To Gift or Not to Gift Before the End of 2012?

By: Jennifer L. Zegel

The year 2013 is fast approaching and the uncertainty of what the future holds regarding federal gift and estate tax rates and exemption amounts for 2013 and beyond looms closer. The last several years have been a roller coaster ride for estate, tax, and financial planning professionals in attempting to properly advise their clients on estate planning while in the midst of tax code provisions slated to expire at the end of 2012 and long-term tax code uncertainty. Until the end of 2012, a limited opportunity is available for high net worth individuals to give large gifts without paying any gift tax. This article will discuss prior gift and estate tax rates, potential gift and estate tax rates in 2013, general techniques to exclude transfer taxes when making gifts, and why the next few months present a unique opportunity, in certain situations, to make large tax-free transfers.

The federal government and many states impose transfer taxes on lifetime gifts and transfers that take effect at death made by United States citizens. The federal gift and estate tax rates and exemption amounts for the years 2010 – 2012, are set forth in The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act (P.L. 111-312) (the “Tax Relief Act”) signed by President Obama on December 17, 2010. The Tax Relief Act reunified the estate and gift tax exemption amount to be set together at $5,000,000 (adjusted annually for inflation) and set the estate and gift tax rate at 35%.

Now through the end of 2012, high net worth individuals can transfer up to $5,120,000 ($10,240,000 for a married couple) in assets without incurring any federal gift tax. An estate may transfer $5,120,000 without incurring any federal estate tax. However, some states apply their own gift tax and estate or inheritance tax in addition to the federal estate tax. Pennsylvania does not tax gifts, but does have an inheritance tax that applies on all asset transfers at a rate from 0% – 15% based upon the relationship between the decedent and beneficiary.

The Tax Relief Act is set to expire on December 31, 2012. In the absence of Congressional action, on January 1, 2013 the current estate and gift tax exemption of $5,120,000 will drastically be reduced to $1,000,000, a difference of $4,120,000. The top estate tax rate will spike from the current rate of 35% to a whopping 55% (plus a 5% surtax will be levied on estates between $10,000,000 and $17,184,000) – ouch!

Amidst the future uncertainty of the tax code, a few favorable provisions remain unthreatened in 2013: the annual gift, medical and educational tax exclusions, which all permit gift transfers without the imposition of tax if certain guidelines are followed as set forth in Sections 2503(b)(1), (e)(2)(A) and (B) of the Internal Revenue Code. In 2012 under the annual gift tax exclusion, an individual may give away up to $13,000 ($26,000 for a married couple) per year, and in 2013 the amount an individual may give away will be $14,000, to an unlimited number of donees without owing any gift tax. However, the recipient must have a present interest in the gift to qualify for the exclusion. Outright gifts of cash or other assets are the clearest form of a present interest. Gifts made to a trust may satisfy the present interest requirement but the rules can be complex. The annual gift tax exclusion is an easy and effective tool to slowly and gradually pass assets from one generation to another without relinquishing control of a large asset.

The educational exclusion allows a donor to pay an unlimited amount of tuition to a qualified educational institution (maintains a regular faculty and student body) for the benefit of any number of donees from pre-school through graduate school. The donor must make the payments directly to the institution to qualify for the tax exclusion and only tuition payments are covered; room and board and other expenditures are excluded.

The medical exclusion permits a donor to pay an unrestricted amount of medical expenses and insurance premium payments for the benefit of any number of donees without the imposition of tax. The donor must make the payments directly to the provider, and the beneficiary of the medical services may not receive any reimbursements from the payment of medical expenses to qualify.

Although the aforementioned gift tax exclusions will continue in 2013, the current gift and estate exemption amounts will be drastically decreased without the intervention of Congress. Wealthy individuals who wish to take advantage of the current exemption amounts (which may never be this high again) have a limited opportunity to make gifts now through the end of 2012. We can only speculate as to what the future holds and whether the current rates will be preserved, kept at the slated 2013 decreased amounts, lowered even further, or whether claw back provisions will be enacted to undo large gifts made free of tax in 2012, among other questions. Despite the concerns of uncertainty in 2013, high net worth individuals seeking to take a small risk and make large gifts free of tax have a short period of time to effectuate these transfers.

In order to take advantage of the current gift tax exemption, an individual must make a transfer to another with the intention of making a gift. As previously discussed, a gift of cash is the easiest way to show a clear intention of making a gift but comes with the burden of relinquishing complete control over the asset. In addition to gifts made through a traditional trust or a family limited partnership, there are some other sophisticated techniques to make a gift without relinquishing complete control.

A Spousal Lifetime Access Trust (“SLAT”) is an irrevocable trust that can be utilized by married couples. A SLAT allows property transferred to the trust to be exempt from estate tax in either spouse’s estate. Distributions from the trust may be made to either spouse or other beneficiaries during the life of both spouses; however, other provisions go into effect upon the death of the grantor-spouse. Many other rules and procedures must be followed when establishing this type of trust to preserve its tax-free status and utilize the current gift and estate tax exemptions, but if done properly, this technique can maximize the current exclusion amounts, allow for some retained control of the trust property, and pass wealth to the next generation free of estate and gift tax.

Another technique that can only be enforced in a few states is the promise to make a future gift. Pennsylvania enforces a promise to make a future gift; however, uncertainty is still prevalent in 2013 as to whether this purported transfer will be respected. The promise to make a future gift, before the end of 2012, is a creative opportunity to potentially utilize the present exemption for a future gift but not actually make the gift until later.

Options are also available to incorporate the uncertainty of future tax laws within estate planning documents, so when the time arrives for decisions to be made the actual estate planning documents provide sufficient flexibility to take advantage of the most favorable tax provisions then in effect. Credit shelter trusts or spousal disclaimer trusts provide for flexibility in an estate plan by providing the personal representative of the estate and the surviving spouse the ability to decide how, when, and what assets are distributed to various beneficiaries, which can change the tax landscape of an estate.

Many other options and techniques are available to reduce or eliminate taxes on present or future gift transfers and ways to maximize gift transfers before the end of 2012. The estate and trust attorneys at Reger Rizzo & Darnall LLP are available to offer guidance and assistance in gift tax transfers or in establishing a general or complex estate plan or business succession plan based on the specific needs of each client.

For questions, comments or additional information, please contact Jen Zegel, Partner in our Estates & Trusts Group, at jzegel@regerlaw.com or via phone at 215.495.6523.