Tax and Financial News for July 2012

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Time Running Out on Rare Estate Planning Opportunity

Individuals, couples and small business owners have a rare opportunity to consider a major estate planning strategy before the end of 2012 – when gift and estate tax rates will revert to pre-2001 levels. Currently, the laws for gifting are extremely favorable for taxpayers. Individuals can give away as much as $5.12 million tax free. Barring Congressional action before the end of the year, estates of more than $1 million will be subject to tax rates as high as 55 percent in 2013. Rather than leaving money in their estate, many taxpayers are giving large gifts to their heirs now, either outright or through the use of trusts.

The federal gift and estate taxes are essentially just one tax. Gifts of more than $13,000 in one year to any one individual or non-charity are taxable. However, in 2012, an individual can claim a $5.12 million lifetime exemption on the gift tax return. This exemption uses up what is known as the unified credit for gift and estate taxes, so named because these taxes are integrated into a unified tax system.

The unified credit is used to calculate the portion of the estate tax due on taxable estates. If an individual exceeds the gift tax exclusion of $13,000 in a given year, he can either pay the tax on the excess or use the unified credit. If he pays the tax, the taxed gifts are added back into the estate and the estate tax is recalculated with a credit for the gift taxes previously paid. By using the unified credit, he reduces the amount available to offset the estate tax upon his death.

The situation is best illustrated with an example. Say Bob owns a business worth $4 million and has $1 million in other assets. His daughter is his only heir. If Bob gifts the business to his daughter in 2012, he can use the unified credit to avoid paying any tax. If Bob dies next year, his daughter would pay the estate tax on $1 million. (Because Bob used the unified credit, his daughter would not receive the estate tax exemption.) If Bob did not gift the business to his daughter and died the next year, his daughter would get the $1 million exemption but she would have to pay estate taxes on $4 million, which could possibly even jeopardize the future viability of the business.

Another advantage for taxpayers is that gift and estate taxes are based on the individual, so a couple can each receive the full exemption amount of $5.12 million, allowing them to shelter gifts of $10.24 million from tax. In addition, if the assets appreciate in value after the gift is made, the appreciation is out of the estate.

When assets are given away, the gift must be complete, meaning that it cannot be taken back. Gifts can be made either outright or through trusts, which often have the advantage of being protected from creditors. An irrevocable trust can be used to preserve assets for children, although state laws differ on their term limits. In addition, charitable trusts and life insurance trusts can be used to avoid paying estate tax.

Of course, making a large gift to one’s heirs raises other concerns besides taxes. Older individuals do not want to outlive their money, especially in the event of a health crisis. Parents need to also consider how a sudden windfall would affect their children, and business owners will want to know whether their children will continue a family business.

Individuals can make charitable gifts, gifts to political organizations, gifts of medical and educational expenses and gifts to a spouse without triggering the gift tax. But if you intend to leave a significant amount for your heirs, a discussion with a tax advisor regarding your options is highly recommended before the laws change. Congress still could take action to raise the exemption amount for 2013; but given its contentious atmosphere, that does not seem likely at this time.

It can take as long as three months to properly set up a trust, so time is running short. A qualified tax advisor can help you sort through the myriad issues.


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