|A tax-free chance of a lifetime is at hand.|
Everyone knows the only two certainties in life are death and taxes. The inevitability of the former, of course, is indisputable. But for the remainder of 2012, some fortunate souls may have a chance, just this once, to avoid a multimillion-dollar hit from the latter.
Taking advantage of this rare opportunity requires that one be, frankly, rich. So if your net worth as an individual or a married couple totals well into the millions, and you'd like to shield your estate from a body blow following your death, now is the time to act.
“Humongous” is how financial planner Tommy Bernard describes the potential savings wealthy taxpayers can reap from the current convergence of favorable inheritance laws. “People have a huge opportunity between now and the end of the year,” he says.
The situation stems from a series of actions Congress took to amend estate tax laws as tax cuts that were enacted by President George Bush in 2001 neared their expiration date. The estate tax rate had declined incrementally, and some lawmakers hoped to reverse its direction. But in December 2010, President Barack Obama signed a “tax relief” bill that extended the Bush-era tax cuts for two years.
That bill also incorporated unexpected increases in exemptions from both estate and gift taxes, sheltering up to $5 million per taxpayer or $10 million for a married couple from the Internal Revenue Service during 2011 and 2012.
This fortuitous combination of estate and gift tax provisions is unprecedented, and it's unrivaled even by a 2010 legislative anomaly that allowed the estate tax to fall to zero for one year. It was during that year that New York Yankees owner George Steinbrenner died, and his $1.1 billion estate famously changed hands tax-free, at an estimated savings to his heirs of about $600 million.
Not just for the rich
Taxpayers needn't be as wealthy as Steinbrenner to enjoy the currently available breaks, but they do need to watch the calendar. The estate and gift tax measures are set to expire this year, and it's possible they will never return.
“The exemptions have never been this big, and at year's end they probably will disappear,” Bernard says.
Here are three ways the exemptions can benefit estates this year:
• For a taxpayer who dies before Dec. 31, 2012, leaving an estate with a net value of $5.1 million or less, the estate may pass to beneficiaries completely free of tax. Portions of an estate above that benchmark will be subject to a tax rate of 35%.
• During 2012, living taxpayers may pare down the size of their estate by giving away up to $5.1 million (or $10.2 million for a married couple) without having to pay gift tax. Gift values above those limits will be taxed at 35%.
DON'T GO IT ALONE
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• Enlarging on the gift tax exemption opportunity, the law also applies the $5 million/$10 million exemption to the generation-skipping transfer tax. This means that during 2012 individuals or couples can give those totals to grandchildren or great-grandchildren without owing any gift tax.
In all three cases, unless Congress and the president act to extend these laws—and there's no reason to assume they will—the benefits will expire at the year's end. With estate, gift and generation-skipping tax exemptions slated to drop to $1 million or thereabouts on Jan. 1, and the related tax rates set to rise to 55%, the above actions—including dying—will become a lot more expensive in 2013.
“Nobody really saw this coming,” says tax lawyer and CPA David Lukinovich, who works with many clients whose net worth exceeds $25 million. A number of his clients this year have set up trusts and paid large amounts into them in order to shield chunks of their estates from taxes.
Lukinovich says the beauty of the current exemptions lies not just in the large current sums they can protect, but also in the shelter they offer for future appreciation of the assets, courtesy of the generation-skipping provisions.
“In Louisiana, parents could put a $10 million gift into a trust for children, future grandchildren and great- grandchildren in a manner that the gift can be deferred for estate tax purposes until the death of the great- grandchildren,” he says.
Meanwhile, the size of the gift could increase exponentially through investment, and the beneficiaries could use the income without touching the principal. “The gift becomes huge,” Lukinovich says.
Advisers say the simplest way for parents to take advantage of the current gift tax exemptions is by writing a check—a $10 million gift to a son or daughter, or maybe smaller checks totaling $10 million to children, nieces, nephews and grandchildren.
Bernard points to the example of a client couple who, on Dec. 25, 2011, wrote three $1 million checks to their three kids and put them in Christmas stockings.
He says another option would have been to put the $3 million into a trust with the children as primary beneficiaries. “Then you can put some strings on the money, maybe give them access to 5% a year or so. You can put some rules on how they get it out, even though it's their money,” he says.
Often, wealthy people want to transfer other kinds of assets, ranging from real property to family businesses to stocks and collectibles. The important thing to remember when transferring non-cash assets is that their valuation must pass muster with the IRS. Lukinovich says that's why families need to act soon.
“If people have a significant amount of wealth in a family company, it's not like you can value that company tomorrow and just give away half of it,” he says. “You have to go through a valuation.”
Advisers around the country are urging clients to examine their estate needs now in order to avoid facing difficult decisions near the end of the year. Although tapping into the current tax exemptions seems fairly straightforward, the process can become quite complicated depending on the kinds of assets involved, investment strategies, and the beneficiaries who will end up holding the wealth.
“These are tough, emotional decisions, and it's an adviser's role to help clients figure out their wants and needs, and explain the pluses and minuses,” Bernard says.
The decision to act ultimately falls to the estate owner, but there's little question that a tax-avoiding opportunity of a lifetime is at hand. And compared with the impact of past estate tax provisions, the cost of waiting too long to act on this one could be off the charts.
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