As you may already know, the unprecedented high gift, estate and generation-skipping transfer (“GST”) tax exemptions of more than $5 million for individuals (more than $10 million for married couples) are set to expire at the end of this year. Unless Congress passes new legislation, the exemption amounts will drop to $1 million per individual ($2 million for married couples) on January 1, 2013. The current exemption amount was (like the estate tax itself) a very contentious issue in Congress when it was enacted in 2010, and it is unclear whether it will be extended.

In light of the political uncertainties, we recommend that clients with significant wealth consider making gifts by December 31 to take advantage of the current exemption amounts if they have not already done so. Any assets transferred—and all the future appreciation on those assets—will escape federal and New York estate and gift taxation, a savings of about 45% of the value transferred at current tax rates. The tax savings could be significantly higher if estate tax rates increase.1

Even if the exemption amounts are extended past 2012 (either at the current level or at the 2009 level of $3.5 million per individual and $7 million for married couples), there will still be an advantage in making a gift now if you believe that asset values are relatively depressed and are likely to increase within the next few years.2

In addition, by using the gift and GST tax exemptions together, gifts can be made— completely free of federal transfer tax—to grandchildren, great-grandchildren or perpetual “dynasty” trusts.

For those clients who wish to make large gifts but are concerned about reducing their current personal liquidity, there are a number of alternatives. For example, you can:

  • Make a gift of illiquid assets, such as investment real estate or an interest in a closely held entity.
  • Borrow against illiquid assets and make a gift of cash.
  • Forgive debts owed to you by children or by family trusts (which would be considered a gift for gift tax purposes). This may be an especially attractive option for clients holding large promissory notes from family trusts that purchased assets from them in an installment sale.
  • Give a vacation home or other residential real property to a family trust. (This requires paying fair market rent to the trust if you continue to use the property.)

If you give real property or other illiquid assets to a trust now to use your exemption amount and your personal liquidity increases in the future, you can buy the property back without any income tax consequences if the trust is properly structured.

Some clients may be worried about losing access to a significant portion of their wealth if future circumstances should change. This concern can be addressed (within limits) by including a spouse as a permissible beneficiary of the trust receiving the gift or by creating a trust in a so-called “asset protection” jurisdiction such as Delaware or Alaska that permits the donor to be a permissible beneficiary (now or at some future point in time). These kinds of trusts, however, require careful review and structuring to avoid potential gift and estate tax issues.