Wealth Matters - A Year to Give to Your Heirs, and Save on Taxes
THE estate tax is a great wedge issue in a politically polarized time. Take this oft-cited example: If a billionaire dies this year, no estate tax will be paid, but the estate of someone with more than $1 million who dies next year will pay a 55 percent tax on that extra amount. That seems arbitrary if not bizarre, but such is the tax regime unless Congress changes it.
A bigger issue as 2010 winds down, however, has become the gift tax, which is linked to the estate tax to prevent people from giving away their fortune in life to avoid taxes at death. It now stands at 35 percent, the lowest rate since the 1930s. And since a retroactive reinstatement of the estate and gift taxes appears unlikely — or will be contested in the courts for years — the wealthy are starting to look at making large gifts this year to reduce their estates later.
But why would they voluntarily pay a 35 percent gift tax now when they could roll the dice and end up paying less when they die? Because this rate is a gift, as it were, to the rich.
First, the gift tax rises to 55 percent next year with an exemption of only $1.12 million. That 20 percentage point difference is a 57 percent increase in the rate, if the law stays the same.
“People are so focused on the estate tax that they’re not paying attention to this,” said Steve Kunkel, director of taxes at CBIZ MHM, an accounting firm. “People are looking beyond 2010, and in doing so they’re going to miss some significant savings this year.”
In addition to the historically low rate, another reason to make sizable gifts this year is that the values of many assets are still depressed. Long-held stocks, real estate and shares in private businesses could all increase in value, and giving them away now will allow them to appreciate with your heirs and not in your estate.
Richard A. Behrendt, first vice president and senior estate planner at Robert W. Baird & Company, said single people with more than $5 million and couples with more than $10 million should look at making gifts. The reason is the likelihood of a higher estate tax in the future.
“I wouldn’t be rushing to do this today, but I would be planning,” Mr. Behrendt said. He says much will hinge on Senator Harry Reid’s proposed debates in September on the estate tax as well as the outcome of the midterm elections. “This is not the kind of thing you want to be rushing to do at the end of the year.”
While the break on the gift tax is a boon to the children of wealthy parents, this year offers an even greater savings for those who want to transfer wealth to grandchildren. These gifts are usually subject to a hefty tax above the exemption rate, called the generation-skipping tax, but not this year. It was linked to the estate tax and has likewise been repealed this year.
Mr. Kunkel calculated the different tax rates paid on a $3 million gift to a grandchild, assuming that the lifetime exemptions had been used up. (Last year, the lifetime exemption on the generation-skipping tax was $3.5 million; next year it is set to be $1.12 million. But this year, it is not in force. The gift tax exemption remains $1 million.)
In 2009, the total tax rate on gifts to grandchildren — which included the 45 percent gift tax, the 45 percent generation-skipping tax and a 45 percent gift tax on the generation-skipping tax — worked out to 110 percent on the gift. Next year, the total tax rate, assuming no change, will be 140 percent, meaning it would cost someone over $7.2 million to make a $3 million gift.
Yet this year, only the 35 percent gift tax applies, which makes the $1.05 million tax on a $3 million gift to a grandchild a relative bargain.
Of course, there are risks in doing anything when the tax picture is so uncertain. Pushing the boundaries on gifts is at the top of the list, said Mr. Behrendt, who audited estate tax returns for 12 years at the Internal Revenue Service before he began advising wealthy clients. He said that without the usual stream of estate tax returns to review, auditors would fill their days going through gift tax returns.
He warned that certain techniques guaranteed an audit. Giving away interests in family limited partnerships at vastly discounted values, for example, is a red flag to auditors. Yet he sees little risk in making gifts of cash and marketable securities or using approved techniques, like grantor retained annuity trusts, to pass money to heirs.
The less obvious risk is the psychological one. The best way to take advantage of the lack of a generation-skipping tax is to give the money outright, instead of in a trust that could protect a grandchild from himself and others, said Lewis W. Dymond Jr., an estate planning lawyer and a founder of WealthCounsel. (If the money were put into a trust, it could be subject to tax when it was withdrawn, he said.) But as a cadre of psychologists will tell you, wealth without restrictions can also hurt heirs far more than it helps them.
Mr. Dymond hews to the practical. “As estate planners, the idea of giving money outright is not good planning,” he said. “You’re putting the money in the hands of someone who is not protected. It’s an abhorrent thought to be distributing a lot of money outright, but it’s an effective time to be doing it.”
Beating the federal government at the tax game is great, but damaging the lives of your heirs in the process could make it a Pyrrhic victory.
It'd be interesting to know if this plays a part for any of the participants in the recent 'Giving Pledge'.
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