2012 Estate Planning: Gifting examples

Examples of Situations Where Gifting in 2012 Can Reduce Estate Taxes

This post is a follow up to my post earlier this week on the unique opportunities available in 2012 to reduce your estate tax liabilities through gifting strategies. I have included a few examples below to illustrate how individuals or couples might be able to take advantage of the estate and gift tax laws in place this year to reduce their taxable estate and lower the federal and state estate taxes due upon their death by making a one-off large gift in 2012. These examples are for purposes of illustration only and are not meant as a complete how-to guide nor are they attorney advice. If you have a potentially taxable estate or are considering any of these methods, I urge you to talk to an estate planning attorney to more fully assess your options and get appropriate recommendations.

Example 1: The Moderately Wealthy Baby Boomer Couple

In this example, as in all of the examples that follow, we must make several assumptions in order to illustrate how and why a gifting strategy can reduce estate taxes. All of my examples assume that the parties are Washington state residents and have the primary goal of reducing estate taxes for their estate plan.

  • Married couple in their 50s to 60s with 2 grown (mostly) independent children.
  • Significant liquid assets, substantial retirement savings, large life insurance policies.
  • All assets are community property and will pass to the surviving spouse upon the death of the first through their established estate plan utilizing credit shelter, A/B, or disclaimer trusts to maximize tax benefits.
  • Total taxable estate (which includes all assets, retirement accounts, home equity, life insurance proceeds, etc.) are $5 million
  • Couple believe that the income from savings, retirement benefits, etc. will be sufficient to sustain them in retirement but total assets at their deaths could be slightly lower or higher due to a number of factors such as unexpected expenses or investment gains/losses; accordingly they would like to hold as much liquid assets as is tax efficient as a surplus or emergency fund.

A very simplified version of the need for and gifting strategy example follows:

  1. Why is a gifting strategy needed? Although the current federal estate and gift tax laws allow a married couple to exempt the first $10 million of their combined estates and any gifts they made during their lifetime, Washington state only allows an exemption for the first $2 million per person, but it does not currently assess a tax on lifetime gifts. So a couple with more than $4 million in assets (that already has a comprehensive estate plan in place that uses one of a variety of trusts to take advantage of both individuals $2 million exemption) can gift some of their assets away during their lifetime (with various conditions and restrictions on what counts as a gift and how long before death a gift must be made – an important reason to turn to a professional to assist with a gifting strategy) to move those assets outside their taxable estate and thus take advantage of the higher federal exemption and the fact that Washington state does not tax lifetime gifts.
  2. What type of gift could be made? Generally, any asset or interest in property can be gifted but there are some conditions for the gift to count as a completed gift and the gift must be made at least 3 years before the death of the “donor” (the gift giver). In the example here of the Baby Boomer Couple, one recommendation might be to gift any life insurance into an “irrevocable life insurance trust” for the benefit of the children. This is useful for both whole and term life policies, since normally the death benefit proceeds are includable in the estate of the insured; however if the life insurance policy is owned by the irrevocable life insurance trust, then the proceeds are not included in the estate of the insured. The Baby Boomer Couple could also choose to gift other assets, such as investments or even cash, to their children or into a trust for their children.
  3. What is the result of the gift? The Baby Boomer Couple reports a taxable gift tot heir children in the amount of the assets gifted less the applicable annual deduction for gifts ($13,000 per person, per year). So if the Boomers gift $1 million into a trust for their children, they would submit a gift tax return to the IRS in the following year reporting the gift in the amount of $948,000 ($1 million minus an excludable amount of $13,000 per kid per donor or $52,000). There is no tax due on the gift amount because the Boomers have a $5 million unified gift and estate tax exemption each that they haven’t exhausted yet (indeed, they have not ever used it until now). So now the Boomers have a taxable estate of $4 million, which will avoid Washington state estate taxes if their estate plans are drafted appropriately to utilize both $2 million exemptions and is less than their current combined federal exemption of $9,052,000 ($10 million minus the $948,000 gift).
  4. What happens if the laws change in the future? This is one of the key reasons that this type of gifting strategy should be undertaken this year. The current $5 million unified gift and estate tax exemption ($10 million per couple) is set to expire at the end of this year. While it is likely that congress will not let the law sunset and revert back to a $1 million per person exemption, it is very possible that any future estate and gift tax exemptions will be somewhere between the $1 million and $5 million marks. Indeed, President Obama’s proposed budget includes provisions to decrease the estate tax exemption to $3.5 million and the gift tax exemption to $1 million per person. It is also possible that Washington state may lower their exemption amounts or impose a state gift tax which would also reduce the viability of this type of large gift in the future.

