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Thursday, March 31, 2011

New Gift and Estate Taxes May Prompt New Planning

A new tax law passed in Congress on gift and estate taxes may prompt clients to think about strategy in near-future gifting.  The new law increases the gift and estate tax exemption amount to $5 million from $1 million for individuals and to $10 million from $2 million for couples. Tax on the gift in excess of these amounts is 35 percent as opposed to 45 percent in 2009.

What The Law Says
The exemption is part of the Tax Relief, Unemployment Insurance, Reauthorization and Job Creation law signed into law on December 17, 2010. The law reunified gift and estate taxes and may prompt individuals with assets in this range to make gifts now.

Under the same law, the exemption was raised on the estate and generation-skipping tax to $5 million and the tax rate lowered to 35 percent for 2011 and 2012. In 2013, the amount could go as low as $1 million. For the estate tax, the $5 million exemption is up from $3.5 million, which was enacted in 2009. The $5 million is indexed for inflation.

Its Implications

Clients with assets in this range should pay attention to what could be a short window of opportunity to take advantage of these increased exemptions. The risk is the exemption for both gift and estate might go down, so the higher exemption and lower rates may be a one-time opportunity for clients to get this amount of assets out of an estate now.

Clients may want to think about shifting appreciating assets out of their estate to avoid future estate tax now that they can do this to a much larger extent without paying any gift tax. Given this significance, and possibly expiring opportunity, this is an excellent time for clients with large estates to revisit their estate plan. The new law may create new twists on old strategies such as valuation discounts, sales to trusts, and life insurance planning.  Clients with illiquid assets, such as real estate or a closely held business, have an opportunity to eliminate, or at least reduce a selloff by their estate to pay estate taxes.

A summary of possibilities that could follow the expiration of these temporary provisions are:

  • The law could expire, and the amount could go back to $3.5 million.
  • Without further action, the tax rate in 2013 will revert to its pre-2001 level of 55 percent with an exemption of $1 million.
  • The exemptions could remain at $5 million indexed for inflation.  Since 1938, other than when it was repealed in 2010, the exemption has not gone down.
  • Estate tax repeal remains a possibility.  There would likely continue to be a tax on gifts over a certain amount.

If the legislation passes that reduces the exemption from today’s $5 million back to $3.5 million, there may be other changes. This option could also include changing some favorable rules. These include tightening up the ability to take discounts for valuation, restricting the use of  grantor retained annuity trusts, and triggering immediate income tax at ordinary rates on the gifts of carried interests. These possibilities increase the urgency of taking action now.

Who It Affects
The urgency and changes may prompt clients to revisit their estate plans and consult with accountants, especially for clients:

  • who have already used the previous gift exemption of $1 million.
  • who own businesses that they may want to pass down to their children. In this case, clients should pay attention to valuation very closely.
  • with large real estate holdings and/or family-limited partnership interests.
  • with large stock portfolios.
  • who are executives in large corporations with significant holdings in the company’s stock.
  • who may be sitting on a future IPO.


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