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Time is now for tax breaks on estate plans
With the extension of very favorable estate and gift tax provisions set to expire at the end of 2012, estate planners and their clients are entering the final stretch in the race to take advantage of planning opportunities that may never return.
In December 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 that provides for greater transfer tax exclusion amounts than previously seen, as well as a low uniform tax rate. However, the act is set to expire on midnight on Dec. 31, 2012. Congress has not yet taken any action to extend the provisions of the act, so it remains to be seen whether these favorable transfer tax provisions will apply beyond 2012. In light of this uncertainty, 2012 is the year to engage in estate planning with an eye toward the impending end of the favorable treatment.
The act addresses the exemptions and tax rates related to three types of transfers taxed by the IRS: lifetime gifts (gift tax), transfers at death (estate tax), and transfers to grandchildren (generation-skipping transfer tax). Currently, the act provides for a $5 million exemption per person for estate, gift, and generation-skipping transfer ("GST") tax purposes, which is indexed for inflation to $5,120,000 in 2012. This exemption is unified among the three types of transfer taxes so that a transfer during life reduces the exemption available at death. Therefore, if an individual makes taxable gifts of $1 million during his lifetime, then at his death he can only transfer assets worth $4,120,000 to his children without incurring any estate tax. Any transfers in excess of the exemption are taxed at a rate of 35 percent.
In addition to the lifetime exemption, the gift tax also includes a $13,000 annual exclusion per donor, per donee, which does not reduce an individual's lifetime exemption and can therefore be another powerful tool to transfer wealth to children and grandchildren when properly used. Importantly, lifetime and testamentary transfers to spouses usually do not reduce those exemptions because the transfer of property between spouses receives an unlimited marital deduction. Such transfers delay the estate tax until the second spouse passes away.
Planning now is important because if the provisions of this act are allowed to expire, then on Jan. 1, 2013, the lifetime gift tax exemption amount will be dramatically reduced to only $1 million, unified between the gift and estate tax, with a 55 percent top tax rate on transfers in excess of the exemption and a 5 percent additional estate tax on very large estates.
To illustrate the dramatic difference between 2012 and 2013, assume a wealthy individual has an estate of $5 million. If the individual dies in 2012, his estate can pass the remaining $5 million of his estate to his beneficiaries with no estate taxes. If that individual dies in 2013, however, after the act has expired, then only $1 million is exempt and the remaining $4 million would be subject to estate tax. The estate would end up owing a tax of approximately $2,400,000 (assuming a graduated tax rate with the top tax rate at 55 percent). By not maximizing the gifts he could make in 2012, the wealthy individual dying in 2013 essentially wasted an additional $4 million of transfer tax exemption and only passes $2,600,000 to his beneficiaries after taxes.
Therefore, for wealthy individuals, 2012 may be the ideal year to transfer assets to children and grandchildren in order to utilize the $5,120,000 exclusion amount and so that they avoid the potential reduction in the lifetime exemption and the potential increase in the tax rate. By not fully utilizing their $5,120,000 exclusion amount, or $10,240,000 in the case of a married couple, clients may be forfeiting a significant estate tax planning opportunity.
Everyone's situation is different and should be evaluated by estate planning professionals, but there are a multitude of techniques, ranging from very basic to complex planning techniques for families. Some of the basic techniques may include gifts of cash or investments or transfers of business interests to descendants, either outright or in trust, or forgiveness of debt owed by a descendant or family member. For clients with greater liquidity or more complex planning needs, various types of trusts, life insurance planning and business restructuring may be appropriate.
An estate plan is specific to an individual family and a particular situation, so clients should consult with their estate and tax planning professionals for advice on particular strategies and which opportunities may be most appropriate for their situation.
Whether Congress acts prior to Jan. 1 and extends or changes these estate tax benefits or whether Congress does nothing is anyone's guess. However, most experts expect the congressional deadlock to continue. Thus, the bet is that the IRS will start next year by taking a much larger "bite" out of your estate. Wealthy individuals should take advantage of these opportunities now.
J. Scot Kirkpatrick is a shareholder of Chamberlain, Hrdlicka, White, Williams & Aughtry and heads the Trust and Estates Practice Group of the firm's Atlanta office. Ashley P. Alderman is an associate in the Atlanta office who specializes in estate planning and estate administration for high net-worth families and individuals.