With summer behind us and the holiday season now on the horizon, taxpayers contemplating the use of gifts as a tax reduction strategy are reminded that the generous exemptions and reduced rates currently available are set to expire at the end of the year. These individuals and families are encouraged to act without delay to allow time for an appropriate plan to be developed and implemented before the impending deadline.
Tax legislation signed into law by President Obama on December 17, 2010 has temporarily lowered the federal estate, gift and generation-skipping transfer tax rates to 35%. In addition, the law has increased the federal estate tax exemption from $3.5 million to $5.12 million, and increased both the federal gift and generation-skipping transfer exemptions from $1 million to $5.12 million for calendar year 2012. These changes present taxpayers with an unprecedented opportunity to transfer significant amounts of wealth on a tax-free basis.
The laws establishing these generous rates and exemptions are written such that they will expire automatically at the end of this year unless new legislation is forthcoming. Experts consider it unlikely that any such proposed legislation would transcend the political gridlock currently in Washington. In the event expiration occurs, the estate, gift and generation-skipping transfer exemptions will revert to $1 million, and top tax rates will increase to an onerous 55%.
Taxpayers who act quickly have access to a number of strategies to avail themselves of this window of opportunity. For example, outright gifts made before the end of the year allow a taxpayer to remove assets from his or her estate while providing loved ones with immediate enjoyment of the transferred property. It is important to note that the law permits married taxpayers to split gifts as if each spouse had contributed half of the value. Accordingly, in 2012, a married couple may gift a total of $10.24 million without gift tax consequences, in addition to the annual exclusion that allows every taxpayer to gift away $13,000 each year to as many individuals as he or she chooses. This same couple will pay gift taxes on amounts above $2 million if the gifts are delayed until 2013.
Outright gifts may not be appropriate in cases of large gifts to young beneficiaries who may not yet possess the financial responsibility necessary to manage a sudden windfall. By instead making the gift to an irrevocable trust, a grantor can rest assured that trust assets will be competently managed and protected from the beneficiary’s creditors. A gift of property to an irrevocable trust triggers gift taxes to the extent the gift exceeds the taxpayer’s available exemption, but removes the assets from the donor’s estate such that future appreciation is free from estate taxes. The current $5.12 million gift tax exemption provides a tremendous incentive to transfer substantial assets into trusts for the next generation on a tax-free basis.
Taxpayers considering making gifts are well-advised that procrastination may be costly. Although the deadline does not officially expire until December 31, the preparation of trust documents and the transfer of title to assets is not an overnight process, and practitioners inundated with final hour requests may be unable to fulfill client demand. As the year draws to a close, families are encouraged to meet with a professional immediately to ensure the feasibility of meeting their goals before this extraordinary opportunity is lost.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.