From a federal gift, estate and generation-skipping tax (GST) perspective, there is what we know, and what we don’t know. We know that the current, generous federal estate, gift and GST framework gives each individual the ability to transfer $5.12 million in assets to certain descendants, including children, grandchildren and more remote generations, free from federal estate, gift and GST taxes. We also know that these historically high exemptions expire Jan. 1, 2013. On that date, the $5.12 million exemption drops to $1 Million, with any amount above that exemption being taxed at the much higher 55 percent tax rate, when compared to the current rate of 35 percent applied to amounts above the current $5.12 million exemption.

With federal politicians wrangling over future gift and estate tax policy, and November election outcomes hard to predict, the future is uncertain, but it is likely that the current framework will be more generous than whatever future framework is enacted by our federal government.

The following techniques may allow you to utilize the existing tax structure to minimize the overall tax impact on your estate. Please be aware that some of these opportunities may not be available after Dec. 31, 2012.

  • Installment Sale to Grantor Trusts: You, as grantor, form a “grantor trust” (meaning that you are still responsible for the income taxes associated with the trust during your lifetime). You then fund the trust with a gift, likely equal to your remaining gift exemption. Thereafter, you enter into a transaction with the trust to sell selected assets to the trust. In return, you receive back your initial gift, in the form of a down payment, and a promissory note for the remainder of the purchase price. The assets sold can often be transferred at a discount, and the promissory note can represent up to 90 percent of the value of the asset being transferred (e.g. a $4 million down payment can allow for a transfer of assets valued at $40 million). This allows you to take increased advantage of your gift tax exemption. This is known as a “leveraged” gift. While this technique does not serve to decrease the value of your estate (as you still hold a promissory note for the remaining value of the asset), it will remove future growth on the assets from your estate.
  • Spousal Access Trusts: Many individuals would like to take advantage of the current gift tax environment, but are concerned with giving up access to their assets. To “have your cake and eat it too,” you may be able to use Spousal Access Trusts. Here, a married couple each forms a trust. The beneficiaries of each trust are the other spouse, and the couple’s children and later generations. The trusts are drafted in such a way to ensure that they are not viewed by the taxing authorities as “reciprocal” trusts, in which case they would not accomplish anything from a gift and estate tax perspective. The couple then each makes a gift of an amount up to the remaining gift tax exemption to their trust. Going forward, the couple can still access the gifted funds if need be, as they are beneficiaries of each other’s trusts. Even so, the couple will have accomplished a completed gift, thereby locking-in the use of the current exemption. This technique may be paired with the Installment Sale to a Grantor Trust described above to allow for an even greater wealth transfer by the couple.
  • Outright Gifts: Outright gifts are gifts given by an individual directly to a recipient. Outright gifts can take various forms, including cash, securities, real property, retirement plan assets, life insurance policies and other forms of assets and property. This type of a transfer may very well make the most sense for many families. If this is the intended method of transfer, there may still be some discounting techniques that may be used to further leverage the use of the gift tax exemption.
  • Grantor Retained Annuity Trusts (GRATs): Here, you create an irrevocable grantor trust with a gift of assets, but retain the right to an annuity in the form of a defined fixed payment. The right to this fixed payment is for a specified time period. After this time period expires, the remaining assets in the trust transfer either outright or in trust to your children. Because the value of the GRAT is determined at the start of the trust and is reduced by the fair market value of your retained interest in the trust (i.e. the value of the fixed payment annuity), the value of the GRAT gift is always less than the value of the actual assets used to populate the trust. The larger the value of the retained annuity, the less the taxable value of the gift to the beneficiary. Taxes owed on the gift to the GRAT can be offset by your gift tax exemption.

Federal and State Estate, Gift and GST Exemptions and Rates

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