The extension of the Bush tax breaks passed during December, 2010 includes big estate and gift tax breaks for 2011 and 2012.
The federal estate and gift exemption equivalent (by way of an exemption credit) for U.S. citizens and residents for 2011 and 2012 is $5 million. For a married couple, the total amount that could potentially transferred free of estate and gift tax is $10 million. The tax rate for transfers in 2011 and 2012 is 35%.
After 2012, unless Congress takes further action, the exemption equivalent will return to the amount before 2002, $1 million, and the maximum tax rate that will apply to estate and gift transfers will be 55%. Nobody expects this to happen, but with our federal spending deficits, there could be pressure to reduce the breaks that are now available.
The 2011 and 2012 “window” provides an opportunity to possibly avoid future transfer taxes and to shift future appreciation to the beneficiaries. In addition, shifting the assets could result in lower income tax liabilities by giving income-generating assets to taxpayers in lower tax brackets.
The higher exemptions may provide an opportunity to “clean up” items like family loans and installment sales to defective trusts. By eliminating these items now, the transactions may be “old and cold” when the individual who makes the gift passes away.
The exemption can be further leveraged using fractionalization techniques, such as transferring minority interests in family limited partnerships or limited liability companies.
There is a risk involved in making these large gifts now. Gifts made during your lifetime are added to your accumulated transfers for computing the estate tax. Unless Congress passes a technical correction, gifts made during 2011 and 2012 could be “clawed back” when computing the federal estate tax after a death of an individual who made a big gift during 2011 or 2012. This was not the intent of Congress, so it seems likely that a technical correction will be enacted to fix the problem, but it is a cloud of uncertainty until the correction is made, and reserves should be kept to pay the potential tax.
Remember some states also have transfer taxes that apply for estates and gifts that should be considered in your estate and gift planning. (California isn’t one of them.)
Also remember that property that is transferred by gift isn’t eligible for a “fresh start” basis adjustment like inherited property.
If you have a very large estate, say exceeding $10 million, you should meet with your tax advisor and estate planning attorney to discuss whether you should make big gifts during 2011 or 2012, which assets are good candidates for gifts, and how they should be transferred.
IRS Circular 230 Disclosure:
As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.