Opportunity to Use $5.12 Million Gift Tax Exemption and Other Estate Planning Techniques May End on December 31, 2012

The implementation of certain wealth transfer techniques before the end of 2012, in particular the use of the $5.12 million Federal gift tax exemption, is more compelling than ever in light of the scheduled expiration of the Bush-era tax cuts and various legislative proposals that might eliminate or curtail certain gift-giving strategies. The following is a brief summary of the proposals, the impact they may have on estate planning and our recommendations for taking action prior to year end.

Reduction of the Federal Gift, Estate and GST Tax Exemptions and Increase in Rates

This year, each individual may make gifts of up to $5.12 million (or $10.24 million for a married couple electing to split gifts), reduced by previous taxable gifts, without the imposition of a Federal gift tax. The Federal estate tax exemption and the exemption from the generation-skipping transfer (“GST”) tax are also currently $5.12 million, and the Federal gift, estate and GST tax rates for transfers in excess of the exemptions are 35%.

• Exemptions and rates if Congress fails to act. If Congress does not take any action, as of January 1, 2013, the Federal gift, estate and GST tax exemptions will decrease from $5.12 million to $1 million per individual (with the GST exemption indexed for inflation), and the Federal gift, estate and GST top marginal tax rates will increase from 35% to 55%.
  
  
• Proposed legislation. There are numerous legislative proposals that would affect estate planning, including bills that would (i) maintain the status quo for a year or more, (ii) repeal the Federal estate and GST taxes (and, possibly, the Federal gift tax) entirely or (iii) retain all three taxes but lower the exemption levels and increase the tax rates.

Possible Curtailment of Certain Estate Planning Techniques

Certain legislative proposals would eliminate or curtail a number of estate planning techniques, including the following:

• 90-year limit on GST tax-exempt dynasty trusts. The allocation of a donor’s GST tax exemption to a trust would be effective for only 90 years, thereby reducing the transfer-tax benefits of creating a dynasty trust in a jurisdiction, such as Delaware, that permits trusts to continue indefinitely.
  
  
• Decreased availability of valuation discounts. The rules on valuation discounts would be modified to restrict discounts for certain gifts of interests in family-controlled entities.
  
  
• 10-year minimum term on grantor retained annuity trusts (“GRATs”). GRATs would be required to have a minimum term of 10 years. Clients may wish to consult our prior memorandum, Obama Administration’s Fiscal Year 2010 Revenue Proposals Relating to Estate, Gift and Income Taxation of Individuals, which discusses the benefits of short-term GRATs.
  
  
• Elimination of benefits of grantor trusts. One recent proposal would effectively eliminate the use of grantor trusts as an effective estate planning technique, including the benefit associated with the donor’s payment of trust income taxes.

Recommendations

We recommend that, if appropriate, clients make current use of their full Federal gift and GST tax exemptions and take advantage of certain wealth transfer techniques promptly.

For example, a client may wish to give up to $5.12 million (or $10.24 million for a married couple electing to split gifts) to a grantor trust for the client’s children and more remote issue, possibly in Delaware or a similar jurisdiction that would permit the trust to continue indefinitely. In addition, clients may wish to engage in transactions to leverage gifts to grantor trusts without income tax consequences, such as making a low-interest loan to a grantor trust or selling assets to a grantor trust in exchange for a note. Finally, it may be desirable for clients to establish short-term GRATs, which, given the low applicable Federal interest rate for October 2012 of 1.2%, could be a particularly effective means of transferring wealth to children.

A client who has previously funded a trust that is not GST exempt could also allocate GST exemption to the trust by filing a Notice of Allocation with the IRS prior to the end of this year, without making further taxable gifts.

In light of the potential changes in tax laws, clients may wish to review our memorandum, Overview of Estate, Gift and GST Tax Planning in Light of 2010 Tax Legislation, which summarizes various estate planning techniques.

If you would like to discuss any year-end tax planning, please contact one of the attorneys in our Private Clients and Charitable Organizations Practice Group as soon as possible in order to leave sufficient time to implement any wealth transfer techniques prior to the end of the year.