What are the current gift tax rules and what will happen in 2013?
Prior to January 1, 2011, the gift tax exemption was $1,000,000, meaning you could give away $1,000,000 over the span of your life without having to pay a gift tax. For 2011 and 2012, you can give away up to $5,000,000 without a gift tax. That is five times the amount previously allowed. If the aggregate amount of your gifts exceeds $5,000,000, the gift tax rate during 2011 and 2012 is 35% (reduced from 45% in 2009).
In 2013, if Congress does not take any further action, the gift tax exemption will revert to $1,000,000, and the top marginal rate on gifts will increase to 55%. We could see a repeat of Congressional gridlock at the end of 2012, but most estate planning professionals believe that Congress will take some action before the end of next year to establish a gift tax exemption of at least $3,500,000 and a top estate and gift tax rate of no more than 45%.
In addition, gifts of interests in closely held businesses and fractional interests in real estate currently are valued for gift tax purposes based solely on the value of the property received. This often generates discounts for lack of marketability and control that reduce the “tax value” of the property.
Should I consider making gifts now?
Yes, if you can afford to make a gift—that is, you will not need either the assets or income in the future. If your estate exceeds $3,500,000 ($7,000,000 for a married couple) and you cannot afford to give away a significant amount, you might consider combining a small gift with a sale of appreciating assets for a promissory note which will allow you to retain some benefit from the transferred assets. You can also make a gift to a trust that includes your spouse as a beneficiary which will enable your spouse to have access to those funds in the event of future needs.
Following are reasons we recommend that clients consider making gifts during 2011 and 2012:
- It is possible that the gift and estate tax exemptions will be reduced after 2012, even if the exemptions are only reduced to $3,500,000.
- Making tax-free gifts now permits the transfer of future appreciation and income, so the growth of your taxable estate will be reduced, thus saving estate taxes on death.
- Possible future legislation may reduce or eliminate discounts on family businesses and real estate by aggregating ownership for valuation purposes.
- Increased gift tax exemption permits larger transactions with reduced risk of paying gift tax if valuation of the property transferred is challenged by the IRS (we normally recommend a client retain some gift tax exemption as a “cushion” against audit risk).
What kinds of gifts make sense?
- We recommend gifts or sales of appreciating assets to a trust for the benefit of children and future descendants to provide benefits for several generations without reduction by estate tax. Trusts can also protect the gifted property from beneficiaries’ creditors and divorces.
- Assets that are difficult to value often make the best gifts because the gift tax value is normally less than the amount that would be received if the property were liquidated. Hard to value assets include minority interests in a family business and fractional interests in real estate.
- If you make a gift to a trust, the trust should also be designed as a “grantor trust” for federal income tax purposes. A grantor trust allows you to pay income tax on the income of the trust which increases the value of the trust.
- If you have previously entered into one or more transactions with a “generation-skipping” or “dynasty” trust involving a sale and you have promissory notes outstanding, you could consider using part of your exemption to reduce those promissory notes, simplifying administration and complexity.