On Dec. 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act, which extended the Bush tax cuts for two more years. The act provided substantial, although only temporary, estate tax relief.

If not for the act, the federal estate tax rate would have increased Jan. 1, 2011, from 0 percent (2010 only) to 55 percent, and the estate tax exclusion (that portion of a decedent's estate that is exempt from estate tax) would have been set at $1 million.

Instead, the act set the estate tax rate at 35 percent and the estate tax exclusion at $5.12 million. It also increased the gift tax exclusion to $5.12 million.

However, these rates and amounts are only effective for 2011 and 2012. Unless Congress acts by Jan. 1, 2013, the estate tax will increase to 55 percent, and the estate tax and gift tax exclusions will reduce to $1 million.

That's why 2012 could be the "Year of the Gift." This year, it is possible to transfer more wealth to children and grandchildren estate and gift tax free than could be transferred in 2011 — or may be possible to transfer in 2013 or future years.

The lifetime exemption for gift and estate tax purposes is $5.12 million for 2012. If Congress does nothing, the equivalent of the lifetime exemption will revert to $1 million, and the marginal tax rate will increase from 35 percent to 55 percent.

President Obama has floated the idea that the lifetime exemption be reduced to $3.5 million, with a transfer tax rate of 45 percent. The above numbers are for a single person. High-net-worth couples could double these numbers.

Even if you assume that the $3.5 million exemption, and the 45 percent rate represent the worst case, individuals (or couples) could potentially save $729,000, or $1,458,000 (for a couple), if they make gifts in 2012.

Since we know what the rules are for 2012, the phrase "limited time offer" comes to mind.

If you, as an individual or a couple, simply intend to write family members a check, then you probably can wait until late December to make a gift in 2012.

However, if you recognize the added value of including life insurance in any plan, you may need to have a trust drafted before you can actually make the gift. And that takes time — particularly if a large number of high-net-worth individuals delay making their gifts until after the November election. Life insurance, if structured properly, can be passed free of estate tax.

Although individuals should discuss their particular situations with their financial, legal or tax advisers, it may be possible to create and fund a trust today and delay until later in the year the decision to make a gift that would use the lifetime exemption.

For example, the individual could lend $5.12 million to an irrevocable trust that will be taxed as a grantor trust under IRS rules. The loan has to accrue interest, but with the July short-term AFR at 0.24 percent, the amount of interest that would need to be considered is negligible.

Then, if the individual wants to convert the loan into a gift in December, it is a relatively simple matter to notify the trustee that the loan is being forgiven.

If Congress should act and make the $5.12 million lifetime exemption permanent, you could extend the maturity date for the loan using either the mid-term AFR (0.92 percent for July) or the long-term AFR (2.30 percent for July). If the attorney drafting the trust is aware of this possible approach, all of the necessary documents can be drafted upfront.

President Obama also has proposed changes involving intentionally defective grantor trusts (IDGTs) that would coordinate income and transfer tax rules that apply to grantor trusts.

The proposal suggests that when a transfer is made to a grantor trust, if a distribution is made from the grantor trust or the trust ceases to be a grantor trust, the gift tax should apply. Then, at the time of the grantor's death, any amounts not distributed would be subject to the estate tax, which would eliminate transfer tax benefits of sales to IDGTs.

The change also would apply to nongrantors who are deemed to be owners of the trust and then engage in a sale, exchange or comparable transaction with the trust that would have been subject to capital gains if the person were not the deemed owner of the trust.

Obama's proposal would be effective for trusts created on or after the date of the enactment. The treatment of trusts already includible in the grantor's gross estate under existing provisions would not change. This is just another reason to have your situation analyzed sooner than later.

Will Congress act prior to 2013? Well, all the pundits predicted with great authority that Congress would never allow the estate tax to expire in 2010. So if those "in the know" couldn't get it right for 2010, there is no way anyone can predict.

However, the expiration occurs during a presidential election. Are any of the major parties going to run on the platform of raising estate and gift taxes?

Brian Kennedy, of Kennedy-Catalano Advisors Key Financial Group LLC of Camp Hill, is a registered representative and investment adviser representative of Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment adviser.

 

This article is for informational purposes only and does not constitute legal or tax advice. Individuals should consult with their advisor or team of advisers about their particular situation. Neither Lincoln Financial Advisors nor its representatives offer legal or tax advice.