OVERVIEW

Clients may wish to consider making substantial gifts to individuals or trusts prior to the end of 2012, because favorable federal gift, estate and generation-skipping transfer (“GST”) tax laws currently in effect are scheduled to expire automatically on January 1, 2013.

CURRENT GIFT, ESTATE AND GST TAX LAWS

In 2012, the combined lifetime gift and estate tax exemption amount is $5,120,000 per individual, and the lifetime GST tax exemption amount is $5,120,000 per individual. For transfers in excess of these exemption amounts, the maximum gift tax rate, estate tax rate and GST tax rate is 35%.

CURRENT LAWS SET TO EXPIRE AT THE END OF THE YEAR

Unless Congress acts affirmatively by enacting further legislation, effective January 1, 2013 the following changes will occur automatically: (1) the combined gift and estate tax exemption amount will be reduced from $5,120,000 to $1,000,000 per individual; (2) the GST tax exemption amount will be reduced from $5,120,000 to $1,000,000 per individual, indexed for inflation; and (3) the maximum gift, estate and GST tax rates will increase from 35% to 55%.

BENEFITS OF MAKING LARGE GIFTS THIS YEAR

While it is possible that Congress will change the laws prior to January 1, 2013 or soon thereafter, for clients who are willing to make large gifts, it is beneficial to do so this year. All future appreciation on such gifts will be removed from the client’s taxable estate, and additional tax savings may be realized if the exemption amounts and tax rates return to and remain at less favorable levels. Certain types of gifts that take advantage of depressed asset values and/or historically low interest rates may also be particularly attractive this year. For residents of states such as Massachusetts and New York that have no gift tax but do impose an estate tax, there is an added benefit to making such gifts: property transferred by lifetime gift avoids any state gift or estate tax.

ESTATE PLANNING OPPORTUNITIES

There are numerous ways in which individuals can take advantage of the current $5,120,000 gift and/or GST exemption amounts before the end of the year, including but not limited to: (1) outright gifts to individuals; (2) gifts to irrevocable trusts; (3) gifts to split interest trusts such as qualified personal residence trusts (“QPRTs”); (4) transfers of interests in closely-held businesses or family investment companies to future generations (in certain cases without the need to relinquish voting control), with the option to use bargain sales or leverage to make even larger transfers; (5) forgiveness of family indebtedness; and (6) unwinding or funding various types of life insurance programs.

For clients who do not believe that they are in a financial position to make large irrevocable gifts this year, certain strategies offer additional flexibility. For example, a client who is married can make a gift to a trust under which the client’s spouse is one of the beneficiaries, so that the spouse could receive a trust distribution in the future if necessary. A second option is a gift of real estate such as a vacation house, which removes an asset from the client’s estate without reducing the value of the client’s liquid, income-producing assets. Another strategy that may be possible for clients who have made prior gifts to trusts that are not currently exempt from GST tax is to make a late allocation of GST exemption to such trusts, thereby protecting the existing trusts from estate tax for additional generations.

BASIS OF ASSETS TRANSFERRED

As with any estate planning opportunity, clients should give careful consideration to the nature of the assets transferred. Making a lifetime gift of appreciated assets results in the beneficiary of the gift acquiring the client’s basis in the assets (often referred to as a “carryover basis”) and losing the step-up in basis to fair market value that would have otherwise occurred had the assets been included in the client’s estate and then passed to the beneficiary after the client’s death. The beneficiary’s carryover basis will impact the amount of income tax due if the beneficiary sells the assets in the future.

OTHER ESTATE PLANNING OPPORTUNITIES ALSO TARGETED TO BE ELIMINATED

The Treasury Department has also expressed interest in eliminating several other favorable estate planning techniques, including short-term GRATs, grantor trusts, valuation discounts, and long-term GST-exempt trusts. While these proposals are purely speculative, if you have been considering using one of these techniques, you should analyze the benefits and drawbacks of completing the transaction at this time.