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Gift/Estate Planning Opportunities in 2012

Amy Joyce, CPA, J.D., Tax ManagerMargolin, Winer & Evens LLP

ajoyce@mwellp.com

Estate/Gift/GST Taxes – Beneficial Provisions Set to Expire 1/1/2013

2012 Current Rules $5,120,000 Lifetime

Gift/Estate Exemption $5,120,000 Lifetime GST tax

exemption 35% Tax on Transfers in Excess

of the Exemption Amount Deduction for state estate tax

2013 Sunset Provisions $1,00,000 Lifetime Gift/Estate

Exemption $1,00,000 Lifetime GST tax

exemption 55% Tax on Transfers in Excess

of the Exemption Amount Credit for state estate tax

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A Note About the Generation-Skipping Transfer (“GST”) Exemption

• The GST is tax designed to complement the estate and gift taxes by ensuring that transfers of property are taxed at each generation level.

• The GST exemption allows property gifted outright, up to available exemption amount, to avoid being subject to gift or GST taxes.

• The GST exemption allows property placed in trust up to available exemption amount to avoid being subject to gift, GST or Estate taxes.

• With effective GST exemption utilization, “dynasty” trusts can be used to avoid transfer taxes for multiple generations.

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Estate/Gift/GST Taxes – Legislative Uncertainty After 12/31/12

Several Possibilities:1. Old Rules Return as Scheduled (“Sunset”) – Likely if Democrats

retain the Senate and the Presidency and seize the House.2. Extension of Existing Rules – Likely if Republicans seize the

Senate and the Presidency.3. Repeal of Estate/Gift Taxes – Possible (less likely than extension

of existing rules) if Republicans seize the Senate and the Presidency.

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Estate/Gift/GST Taxes – Legislative Uncertainty After 12/31/12 (cont’d)

4. 2009 Rules Return – Possibility if November 2012 election results in mixed outcome (compromise)

$3,500,000 Estate & GST Exemptions $1,000,000 Gift Tax Exemption 45% Tax Rate

Many experts with significant political observation histories feel that political compromise will not be reached until well into 2013 but will be retroactive to January 1, 2013.

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President Obama’s February 2012 Budget Suggestions

1. Estate Tax Exclusion – $3,500,000 (no mention of gift tax exclusion).2. Portability – Obama proposal would make this permanent.3. Irrevocable Grantor Trust – Obama proposal would subject trust to estate

tax upon grantor’s death; however, existing grantor trusts expected to be grandfathered.

4. Dynasty Trust – Obama proposal would limit generation skipping trust effect to 90 years (under current law some states, such as FL, allow trust to exist as long as 360 years).

5. Valuation Discounts – Obama proposal would eliminate discounts for lack of control, lack of marketability, etc.

Observation:Republican House may be able to resist some or all of Obama’s

proposed new restrictive estate tax provisions, but trade off may be drop in exemptions from $5.12 million to $1 million.

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A Look at the 2010 Compromise – Something similar for 2012?

• In December 2010, Congress intervened to prevent the Sunset provisions from taking effect and increased the exemptions.

• Further, Congress provided for portability of spousal exemptions.

• Does this sound like a Congress that would now go back to a non-portable $1 million exemption?

• Uncertainty remains; however, respected commentators suggest the more likely outcome will be to reset the exemption to $2 million or $3.5 million and retain portability.

2012 Offers the Perfect Storm forSubstantial Gift Planning

• Historically low interest rates work well with commonly used techniques such as gifts and sales to trusts - extend beyond 2012

• Depressed asset values permit substantial appreciation to grow free of transfer taxes –extend beyond 2012

• $5,120,000 gift/estate and GST exclusion permit transfers of significant wealth free of transfer tax – may NOT extend beyond 2012

• 35% gift/estate/GST tax rates – may NOT extend beyond 2012

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Which Assets Should be Gifted?

• Assets increasing in value – Appreciating assets held until death may produce greater estate tax.

• High basis assets – Since the donor’s income tax basis carries over to the donee, gifting higher basis assets reduces potential income tax to the donee upon his later disposition of the assets.

• Valuation discounts – Take advantage of discounts when available, such as lack of marketability & lack of control (e.g., limited partner or non-managing member interests).

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Lifetime Gifting Can Result in Estate “Freeze”

• Freeze = Planning device which allows one to freeze the present value of his estate and shift future growth to successors.

• Basic Technique (outright gift): Parent gives real property worth $100,000 to Child. Parent dies 25 years later when asset is worth $500,000. Only $100,000 is includable in Parents' estate.

• Advanced Techniques: GRATs, IDGTs & other trust arrangements• State Estate Taxes – Gifted assets are truly removed from one’s

estate (not just frozen in value) since all states (except CT) do not impose any gift tax.

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2012 Gift Planning – Basic Techniques

• $13,000 per donee annual gift/GST exclusion ($26,000 for married couple) for outright gifts:• Example: Grandma & Grandpa have 2 married children and 6

grandchildren. Together Grandma & Grandpa can gift $260,000 ($26,000 x 10 donees) of assets every year free of gift and GST taxes and without depleting their lifetime exemption amounts.

• Unlimited exclusion for tuition payments.

• Unlimited exclusion for medical payments.

• If a family member has borrowed money, consider forgiving the loan.

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Benefits of Trusts

• Leverage annual gift tax exemptions – withdrawal powers for multiple beneficiaries.

• Provide for spouse and children.• Preserve some control over what happens to

transferred assets.

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Personal Residence Trust

• Residence is excellent choice where liquidity is a concern.

• Direct gift versus qualified personal residence trust (“QPRT”) – impacted by low interest rates.

• Use/possession of residence after gift will require FMV rental payments to avoid estate inclusion.

