Old-Line Tax Planning Techniques Still Work

Register now

For taxpayers who scrambled to make last-minute gifts at the end of 2012 to take advantage of the gift tax exemption and lower tax rate, it was a good thing to do despite the fact that within 23 hours of year’s end, legislation passed averting the return to the old-law $1 million exemption and 55 percent maximum tax rate.

“That exemption amount of $1 million and the 55 percent rate actually became effective for 23 hours,” said Shari Levitan, a partner at Holland & Knight. “The legislation could have just as easily been limited to adjustments in income tax rates, and few were willing to bet on Congress.”

As a result of the American Taxpayer Relief Act of 2012 the exemptions for federal estate, gift and generation-skipping tax transfers will remain at $5 million, indexed for inflation. For 2013, the exemption amount will be $5,250,000. ATRA retained portability, so a surviving spouse can still use a deceased spouse’s unused exemption, provided that an estate tax return is filed and the portability election is made, Levitan observed. The maximum tax rate increased to nearly 40 percent.

“Those who thought they missed the window of opportunity to take advantage of the exemption with pre-2013 gifts have been given a second chance,” Levitan said. But while the Act’s provisions are stated to be “permanent,” this means only that the new provisions will not automatically sunset, she noted.

“I think ‘permanent’ is a word that causes people to think that they know what the rules are forever, and they won’t change,” she said. “But all it signifies is that there is not an automatic future reversion to prior and lower exemption levels and higher tax rates.”

“For example, it would be entirely possible for Congress to decide that the exemption level is fine for death transfers, but that lifetime transfers will be limited to, say, a million dollars, as was the case prior to 2011,” she said. “Also, Congress has the ability to change the rates in the future up or down. So, when we say ‘permanent,’ it still bears watching because budgetary concerns have not eased, and will certainly be discussed further this calendar year.”

Taxpayers may consider making taxable gifts above the exemption limits, Levitan said. “While the transfer tax has increased from 35 percent to 40 percent, gifting during lifetime remains a more efficient manner of shifting wealth than testamentary bequests,” she said.

“To illustrate, if a taxpayer makes a testamentary bequest of $1 million, the estate tax, which comes off the top, is $400,000, and the beneficiary receives $600,000,” she explained. “Effectively, the beneficiary bears the burden of estate tax. By comparison, the donor bears the burden of the gift tax. To make an equivalent gift during lifetime, the donor can make a gift of $600,000, which results in gift tax of $240,000. In short, for a beneficiary to receive $600,000, the total outlay is $840,000 when making the lifetime gift, as compared to the $1 million bequest at death. Even better, if the taxpayer lives more than three years from the date the gift is made, the gift taxes paid are excluded from the donor’s taxable estate for federal estate tax purposes.”

Contrary to some prior proposals, ATRA does not curtail a taxpayer’s ability to take advantage of the transfer techniques that that have worked well in the current low interest environment, Levitan indicated. “For example, the Obama administration previously made broad proposals, including requiring a minimum term for Grantor Retained Annuity Trusts (GRATs), substantially revising the grantor trust rules.”

ATRA contained no such limitations, so many planning techniques are still in effect, Levitan observed. “These include planning techniques such as short duration GRATs, sales to grantor trusts, loans to family members and trusts at the applicable federal rate (0.87 percent for mid-term loans made in January, 2013), and gifts of non-marketable minority interests in entities.”

However, she said that clients who are thinking about making gifts should do them sooner rather than later, so the attractive planning is not legislated away. “It would not be surprising to see some of the administration’s prior proposals reappear in further tax reform. It would be unlikely, though not impossible, for any such legislation to be retroactive. Taxpayers who have not made use of these beneficial transfer opportunities might consider doing so early in 2013, so that if adverse legislation is introduced, such gifts may be grandfathered,” she cautioned. “This will bear careful watching.”

For reprint and licensing requests for this article, click here.
Tax practice Tax planning Wealth management