and asset protection benefits outweighs your estate tax planning concerns. Malpractice, divorce, premises liability, and other unmanaged risks can decimate an estate far worse than any tax.
Steps for Professional Advisers
CHAPTER TWO
CURRENT TRANSFER TAX LAW—PROPOSED AND POTENTIAL CHANGES
To better understand the overview of planning ideas discussed in this book, this chapter offers a more detailed discussion of many of the proposed law changes. It includes a brief overview of the generation-skipping transfer (GST) tax. It also discusses some of the many proposals to modify the income tax rules, especially as they apply to higher income taxpayers. The possible changes to the income tax rules have important implications to estate planning and should be considered when evaluating 2012 estate planning options. A major difficulty with all these rules is that there is little certainty as to what changes might eventually be enacted. It is possible that new proposals not mentioned below might become law instead. The real challenge for 2012 is to understand that uncertainty often provides opportunity. Chapters 5 and 9 discuss many of the planning options to consider in light of the transfer and income tax changes discussed here.
EXEMPTION AMOUNT AND RATE
The 2010 Act set the estate, gift, and GST tax exemption at $5 million per person (or $10 million per married couple), inflation adjusted starting in 2012; it’s now $5.12 million. An effective tax rate of 35 percent was set for all the federal transfer taxes: the estate tax applicable at death, the gift tax applicable to lifetime (inter-vivos) transfers, and the generation-skipping transfer (GST) tax. These favorable 2010 Act changes, however, all expire (i.e., sunset) at the end of 2012 and, absent congressional action, the exemption will decline to $1 million (although the GST exemption will be higher as a result of it being inflation adjusted) and the unified rate will rise to 55 percent.
PLANNING NOTE: While there are a number of proposals, and many more predictions, the law right now is as provided above. The critical point to 2012 planning is that, absent a visit by Carnac the Great, we may not know what the 2013 laws will be until well after 2012 planning opportunities have disappeared. Remember, the 2010 estate tax rules were not known until mid-December 2010!
COMPOUNDING: THE EIGHTH WONDER OF THE WORLD
Why is it so incredibly important for you to consider gifts today? In one word, compounding. Why is it so important for you, even if your estate is under $5 million today, to consider gifts? Again, compounding. Whether the future estate tax exemption is $5 million, $1 million, or anything in between, even if your net worth is below what might seem to make planning essential in 2012, you may still benefit significantly from planning. Consider the following example.
EXAMPLE: You transferred $5 million in securities in 2012 to aGST-exempt trust. You die in 2042, 30 years later:
•If the portfolio grew at a mere 3 percent a year, over $12 million would be excluded from your estate.
•If the portfolio grew at a rate of 6 percent a year, which is historically a modest rate of return for a well balanced portfolio, nearly $29 million would be excluded from your estate.
•If the portfolio grew at 10 percent a year, over $80 million would escape estate and GST taxation. Even those who believe their estates may be too small to have to plan today should seriously consider doing so.
Even those who believe their estates may be too small to have to plan today should seriously consider doing so.
THROW MOMMA FROM THE TRAIN BEFORE NEW YEAR’S
If the $5.12 million exemption really declines to $1 million, the more macabre impact of the possible change in the tax laws might entice would-be heirs of aging wealthy benefactors to take them on extreme adventure vacations such as mountain climbing, skydiving, or parasailing between Christmas and New Year’s. Okay, that is probably too cynical, but if Momma has under a $5.12 million estate, there will be no federal estate tax in 2012 (although beware of state death taxes). If the exemption drops to $1 million in 2013 and the rate increases to 55 percent, as the law presently provides, pushing Momma from the train in 2012 instead of 2013 could lead to some multi-million dollar savings. Then again, there’s probably not much you’ll be able to spend that inheritance on while you’re living in the Spartan government quarters you are likely to be residing in. The point is that the differing impact of current 2012 law, and what is scheduled to take effect in 2013 is dramatic.
ESTATE TAX PROPOSALS MAY CHANGE THE PLANNING LANDSCAPE
A host of proposed law changes are floating around Washington. Given the current political climate, it would be impossible to guesstimate the likelihood of any particular proposal being enacted. Thus, the real benefit of reviewing the proposals is to assess what tax benefits might be lost. This will help determine what planning steps to take in the remaining months of 2012. If you’re waiting for certainty before planning, you will likely miss the boat. Some of these proposed changes are discussed next.
Grantor Retained Annuity Trusts (GRATs)
GRATs in simple terms are irrevocable trusts to which you as the donor (the one making a gift to the trust) and grantor (this has important income tax implications discussed later) makes a gratuitous transfer of appreciating or high yielding assets. In exchange for this gift, you will be paid an annuity amount each year for a fixed number of years (the GRAT term). The annuity amount is typically based on a percentage of the initial value of the assets you gifted to the GRAT. The amount is typically set at a level that for gift tax purposes reduces the value of the remainder interest (what is left when your annuity ends) in the GRAT to zero or near zero. The result is that any appreciation of the assets inside the GRAT that exceed the mandated federal interest rate used in the calculation will go to the remainder beneficiaries, typically your children, or a trust for their benefit, with no transfer tax cost. Basically, these so-called “zeroed-out” GRATs are a win-win for the taxpayer since, if the GRAT property appreciates at a rate in excess of the IRS hurdle rate, you will have achieved a tax-free transfer of wealth to your children and, if the property fails to achieve that level of appreciation, you are no worse off than had you never created the GRAT in the first place (i.e., because you made no or a minimal taxable gift when creating the GRAT). Over time, the GRAT technique was engineered into a series of rolling or cascading short-term (e.g., two-year) trusts that could capture upside market volatility