• Appraisal and possible TIC valuation needed.• Example – Valuable vacation home.

Grantor Retained Annuity Trust (“GRAT”)

• Mechanics: Grantor transfers appreciating assets into an irrevocable trust for

a predetermined term of years (usually 2 – 15 years). During the trust term the grantor receives annual annuity

payments. Taxable Gift = FMV of property transferred reduced by actuarially

determined value of grantor’s retained annuity interest. At the end of the trust term, remaining assets pass to named

beneficiaries free of gift tax.

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Grantor Retained Annuity Trust (“GRAT”) – cont’d

• Beware of the Estate Tax Inclusion Period (“ETIP”) – If grantor dies prior to end of trust term, assets are included in grantor’s estate.

• GRAT can still be very effective with $1 million or less of gift exemption.

• Choosing a higher annuity will increase the present value of grantor’s retained income interest to a point that the remainder interest (and hence the gift) can be very small or even eliminated.

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Generation-Skipping Trust

• Also known as a “dynasty” trust.• Leverages both gift and GST tax exemptions.• Excellent choice for locking in current $5.12

million exemptions.

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Irrevocable Life Insurance Trust (“ILIT”)

• Life insurance proceeds not subject to estate tax or income tax.

• Gift/GST Tax Leverage – value of “gift” equal to premium payments but eventual exclusion of policy’s full face value from transfer taxes.

• Creditor/Divorce Protection – spendthrift and other provisions may protect proceeds from claims of creditors & beneficiaries’ ex-spouses.

Installment Sale to Intentionally Defective Grantor Trust (“IDGT”)

• Mechanics: Trust intentionally drafted to be disregarded for income tax

purposes but not for gift, estate or GST purposes. Grantor “seeds” the trust with a gift equal to 10% of the value of

the property to be sold. Grantor sells appreciating assets to the trust and takes back an

installment note at a low interest rate. Since the trust disregarded for income taxes, no capital gain on

sale of assets and no tax on interest collected.

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Installment Sale to IDGT – cont’d

• Grantor achieves indirect gift-tax free transfers to trust via paying tax on income earned by the trust, thus allowing trust assets to compound on tax favorable basis.

• Trust can have tax reimbursement clause if grantor’s income tax liability causes cash flow concern.

• No ETIP concern.• Sale to IDGT can still be very effective with $1 million or less of gift

exemption.

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“Portability” Trust

• If spouse dies and leaves unused estate tax exemption:1. Surviving spouse may use exemption of

deceased spouse.2. Under current law, only available for spouse

who died in 2011 or 2012.3. Portability does NOT apply to GST tax

exemption.4. Example – separate trusts.

Trusts Created by Married Couples & Asset Protection Trusts for Single Individuals

• Alternative for those reluctant to part with assets at this time, but who also do not want to waste the savings available via the increased gift tax exemption amount.

• Have your cake and eat it too!

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Nonreciprocal Trusts Created by Married Couples

• Spouses can create trusts for each other’s benefit. Assets transferred to such trusts, plus appreciation, are removed from the spouses estates.

• If the grantor-spouse needs access to assets, the beneficiary-spouse can receive a distribution from the trust.

• If descendants are included as trust beneficiaries, the trustee can make distributions to the descendants free from gift tax.

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Nonreciprocal Trusts Created by Married Couples – cont’d

Reciprocal Trust Doctrine (“RTD”)• If trust leaves donor in essentially same economic

position as if he simply named himself beneficiary of his own trust, then gift transfer is disregarded and trust for beneficiary spouse is included in his estate.

• Avoid RTD by varying terms of each trust: Different trustees Different beneficiaries (useful in personal residence trusts) Different distribution standards Different assets Different funding dates – allow as much time as possible to elapse

between funding two trusts.

Domestic Asset Protection Trusts (“DAPT”) for Single Individuals

• A DAPT is self-settled trust of which the grantor is a beneficiary.• The trust must be formed in a jurisdiction, such as Delaware, that

has DAPT legislation.• If properly structured, the value of the assets transferred to the

trust are frozen in the grantor’s estate and the assets remain available for use during his lifetime (provided that a DAPT state resident trustee is responsible for making distributions from the trust).

• To the extent distributions are not made, trust assets will accumulate within the DAPT free from future transfer taxes.

*Proper asset protection planning requires knowledge and experience in the areas of debtor-creditor law, commercial law, civil procedure law, conflicts of laws, judgments & remedies and bankruptcy, etc.

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Amending “Irrevocable” Trusts - Decanting

• “Decanting” is the process by which a trustee, who has discretion to distribute trust principal, exercises such discretion in favor of a new trust with different terms and conditions.

• Many states, including NY, have enacted statutes that specifically authorize the decanting of a trust.

• Under NY law, the new trust cannot expand the trustee’s distribution authority.

• Decanting is useful for a surviving spouse who wants to gift assets held in a QTIP where principal distributions are subject to a standard, i.e., not purely discretionary.

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Selecting a Trustee

• Consider trustee provisions carefully as trust flexibility often requires giving the trustee lots of power.

• Ensure that trustee and successor trustees are people or entities that you trust.

• Establish clear, well thought out plan for naming successor trustees. Example – Trust may permit majority of adult income

beneficiaries to name successor.

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How to Fund Trusts When Time is Running Out

• Leveraged gifts of equity interests or real estate require appraisals, discount valuations and/or lender approvals.

• If appraisals, etc. have not been done or cannot be completed before 12/31/12, consider gifting cash to trust in 2012 and using “swap power” in 2013 to transfer hard to value or contractually constricted assets.

• Asset substitution is a “non-gift” transfer; may start statute of limitations by filing 2013 gift return.

• Gift to existing trust versus creating new trust.