Example 2: The Young Professional

  • Single or Married Young Professionals with Children
  • Large current incomes expected to increase over time, current assets may not currently be very sizable but it is anticipated that over time the estate of the professional could be quite large and easily over $2 million upon their death.
  • Life insurance contract naming spouse or children as beneficiary owned for purposes of providing for children in case of an early and unexpected death of a parent.

Unlike in the first example, this person or couple has a realistic expectation of large future earning potential that will result in a significant estate at the time of their death (whether in 10, 20 or more years). Perhaps they have recently purchased a house that will be paid off by the time they die and they are saving a significant amount of money every year in a retirement plan (401k, 403b, SEP or SIMPLE IRA, etc). They may also own assets that have the potential to appreciate significantly, such as ownership interests in a small business or stock in an employer. The issue facing the person(s) in this example is how to move money out of their estate and avoid estate taxes even if they don’t have much in the way of liquid assets. Here are a few assets that could be gifted into an irrevocable trust for the benefit of their children:

  1. Life Insurance Policies. As in the first example, transferring ownership in a life insurance policy or purchasing term life using a gift of cash into an irrevocable trust can move the proceeds out of the taxable estate and result in estate tax savings.
  2. Stock. Appreciable assets are perfect for gifting because they are taxable as a gift (but you get an exemption on the first $5 million) at the present value and are removed from your taxable estate, but they would be taxed at the future value at your death if they remained in your name. So $250,000 worth of stock today could be worth millions 20 or 30 years down the road.

In addition to the ability to make a large one-time gift under the beneficial tax regime currently in place, our Young Professionals should likely continue making annual gifts up to the annual exemption amount ($13,000 per person per year) to continue to fund the irrevocable trust (to pay life insurance premiums or purchase appreciable assets) and keep moving assets out of their taxable estate over their lifetime. Implementing such an annual exemption gifting strategy early in their lives can result in removing hundreds of thousands or even millions of dollars of assets (particularly in the case of life insurance) from the taxable estate at both the federal and state levels.

Example 3: Older Widow Whose Spouse Left Them A Sizable Estate

  • Older Widow/Divorcee who has a large estate, due to inheritance, property appreciation, investments, etc. There are plenty of liquid assets to both pay for all expenses (including any unforeseen health expenses) and to make gifts of property.
  • Individual would like to leave a large inheritance to certain people, but their taxable estate is greater than $2 million, so Washington estate tax would have to be paid first.
  • As the individual is not married, there is no opportunity to take advantage of credit-shelter or disclaimer trusts to exempt $4 million of the estate for Washington state taxes.

Here, the individual should act immediately to look into the possibility of gifting assets directly to their beneficiaries (or into a trust for their benefit) to take advantage of the $5 million federal estate and gift tax exemption before it ends at the end of the year. In addition, gifts generally must be completed 3 years prior to the donor’s death to count as a gift and be removed from their taxable estate. If the estate was worth $5 million, by gifting $3 million during 2012, the individual could potentially save $390,000 in Washington state estate taxes (and even more as those gifted assets increase in value over time).

It is extremely important to talk to an estate planning professional if you have any questions about the 2012 estate and gift tax laws and the large gift opportunity available to Washington state residents.

Ryan Velo-Simpson is an attorney licensed to practice in Washington state who has a solo practice focused on estate planning. To contact Ryan regarding your estate plan, please call at (206) 660-9401 or email at ryan@ryanvelo-simpson.com. This article constitutes attorney advertising and is meant only for Washington residents. This article is for educational purposes and should not be construed as attorney advice. IRS Circular 230 requires me to advise you that, if this communication or any attachment contains any tax advice, the advice is not intended to be used, and cannot be used, for the purpose of avoiding federal tax penalties. A taxpayer may rely on professional advice to avoid federal tax penalties only if the advice is reflected in a comprehensive tax opinion that conforms to stringent requirements, of which this does not qualify.

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