Lifetime Gifts – Time To Take Another Look: Increase In The Lifetime Gift Tax Exemption To $5 Million For 2011 And 2012 Transfers May Provide Estate Planning Opportunities


by Tom Kelley

Kelley,Thomas 
tkelley@mcgrathnorth.com
(402) 341-3070

One hundred years ago, the average U.S. life expectancy at birth was a mere 52.6 years. During this time, many children could expect to inherit from their parents in their late 20s or early 30s. Fifty years later, by 1961, life expectancy at birth had risen to 70.2 years and  by 1986 it was 74.7. In 2007, for individuals who had already reached age 65, life expectancy stretched to 83.6 years, and for those reaching 70 years, males were expected to live until age 83.7, while females were expected to live until age 86.0. These additional 30 years in life expectancy work to significantly delay children’s inheritance.

Given this trend of increased life expectancies, many clients have reassessed what may have been an estate plan focused primarily on testamentary transfers – the disposition of their assets at death. Clients with assets in excess of what is required to comfortably fund their respective retirements have reconsidered the advantages of lifetime gifting of assets to beneficiaries, rather than at death.  Reasons for this change include the following:

  • First, the client’s increased life expectancy means that, without lifetime gifting, the client’s children will not inherit until after they have made many of their major life expenditures, often resulting in a massive build-up of debt, including student loans and mortgages.
  •  Second, without disciplined lifetime transfer planning, there is a danger that a client’s estate may grow significantly beyond the current estate tax exemption over his or her extended life expectancy, resulting in significant estate tax liability.
  • Third, the gift tax is often “cheaper” than the estate tax in that following a lifetime transfer, income and appreciation related to the gifted assets will generally be considered to be outside the donor’s estate.
  • Finally, many clients simply take great pleasure in living to see their beneficiaries enjoy their wealth.

Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. On December 17, 2010, President Obama and Congress gave such clients an additional reason to reassess the role of lifetime gifting in their estate plans. On that date, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (“Act”). In addition to extending Bush-era income tax cuts and resolving some of the uncertainty surrounding the future of the federal transfer tax system, the Act makes the following changes to the federal transfer tax system regarding gifts made in 2011 and 2012:

  • 35% Gift Tax Rate: For gifts made in 2011 and 2012, the gift tax rate is 35%, the same rate that was in effect for 2010.  Note that the estate tax and GST tax rate for 2011 and 2012 is also 35%.
  • Lifetime Gift Tax Exemption Raised to $5 Million from $1 Million. Before 2011, lifetime transfers by taxpayers were constrained by a $1 million gift tax exemption amount which was significantly less than the estate tax and GST tax exemption ($3.5 million for 2009). The Act, however, reunifies the estate, GST tax and gift tax exemption amounts at $5 million for 2011 and 2012, thereby providing taxpayers who utilized their $1 million lifetime gift tax exemption prior to 2011 with a new opportunity to make additional lifetime transfers of $4 million without incurring gift tax.
  • Sunset. Absent additional action by Congress, on January 1, 2013, the tax law in effect prior to 2001 will return: a top 55 percent tax rate for estate, gift and GST taxes, and $1 million in estate, gift and GST tax exemption amounts.

Accordingly, in light of the trend of increased life expectancies set out above, and more significantly, the $4 million increase in the lifetime gift tax exemption amount for 2011 and 2012 transfers, clients may wish to reassess their estate plans regarding lifetime gifting strategies for 2011 and 2012.

We briefly identify several strategies in the paragraphs that follow. Other strategies may apply to a client’s situation. Before implementing any strategy, however, we recommend conferring with a member of the McGrath North Tax Practice Group to ensure a proper fit given the client’s situation and the client’s level of wealth, and to determine which technique or combination of techniques the client may find most useful in achieving the client’s lifetime gifting and general estate tax reduction goals.

