2010 Estate and Tax Planning

I have set out below the techniques for make year end gifts to your children and/or grandchildren without incurring any gift tax consequences. Such techniques are as follows:

Legislative Update. At the time this update is being drafted, there is much continued debate and many proposed changes pending in Congress with respect to the income and estate tax legislation. As of December 9, 2010, Senate leaders indicated that the legislative language to extend existing tax rates for two years is complete and they hope to move forward to a December 11th closure vote on the package. The bill is expected to include an extension of all of the 2001 and 2003 individual income tax rates, regardless of the taxpayer's income. In addition, the bill will put in place a two-year alternative minimum tax “patch,” a two-year extension of popular tax breaks, such as the research and development tax credit, and an extension of several tax credits created to stimulate the economy under the American Recovery and Reinvestment Act.

However, revisions to the estate tax legislation have not fared as well. President Obama previously agreed to a compromise which would increase the estate tax exemption to $5 million and decrease the estate tax rates to 35%. The House Democratic Caucus adopted a resolution on December 9th providing that House Democrats not bring any legislation to the floor of the House that represents the tax cuts framework agreed to by President Obama and congressional Republicans. With this latest round of bickering between Democrats and Republicans, Congress may not be able to reach a compromise regarding any revisions to prevent the sunset of the estate tax legislation.

If Congress does nothing, the federal estate tax is scheduled to come back in 2011. The amount of the federal estate tax exemption, if Congress does nothing, will be $1 million with estate tax rates as high as 55%. It appears that the current legislation is still uncertain and, by the time you receive this update, the current status of the tax legislation will most certainly have changed.

Use of Gift Tax Exemptions to Reduce Estate and Gift Tax. Although the exemption amount and tax rates in future years are uncertain, there is no doubt that the estate tax is returning. Therefore, you should consider making sufficient gifts during your lifetime to reduce a possible estate tax liability.

Any gift-giving programs must take into consideration that your lifetime gifts are subject to a gift tax which is imposed at the same rate as the estate tax. This unified system is intended to eliminate any tax advantage to making gifts. But certain types of lifetime transfers are not subject to gift tax, and the end of the year could be a good time to make these tax-free gifts.

Annual Gift Tax Exclusion. The most commonly-used method for tax-free giving is the annual gift tax exclusion, which allows you to make a gift of up to $13,000 in 2010 to each beneficiary without using your lifetime $1 million gift tax exclusion. There is no limit on the number of beneficiaries to whom you can make such gifts; if you make $13,000 gifts to 10 beneficiaries, you can exclude $130,000 from tax. The exclusion applies to gifts of any type of property, although certain types of property may require an appraisal. Gifts of appreciated property can also result in income tax savings because the recipient will pay the capital gains tax upon any sale. The threat of higher income tax rates in 2011 make this an important consideration.

Your annual gift tax exclusion expires at the end of each year, so the year end is the appropriate time to use it. If you want to make a gift that exceeds the amount of the exclusion, you can effectively double the exclusion by making one gift in December and the second in January. For example, if you are married, you can make a tax-free gift of $52,000 to any individual by making a gift of $26,000 in December 2010 and another $26,000 gift in January 2011. Because the annual exclusion is applied on a per-beneficiary basis, you can leverage the exclusion by making gifts to multiple members of the same family.

Section 529 College Savings Plans. Contributions to a §529 college savings plan do not qualify for the exclusion for tuition payments, but can take advantage of the $13,000 annual gift tax exclusion. Distributions from a 529 plan can be used for a wide range of educational expenses, including tuition, fees, books, supplies, computers, and room and board. An added advantage of a gift to a 529 plan is that the income earned on the plan contributions is tax-free, as long as it is eventually used for educational purposes. Thus, you can reduce your own income taxes by funding a 529 plan with savings that would have been used for college anyway. And, because you can name yourself as the custodian of the account, you ensure that your beneficiary uses the account for educational purposes.

Gifts in Trust. Despite the tax savings, you may be uneasy about making outright gifts to your children or grandchildren due to your loss of control over how they use the gift. This concern can be addressed by making the gifts in trust. This type of gifting will allow you to determine when the beneficiary receives the money and how it is to be used.

There are special requirements for ensuring that a gift in trust qualifies for the $13,000 annual exclusion. Usually, the trust is drafted to provide the beneficiary with temporary withdrawal rights over the gift (usually for 30 days), so that it is considered a present interest rather than one that vests in the future. Although this presents a risk of the beneficiary withdrawing the gift from the trust, the probability of your terminating any further gifts to the trust is usually sufficient to prevent this. If you are interested in making a gift in trust, we will be glad to further explain how this can be done.