The “Perfect Storm” For Estate Planning

Assets are shifting following the implementation of the Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010

March 25, 2011

We are experiencing a “perfect storm” in the estate-planning arena. Three events are combining to make the current environment the best opportunity on record to save literally millions of dollars in ultimate estate taxes for wealthy families. Interest rates remain at all-time lows, asset values remain depressed (especially in real estate), and the “Tax Relief, Unemployment Insurance Authorization and Job Creation Act of 2010” (hereinafter referred to as “the Act”) signed by President Obama in December 2010, allows for the shifting of assets on a grand scale never before seen in the 94 years of the modern estate tax regime.

The Act caps the estate tax rate at 35% and allows for an exemption from estate taxes of the first $5 million of estate value. This means that married couples with estates less than $10 million will incur no estate taxes whatsoever. Without the Act, the rate would have been 55% with an exemption of just $1 million in 2011. So the new law will allow many families to escape the estate tax altogether or lower the taxes significantly for those with estates greater than $5 million (or $10 million for married couples).

“The Act caps the estate tax rate at 35% and allows for an exemption from estate taxes of the first $5 million of estate value.”

Perhaps the biggest benefit of the law is the reunification of estate and gift taxes. Prior law fixed the lifetime exemption for gifting at $1 million, even though the death exemption was larger ($3.5 million in 2009). The Act reunifies the gift exemption with the death exemption. This means both a husband and wife could transfer by gift up to $10 million of assets during their lifetimes as opposed to just $2 million under prior law. This is a tremendous opportunity to shift significant assets out of the estate, forever shielding the growth on the gifted assets from estate taxes.

As good as this news is, the Act will only last through 2012, after which the estate taxes will revert to pre-2001 law (55% rate and $1 million exemption) unless a new law is passed before then. That is why it is so important to implement a gifting strategy during the next two years that will maximize the amount of future estate tax savings. Even though the law will change by 2013, any gifting done prior to a change in the law will be grandfathered – Uncle Sam cannot unwind the gifts made under current law.

Why would you want to make gifts up to $10 million if you are a wealthy family and can afford to do so? The best way to beat Uncle Sam in the estate tax game is to transfer assets from you to trusts for your children’s and grandchildren’s benefit. The reason for this is best shown by example.

Assume you own a portfolio of real estate worth $10 million and the portfolio will grow at an average of 6% per year over a 20- year period when the death of the second spouse is assumed and the estate tax is due. If you retain the real estate, it will ultimately be taxed in your estate at 35% (the rate could be more or less when they change the law by 2013). The projected value of the real estate would be $32,071,000 in 20 years with an estate tax of $11,225,000.

If instead you transfer the real estate to a special trust benefiting your heirs, then all the appreciation from the date of transfer would inure to the trust and would not be included in your estate. Based on the assumptions above, in 20 years the appreciation on the real estate of $22,071,000 would be removed from your estate, saving over $7.7 million in estate taxes.

“Now is the time to explore whether or not a gifting program should be executed and to what extent.”

There are techniques to leverage the $5 million exemption to enhance the estate tax savings even further. These include Grantor Retained Annuity Trusts (GRATs), sales to defective trusts (IDITs), financed net gift transactions, and other techniques I will cover in future articles. These techniques use much less of your gifting exemption for each dollar of asset transferred and work best in a lower interest rate environment. The current low interest rates combined with the fact that most assets, including businesses and real estate, have decreased in value since 2006 and the opportunity the Act gives to transfer tremendous value complete the “perfect storm” opportunity.

Now is the time to explore whether or not a gifting program should be executed and to what extent. The “perfect storm” will disappear quickly –  the Act will only last for two years if not amended beforehand; interest rates will start to rise at some point; and asset values will most likely increase soon from their current lows.

Don’t be behind the “eight ball” and lose this fantastic opportunity to beat Uncle Sam at the estate tax game. Meet with an advisor who specializes in gifting and estate taxes now to assist in formulating the best plan for you and your family.

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