What you need to know

Though the fates of the federal estate tax and federal gift tax have not yet been determined for 2011, individuals may benefit from making substantial gifts in 2010 to take advantage of the reduced top marginal bracket on taxable gifts.

What you need to do

Individuals with assets in excess of $5 million (or $10 million for married couples) should strongly consider incorporating 2010 gifts into their tax strategy.

Unless Congress acts before year-end, the federal estate tax, which was repealed in full for 2010, returns in January to its 2000 form – an exemption of only $1 million ($2 million for a married couple together) and a top marginal bracket of 55%. While a return to the old exemption amount and rates is possible, it is more likely that Congress will strike a compromise that brings back the federal estate tax next year in a form near to what it was in 2009. Under such a compromise, there might be a federal exemption of $3.5 to $5 million, with top rate of 35% to 45%. While the future of the federal estate tax is far from clear – and likely will have to wait for the outcome of the November elections before any final compromise is struck – some form of the tax is likely to return in January 2011. We do not expect permanent repeal of the tax in the near future.

Even in the face of this uncertainty, for many clients it can make sense to make substantial gifts before the end of 2010.

Unlike the federal estate tax, the federal gift tax was not repealed for 2010. The top marginal bracket on taxable gifts in 2010, however, was reduced to 35%. Unless a compromise is struck by Congress before then, in January 2011 the federal gift tax brackets will revert to the brackets set for the estate tax next year, which could be as high as 55%. Thus, future taxable transfers of property – whether by gift during one’s lifetime or at death – may be subject to higher rates than exist in 2010. By making taxable gifts this year, you lock in the 35% rate, and therefore potentially avoid imposition of higher taxes on the property, and any post-gift appreciation in its value, in the future.

There can also be significant state estate tax benefits to making gifts. For example, Massachusetts imposes a state level estate tax on its residents at death, but has no gift tax. Accordingly, assets given away during one’s lifetime are not subject to any Massachusetts transfer taxes.

There are many ways to make gifts, including outright transfers of property or the use of trusts, family partnerships and other estate planning techniques. In particular, a form of trust known as a grantor retained annuity trust can produce significant tax savings for your family.

Some caution is in order. If your assets are within what ultimately becomes the level that will be exempt from the federal estate tax, making gifts this year which result in a gift tax, even at a reduced 35% rate, will have been a mistake. The difficulty is that we cannot know at present what the ultimate federal estate tax exemption will be. As a rule of thumb, we suggest that if your assets are in excess of $5 million ($10 million for a married couple together), 2010 gifts are worth exploring.