excess of the $5,000,000 of taxable gifts over the then‐prevailing $1,000,000 federal estate tax exemption amount (subject to a cost‐of living adjustment factor) may be subject to federal estate taxes even though the $5,000,000 in taxable gifts were transferred without incurring any federal gift tax liability at the time they were made during 2011 and 2012. This potential “claw‐back” estate tax liability on 2011 and 2012 tax‐free gifts in excess of $1,000,000 (or any other federal estate tax‐free amount less than $5,000,000 that is in effect as of the date of death) is by no means certain under existing statutory provisions and is likely to be addressed by future legislation. But unless or until such future legislation is passed, the specter of a seemingly unintended estate tax liability could exist.
Important notice: The foregoing information is not a comprehensive analysis of the topic presented. It is provided solely as educational information and for general informational purposes only and should not be construed by any person as legal, tax or accounting advice. The insurers comprising American General Life Companies are solely the providers of insurance products and they strongly suggest that any life insurance owner, proposed owner, insured or proposed insured retain the services of qualified tax, accounting and legal counsel for advice on gifting assets or to determine the effect of estate taxes on their factual situation.
American General Life Companies, www.americangeneral.com, is the marketing name for a group of affiliated domestic life insurers, including American General Life Insurance Company (AGL) and The United States Life Insurance Company in the City of New York (US Life).
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