Gift Planning Generally
Annual gifts, using the $13,000 (2010 figure) per donee per year exclusion, is useful for smaller estates. When the direct payment of qualified tuition and medical expenses is added, the amounts that can be given can become more significant. But the real action in gift planning in 2011-2012 will be in creative and aggressive use of the new larger gift exclusion.
As with much of the TRA, the Monty Hall paradigm of 3 doors helps with the analysis:
- Door No.1: High Net Worth Clients — For wealthy clients making large gifts to take advantage of the 2011-2012 dramatic uptick in the gift tax exclusion to a record setting $5 million may be very advantageous. This type of planning could take a number of different forms and use various techniques, some of which are discussed later in this chapter. The bottom line for those with high net worth is to use the additional gift exclusion to leverage wealth out of their estates before 2013. Many of these wealthy clients, if they hadn’t used their gift exclusion on prior transfers, may have used most or all of their remaining $1 million exclusion in the waning days of 2010 to take advantage of the unique GST planning opportunities discussed in Chapter 3. So many of these taxpayers will have only $4 million, not $5 million of exclusion to plan with. Likely for these very wealthy clients that the incremental exclusion will be used to leverage large note sale transactions, GRATs, etc.
Wealthy Client makes a gift of $5 million to her son in 2011. In 2013, the deficit hole has grown so large that Congress chooses to take no action and permits the $1 million gift exclusion to come back into law as the $5 million exclusion sunsets. What will be the tax consequence of the $4 million gift in 2011 over the 2013 $1 million exclusion? Ah, the mysteries of life!
Ultra wealthy clients will use the newfound flexibility of the $5 million gift exclusion to leverage large transfers with note sales, to unwind split-dollar arrangements, and other planning discussed in the following sections.
- Door No.2: Moderate Wealth Clients — A moderate wealth estate could make a large taxable gift to remove future appreciation from their estate without the cost or economic uncertainty of GRATs and other techniques. In the past, far more complex arrangements had to be used to freeze the value of an estate, now for taxpayers in an appropriate range of wealth, they can just give it away. The analysis for older clients in this wealth range will be to first create a comfortable, perhaps generous budget. Project forward the financial needs for perhaps 95% of life expectancy. The rest of the estate, up to the $5 million exclusion that is likely to be intact may be given away. This will shift future appreciation out of their estate. Most importantly, if the gift exclusion is reduced in 2013, these clients that have already transferred a substantial portion of their wealth will hopefully be "grandfathered" and under the new estate tax “wire” by virtue of the significant 2011-2012 gift transfers. If their fear about a return of the estate tax exists, but their quantum of worry is insufficient to justify more aggressive or costly planning, an aggressive gift program may be a viable initial strategy to reduce the estate, or at least cap the upside growth.
Taxpayer is age 85 and has an estate of approximately $4.5 million. She spends about $200,000/year on living expenses. Taxpayer’s life expectancy is 7.6 years. Keeping $3 million to fund 15 years of future living expenses (about double her life expectancy) would leave a substantial cushion, without even considering the earnings from the retained funds. Taxpayer should safely be able to make gifts to her heirs or a trust for their benefit of $1.5 million. This will remove any upside appreciation in the $1.5 million of gift assets from her estate and so long as she spends at her anticipated level she will slowly erode her remaining assets but would be unlikely to ever be in financial need.
The simple gift of $1.5 million would not have been feasible prior to 2011 because of the current gift tax cost and the fact that no gun power would be left if future planning were to become necessary. Unlike GRATs, there is no issue of her gift needing to outperform the 7520 rate; all of the appreciation and income from the gift assets are out of her estate. Unlike a GRAT, there is no worry that if an annuity payment is missed or late, that the IRS would argue that the entire transaction should be unwound. Mortality risk is irrelevant. Thus, the large gift exclusion can provide a simple, inexpensive, and easy way to plan moderate wealth estates. Contrast this with the taxpayer instead doing nothing. The incremental growth of the $1.5 million in her estate over her remaining life could potentially push her estate into a taxable situation. If the 2013 legislative changes bring the $3.5 million exclusion that most anticipated for 2011 into the law, the taxpayer in the preceding example, may have frozen enough of her estate and reduced the remaining estate through spend down, to be below that threshold even if adjusted for her taxable gift.
A moderate wealth client has an estate of $3 million. The client is domiciled in a state which has a decoupled estate tax and has a $1 million estate tax exclusion. Fearful of running out of money, the client refused to undertake any significant planning or gift program. Then, the client is diagnosed with a terminal illness. She immediately gifts $2.1 million to her children, leaving her estate at $900,000. Has this "near deathbed gift" quickly and neatly avoided a state estate tax? Will the $5 million federal gift tax exclusion thus emasculate state estate tax systems, making them effectively avoidable by clients with under $5 million in wealth with a quickie pre-death gift? Will states amend their estate tax laws to capture the state estate tax on these transactions or add state gift taxation? Should powers of attorney be amended to permit, or even direct, such large gift transfers?
- Door No.3: Average Wealth Taxpayers — There are some less wealthy clients for whom gift planning might still make some sense. Elderly clients, whose wealth is likely to be over the $1 million 2013 estate tax threshold (if that comes to pass), but safely under the $5 million 2011-2012 threshold, may benefit from some measured amount of gift planning. Clients who live in states who have decoupled from the federal estate tax, and have a low exemption amount, might use gift planning to minimize or reduce potential state estate tax.
Gift planning could be even more generous, and fortunately for tax practitioners, more complicated, than before. It appears that a surviving spouse may be permitted to use her previously deceased spouse’s unused exclusion for gifts tax purposes (not merely on her estate tax return). TRA Sec. 303(b)(1); IRC Sec. 2505(a)(1). This could permit the surviving spouse far greater flexibility in planning. If this, in fact, is how portability and the gift tax will be applied, then ordering rules might be necessary to ascertain which exclusion is used first. If there is, in fact, an option surviving spouse’s should opt to utilize the unused estate tax exclusion of their deceased spouse first (i.e., before their own exclusion) since the previously deceased spouse’s exclusion won’t be inflation indexed post-death, but the surviving spouse’s exclusion will be (well, until the entire system sunsets at the end of 2012).
If the surviving spouse contemplates remarriage, perhaps a taxable gift should be made before the marriage into an irrevocable trust to utilize as much of the predeceased spouse’s unused exclusion before the marriage. This would avoid the risk of the new spouse dying and leaving no exclusion.
The calculation of the gift tax and the exemption will all differ somewhat under the TRA. TRA Sec. 302(d)(2); IRC Sec. 25025(a). Effectively the gift tax rate in the current year in which a taxable gift is made would be used to ascertain the remaining gift which can be made. The objective is to assure that the maximum gifts can be made without being reduced to reflect that prior year’s gifts were made at higher gift tax rates. So if taxable gifts are made in 2011 when the gift tax rate is 35%, all prior gifts will be calculated for purposes of determining the credit available at that same rate.