Large Gifts To Family And Friends Utilizing The $5 Million Lifetime Gift Tax Exemption. A client’s use of the $5 million lifetime gift tax exemption can range from simple outright cash gifts to family and friends to more complex strategies such as the QPRTs, GRATs and IDGTs described below. Depending on the client’s appetite for risk, there may be instances where a large cash gift does not result in the best use of the lifetime exemption, as other strategies may provide means to leverage the exemption for greater wealth transfer and estate reduction. On the other hand, the other strategies also carry the risk of failure, meaning the exemption could be wasted entirely or in part. In the end, use of the lifetime exemption will generally be governed by the client’s comfort level with a given strategy. Note that use of the lifetime gift tax exemption does reduce the current estate tax exemption, which for 2011 and 2012 is also $5 million.

Annual Exclusion Gifting. For 2011, a donor may make annual gifts of up to $13,000 per donee without using his lifetime exemption from the gift tax (and $26,000, if gifts by a married couple are split). By way of example, consider a couple that begins making annual exclusion “split gifts” to each of two children and two grandchildren beginning when the spouses are each 60 years old and the annual exclusion amount is $13,000 ($26,000 for split gifts). If both live to age 85, then, not accounting for inflation, the spouses have the ability to transfer more than $2.5 million to their descendants.

Section 529 Educational Savings Accounts. Under Section 529 of the Internal Revenue Code, a donor may make annual exclusion gifts to a qualified educational savings account for the benefit of a beneficiary. This permits a donor to currently fund an educational savings account for a beneficiary without gift tax consequence, despite the fact that the beneficiary has no present interest in the account. Further, it allows the gifted funds within the account to begin appreciating free of income tax. A donor may also allocate up to five years of annual exclusion gifts upfront and may split the gifts, meaning that the donor couple may make an initial contribution to the account of up to $130,000, without use of the lifetime exemption (subject to any contribution limits imposed by the plan). The account must be used for the higher education of the beneficiary and generally will not be included in the estate of the donor.

Qualified Personal Residence Trusts. A qualified personal residence trust (“QPRT”) involves the transfer of a grantor’s home to an irrevocable trust, which trust provides that the grantor may live in the home for a certain term, after which the home passes to the remainder beneficiaries, usually the grantor’s children. At the end of the term the grantor may continue to live in the home by paying rent to the trust beneficiaries. The transfer to the QPRT is a taxable gift and the grantor may use his or her lifetime gift tax exemption to cover the value of the remainder interest. If the grantor survives the trust term and the value of the home does not decline significantly, the QPRT can provide very good leverage of the lifetime exemption allocated to the QPRT, particularly if the home appreciates significantly. For a more detailed analysis of QPRTs, please see the July/August 2008 issue of this Newsletter for an article previously authored by Jim Wegner regarding QPRTs.

Grantor Retained Annuity Trusts. In a grantor retained annuity trust (“GRAT”) the grantor transfers assets to an irrevocable trust in which the grantor retains an annuity interest, usually for a term of years. At the end of the term, the assets remaining in the GRAT pass to the remainder beneficiaries. If properly structured, a GRAT can pass substantial wealth gift tax free without utilizing the donor’s lifetime gift tax exemption or any gift tax annual exclusions.  For a more detailed analysis of GRATs, please see the January/February 2008 issue of this Newsletter for an article previously authored by Jeff Pirruccello regarding GRATs.

Sales To Intentionally Defective Grantor Trusts. A sale to an intentionally defective grantor trust (“IDGT”) generally begins with the creation of an “intentionally defective” grantor trust, that is a trust which is not includable in the grantor’s estate, but the income of which is taxable to the grantor as a grantor trust. The grantor’s goal is to sell an asset expected to appreciate to the IDGT in exchange for an installment note. Ideally, the asset’s appreciation will exceed the interest due on the note and such excess will pass to the IDGT’s beneficiaries. Because the IDGT is not includable in the grantor’s estate, any appreciation in the trust assets escapes the grantor’s estate, while the estate includes only the fixed value of the note. Because the IDGT is a grantor trust, there is no recognition of gain on the exchange. Use of the IDGT technique is subject to numerous requirements and for that reason experienced estate planning counsel should be consulted during the setup of an IDGT.

If you would like to learn more about lifetime gifting strategies, please contact a member of the McGrath North Tax Practice Group.

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