Last Chance for Estate Tax Savings?

This month’s alert focuses on the narrowing window to lock-in the current $5.12 million estate and gift tax exemption by gifting prior to year-end. The alert also examines why it may not be possible to wait and do this planning at the last minute.

2010 Tax Law Leads to 2012 LitigationAppraisal firms all across the country have been inundated with business. They are being swamped by taxpayers attempting to implement last minute estate planning strategies prior to January 1, 2013, when the amount that can be passed free of estate taxes goes down.

Under the most recent extension of the “Bush Tax Cuts,” the amount that may be given free of gift tax (when a person is alive) and free of estate tax (upon a person’s death) was increased to $5,120,000 for 2012. If Congress fails to extend the law (as it relates to gift and estate taxes) before year-end, the amount that can be passed free of gift and estate taxes will drop to $1 million on January 1, 2013.

Many estate planning practitioners are encouraging wealthy clients to “lock- in” the current $5.12 million limit in anticipation that Congress will not act by year-end, and even if it does, that the new law, whatever it may be, will not be as favorable to taxpayers as the 2012 limit. Those on the other side of the debate believe that no matter the outcome of the elections, Congress will act sometime in the future to increase the exemption amount beyond the $1 million. These advisors point to a proposal from the Obama administration to set the exemption amount at $3.5 million. But these advisors ignore many other provisions that are also part of this proposal. These other proposals would restrict or eliminate many of the estate planning strategies currently available.

Many taxpayers are waiting for the election results before they decide whether or not they will engage in any tax planning before year-end. While the election is just around the corner, many estate planning attorneys and appraisers are already overbooked with individuals who have engaged these firms. Therefore, it may be difficult, if not impossible, to find quality estate planning attorneys and appraisers who have time to complete the work before the year-end deadline.

We have advised clients in our Alerts earlier this year of the many planning opportunities that are currently available. However, in order to obtain the gift and estate tax savings associated with these estate planning strategies, the plan must be in place before year-end. Because many of these plans involve the transfer of illiquid assets such as business interests and real estate, appraisals must be obtained to assure the assets are accurately valued upon transfer. Further, the appraisal will be included on the gift tax return (IRS Form 709) that must be filed by April 15, 2013, in order to lock in these savings. As a result, some of these strategies cannot be implemented at the last minute.

As the gift and estate tax rate will be as high as 55% under the new law, significant tax savings may be realized by those who act now. At a 55% marginal rate, the gift tax (and estate tax) on a gift of $5 million is $2,750,000. The gift tax on a $1 million gift at the same marginal rate is $550,000. That is a tax savings of as much as $2,200,000 for a taxpayer who locks in his or her savings currently or twice that amount for a married couple.

Recently some clients and prospects have contacted our office and told us they have been informed by their financial planner or tax preparer that it is not possible to “lock-in” these estate tax savings because the IRS will include the gifts made in 2012 on the taxpayer’s estate tax return and therefore any planning done now will not lower any estate taxes that need to be paid in the future. While the IRS has declined to give formal guidance with regard to what many tax gurus call the “clawback,” most tax and estate planning experts believe that the estate tax savings can be locked in and that clawback will not be factor for those taxpayers who plan today. Even if these experts are wrong and clawback is a factor, it is still likely that taxpayers can achieve some tax savings by acting now because they would have gotten the growth on these assets out of the taxable estate. This is something that should be discussed with a knowledgeable estate planning attorney.

Another concern that needs to be addressed before rushing into this type of planning is its effect on income taxes. When a child or other beneficiary receives an asset by inheritance, generally he or she receives a “step-up” (or – down) in basis. This means that the inherited asset can usually be sold without adverse income tax consequences. A gift that is received during lifetime does not receive this favorable income tax treatment, which means the child or other beneficiary will pay capital gain tax on the difference between the donor’s tax basis in the property (usually the price paid for the property) and what it is sold for. As such, some of the estate planning strategies that are being promoted currently will result in estate tax savings at death, but will cause income taxation when the assets are sold. Usually the income tax paid is much less than the estate tax saved, but this is not always the case. This is another reason that taxpayers contemplating year-end estate planning should consult with a knowledgeable estate planning attorney.

Taxpayers with substantial estates can call our office for a free evaluation of the options that are available to them. Those with lesser estates may also benefit from the free consultation, as there have been numerous changes in the past few years relating to probate avoidance, creditor protection, divorce protection, and Medi-Cal and Veterans’ benefits planning that may prove beneficial to these clients.

Our office focuses on estate planning and administration. We also offer trust administration and probate services. As a member of the American Academy of Estate Planning Attorneys, our firm is kept up to date with information regarding tax developments as well as cutting edge planning strategies for persons of all wealth levels. You can get more information about a complimentary review of your clients’ existing estate plans and our planning and administration services by calling our office.