By Laurence I. Blair, Esq.
While the entire country held its collective breath, the U.S. Congress narrowly averted the much publicized “fiscal cliff,” by passing the “American Taxpayer Relief Act of 2012” (the “Act”), which President Obama signed into law less than twenty-four hours later. The Act made certain changes to the Estate, Gift and Generation Skipping Transfer (“GST”) tax laws, the most important of which are:
The Act maintains the $5,000,000 exemption amounts (indexed for inflation yearly) for the Estate, Gift and GST tax. Taking into account the indexing for inflation, the exemption amount for gifts and Generation-Skipping transfers made in 2013 and for the estates of decedents dying in 2013 is $5,250,000.
The Act increases the Estate, Gift and GST tax rate from the 2012 rate of 35% to a maximum rate of 40% on gifts made, or assets passing at death, in excess of the exemption amounts, after December 31, 2012.
Also in 2013, an individual’s gift tax annual exclusion, the amount which an individual can gift to any other person without it counting against their $5,250,000 Gift tax exemption for 2013, increases from $13,000 to $14,000 per donee.
The Act also makes the concept of portability for the estate and gift tax exemptions permanent. This concept was first introduced in 2010 and allows a surviving spouse to utilize their most recent deceased spouse’s unused estate and gift tax exemption, in addition to their own estate and gift tax exemptions. However, unlike the estate and gift tax exemptions, the GST tax exemption is not portable, so it is important to make efficient use of it during your lifetime.
Despite the fact that the Act does not contain an automatic expiration date, which was the case with the previous legislation, Congress has made clear that it intends to address comprehensive tax reform during 2013, which could result in further changes to the Estate, Gift and GST tax laws. Due to time pressures caused by the impending “fiscal cliff,” the Act failed to address certain estate planning techniques, which have been the subject of recent discussions aimed at increasing tax revenue from the Estate, Gift and GST taxes. Any further tax reform by Congress may adversely affect these estate planning techniques, which are widely used to transfer wealth and minimize tax consequences, including: intentionally defective grantor trusts (“IDGTs”), grantor retained annuity trusts (“GRATs”) and entity based valuation discounts. However, due to Congress’ haste to hammer out a deal, these highly beneficial estate planning tools are currently still available, and the advantages of these techniques are discussed in detail below:
INTENTIONALLY DEFECTIVE GRANTOR TRUSTS (IDGTs)
An intentionally defective grantor trust (IDGT) is an irrevocable trust that has the following characteristics: (1) transfers of property to the trust are considered completed gifts for federal gift and estate tax purposes, (2) property in the trust will not be includable in the gross estate of the grantor (the creator of the trust) for federal gift and estate tax purposes, and (3) income from the trust will be taxed to the grantor. An IDGT is a useful estate planning tool if you want to reduce your gross estate, and you want the trust income to be taxed to you during your lifetime, rather than to the trust beneficiaries or the trust entity.
The main benefit of an IDGT is that income from the trust is taxed to you as the grantor of the trust, rather than to the trust itself or its beneficiaries. This can be advantageous for multiple reasons. Paying the taxes on the trust income can reduce the size of your gross estate, and, because neither the trust nor the beneficiaries of the trust will be liable for the taxes, the trust income essentially compounds tax free. In effect, by paying the taxes on the trust income, the grantor is making an additional tax-free gift to the trust and the trust assets will therefore grow more rapidly. The use of an IDGT also allows certain transactions between the grantor and the trust, such as the purchase and sale of assets, to be disregarded for income tax purposes.
GRANTOR RETAINED ANNUITY TRUSTS (GRATs)
Assets transferred to a GRAT, and appreciation in the assets after being transferred to the GRAT, will not be included in the grantor’s gross estate as long as he or she outlives the term of the retained interest. Therefore, a GRAT is only advantageous if the grantor outlives the term of the retained interest. Because of this “Rolling GRATs” have become a popular estate planning tool designed to capture and remove the appreciation of rapidly growing assets from the grantor’s gross estate. Rolling GRATs accomplish this by using a series of short term GRATs and capturing the appreciation at the end of each term. This estate planning tool is most advantageous during times, such as now, when the Section 7520 rate is at historic lows. However, there have been recent proposals in Congress, seeking to eliminate GRATs which have terms of less than 10 years. If this change is implemented GRATs would become a far less effective estate planning tool.
VALUATION DISCOUNTS
Unlike estate taxes, which are based on the total value of the property held at death, gift tax is based on the fair market value (FMV) of the property transferred; the amount a stranger would pay for it. Therefore, it is often advantageous to establish an entity, usually a family limited partnership or limited liability company, to hold and manage assets for business purposes, and then later on, portions of the entity can be gifted to children, or other descendants, at discounted values. The gift tax is computed on the discounted value of the interest, resulting in a lower total gift tax liability than if the gift were of a total majority interest, or an outright interest in the underlying assets.
MISCELLANEOUS
The Act also extended certain individuals’ ability to make a direct transfer of up to $100,000 from an IRA to charity for 2013. If you are required to take distributions from any IRA’s in 2013, you can satisfy your “required minimum distribution” and your charitable intent all at once by having the custodian of your IRA distribute up to $100,000 from your IRA directly to a qualified charity of your choice.
Please contact our office at your first convenience to schedule an appointment, so that we can discuss your existing plan and how you might be able to take advantage of these estate planning tools before further changes to the Estate, Gift and GST tax laws make them unavailable.[email protected] . or 561-994-2212
