shifted out of the estate, may also be essential to the viability of the transaction itself.
Remove Appreciation from the Estate
If assets are transferred to an irrevocable trust in 2012, all post-transfer appreciation to those assets should benefit the trust and be outside your taxable estate. For any transfer (completed gift, sale, or a combination of both) to an irrevocable trust, this is a major planning objective for both transfer tax minimization and asset protection purposes. Apart from the prospect of unfavorable tax law changes, the fact that the economy remains soft in many parts of the country and for many industry sectors should facilitate intra-family transfers today at values that may prove to be quite low. This alone can support current 2012 planning.
Minimize Future State Income Tax
If you gift assets to a grantor trust today, there will be no current state income tax savings since the trust income and gains will be taxed to you, as grantor. However, following your death, the grantor trust status of the trust ends. At that point, the trust will become a separate taxpayer and, with proper planning, heirs residing in high income tax states may be able to minimize or even avoid state income tax on trust income by accumulating the income in the trust. For instance, if the trust is established in one of the trust-friendly states discussed throughout this book (e.g., Alaska, Delaware, Nevada, and South Dakota), there likely will be no state income tax on earnings retained in the trust for out-of-state beneficiaries. This can provide a significant benefit. In-state trust beneficiaries are taxed in Delaware, so caution must be exercised in making any assumptions about tax treatment from state to state.
EXAMPLE: Wealthy Taxpayer establishes a grantor “dynasty” trust in Alaska to which he gifts $5.12 million of marketable securities. During Taxpayer’s lifetime, there is no incremental state income tax savings because the trust earnings will be taxed by Taxpayer’s state of residence. On Taxpayer’s death, grantor trust status terminates. Taxpayer’s only heir is his daughter, age 50 at Taxpayer’s death. Daughter is gainfully employed and has no current need for distributions from the trust so she does not request the trustee to make any discretionary distributions. Daughter retires at age 60 and moves to a state that has no state income tax. At that point, she occasionally requests distributions from the trustee. State income tax will have been avoided for the entire 10-year period following her father’s death.
Save Future Generations’ Estate Tax
Should all the proposed negative transfer tax changes be enacted, and if you do not aggressively plan now to shift significant value and future growth into GST exempt perpetual dynastic trusts, you will likely cause additional and unnecessary discomfort and stress when planning for yourself in the future. For instance, when your heirs are ready to do their own planning, the law might reflect only a $1 million gift tax exemption, allow no discounts, no perpetual GST exemption allocations, no grantor trusts, and so on. With so many advantageous planning tools either eliminated or otherwise restricted, they may be hard-pressed to plan effectively with respect to their own wealth and that inherited from their parents or other loved ones.
Incur Gift Tax at Today’s Low 35 Percent Rate
While most people will be loath to consider this idea, for those of advanced years or in poor health, it may prove beneficial for select high net worth people to make significant gifts in 2012 such that a gift tax would be incurred. This gift tax will be at the current 35 percent rate. This likely will prove favorable when compared to the 45 percent rate that President Obama has proposed and even more so when compared to the 55 percent tax rate scheduled to take effect in 2013 if Congress does not act. There is obvious risk with this type of extreme gift planning in that the gift tax rate may not rise in the future and the hoped for arbitrage may never be realized. Nevertheless, these lifetime gifts may still prove beneficial because, if made more than three years before death, the gift tax paid will be removed from the estate of the person who made the gift.
This is similar to the dilemma many clients faced in 2010 when the risk of such rate increases becoming effective in 2011 were a topic of discussion. Because the rates never rose, the few clients that may have undertaken 2010 taxable gifts likely endeavored to unwind them in 2011.
The different manner in which the gift tax (tax exclusive) and the estate tax (tax inclusive) are calculated favors the net impact of incurring a gift tax over an estate tax.
Protect Assets
Favorable gift tax rules make asset protection planning less complex, more cost efficient, and safer. It is that simple. That may all change in 2013. That risk makes it imperative that anyone concerned about asset protection planning act now, not later. Even if the potentially adverse estate tax changes are not a concern for you (e.g., you are young and not particularly concerned with the impact of estate taxes, or you are comfortable simply using life insurance to fund future estate tax costs), the impact on asset protection options might be critical. Gifting assets to a self-settled domestic asset protection trust (DAPT) today may protect those assets from a future lawsuit and divorce. Selling key assets to a trust may also protect those particular assets from lawsuit and divorce. It will not, however, protect the initial value transferred by sale since the note generated by the sale will be an asset of yours, taxable in your estate, and susceptible to the reach of a claimant or divorcing spouse. However, the terms of the note, including the interest rate, may make the note worth little to any creditor, including your spouse in the event of a divorce. For example, a younger taxpayer might take a note in exchange for the property. That note might not be payable for 30 or more years with very low annual interest—right now, such a note would likely bear interest at less than 2.5 percent a year and, if the note were for only nine years, the rate would be under 1 percent annually.
With a $5.12 million exemption, you may be able to gift assets to a self-settled, completed gift DAPT without incurring gift tax and obtain meaningful asset protection. However, if the gift tax exemption declines to $1 million, this type of planning could become more complex and costly. You would, for example, have to fund a family limited partnership, obtain a discount appraisal, gift non-FLP assets, then consummate a note sale for additional assets. If grantor trust status or discounts are eliminated, even that planning may be less productive, or impractical.
For larger transfers above the $5.12 million exemption, the elimination of grantor trust status or the restriction or elimination of valuation discounts may render a note sale impractical. Planning now, before adverse gift tax changes, may be the most crucial asset protection step you ever take.
Better Than a Prenuptial
Those of you contemplating marriage may benefit by gifting and or selling assets to a self-settled, or other form of irrevocable trust before your marriage. If you do not own the assets when the wedding occurs, they will be safer than even the best-crafted prenuptial agreement can assure. This is not to suggest that a good prenuptial agreement isn’t appropriate as well. To the contrary, a prenuptial agreement may also be used, and should disclose the existence of the self-settled trust funded prior to the marriage. The prenuptial agreement alone cannot possibly afford the same asset protection that an irrevocable transfer made prior to the marriage, and disclosed to the soon-to-be spouse, will afford.
Better Than a Postnuptial
As discussed above, gifting assets
