Especially with the presidential election this year, you have probably been hearing about the “temporary” Bush tax cuts that were implemented in 2001 and are scheduled to expire January 1, 2013. In 2012, tax rates are near historic lows. However, there is currently a stalemate in Washington over what to do. If our politicians do nothing, there will be some tax increases that will go into effect in 2013. How tempting can that be to be able to get more cash for their government programs by doing nothing.
This makes 2012 tax planning imperative. As this goes to press, there will be about 60 days or two months to act before December 31, 2012. If you do not, then it could cost your loved ones millions of dollars if the law changes as scheduled. You know the late night infomercial drill. “Act within the next 30 minutes, and you can have . . . And if you act now, we will double it!” That’s pretty much where we stand with regard to the federal estate, gift and generation skipping transfer taxes.
For the unified federal estate and gift tax, the maximum rate is scheduled to increase from 35% to 55%, with the applicable exclusion amount dropping from $5.12 million to $1.0 million. Similarly with the generation skipping transfer (“GST”) tax, the tax rate is scheduled to increase from 35% to 55%, with the GST tax exclusion amount dropping from $5.12 million to an estimated inflation adjusted $1.4 million.
In today’s column, we will discuss some ways you can avoid or minimize the adverse effects of these changes. If your estate is over $1 million ($2 million for a married couple), and you have assets that you do not need for your own care and support, you can save substantial amounts of taxes for your loved ones by gifting in 2012. Planning for these likely tax changes is a major undertaking. You may want to start the process now or you may not have time to implement any tax savings strategies.
Let’s say you are single with an $8 million estate, you have made no lifetime gifts and you die after 2012. You leave your estate in trust for your descendants. Upon your death after 2012, there will be an estate tax of $3.7 million on your $8 million estate for a net amount available to your loved ones of $4.3 million.
The $2.9 million excess over the $1.4 million GST tax exemption, together with its after-income-tax earnings will have a GST tax of 55% at each generation. If the trust grows 5% after-income-tax and after distributions to beneficiaries, the trust would grow to $22.8 million after 50 years and two generations.
If however, you gave $5 million to your loved ones in a gift trust in 2012, the entire gift would be free of estate, gift and GST taxes. (I used $5 million instead of $5.12 million to simplify it for illustration purposes.) Upon your death after 2012, there would be estate taxes due only on your $3 million after-death trust in the amount of $1.3 million. This would leave a net amount available to your loved ones of $6.7 million, consisting of your $5 million 2012 gift trust, plus $1.7 million from your after death trust. The good news is that the $5 million is not taxable and is out of your estate. The bad news is that it’s out of your estate and not available for your care during your lifetime. But if you do not need it, what does it matter?
The $1.7 million after-death trust, together with its after-income-tax earnings will have a GST tax of 55% at each generation. If properly administered, the $5 million 2012 gift trust is never, ever subject to any estate, gift or GST taxes. If both the $5 million 2012 gift trust and the $1.7 million after-death trust grow at 5% after-income-tax and after distributions to beneficiaries, the trusts would grow to $58.3 million after 50 years and two generations. This amount is more than double or $35.5 million more, than the amounts available to your beneficiaries if you did no gifting in 2012.
If your estate is less than $8 million or your gift is less than $5.12 million, then there would still be some tax savings, just less. If you are married in the same situation, you and your spouse can each gift up to $5.12 million in 2012 free from estate, gift and GST taxes. This would substantially increase the amount that is available to your loved ones after you are gone.
So what should you do if you are in this situation and do not need the potential gifted amounts with which to live? First, you should run, not walk to your estate planning attorney and your CPA. Have them make tax projections to see if gifting makes sense for you. You do not have much time left in 2012 to implement this kind of tax savings plan.
If it makes sense to do a 2012 trust gift, and you can live without the gifted amounts, there is no reason not to do it. Just get proper counselling before you do. By doing a little planning, you may be able to substantially reduce the overall tax burden to your loved ones in future years.
By: Matthew M. Wallace, CPA, JD
Published edited November-December, 2012 in Savvy magazine as: Save a lot in estate, gift taxes in 2012