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Congress creates ‘window’ in 2011 and 2012 for big tax savings.


Congress has created a temporary “window” – between now and the end of 2012 – in which many people can save a lot of money in estate and gift taxes.

You might be able to take advantage of this opportunity by transferring significant assets to a trust. But as they say on TV, hurry – this is a limited-time offer from the federal government. During 2011 and 2012, the federal estate tax exemption will be $5 million, meaning the tax will be applied only to estates that are larger than that. Importantly, the lifetime exemption from the federal gift tax has also been raised, from $1 million to $5 million. The gift tax applies to transfers of assets. In general, any person can give any person up to $13,000 a year without there being any gift tax. If you give someone more than $13,000 in a calendar year, then the excess is subject to gift tax. However, you also have a “lifetime exemption.” In the past, this amount was $1 million. That meant that over your lifetime, you could make up to $1 million in gifts over the $13,000 annual threshold without immediately paying a gift tax.

This wasn’t a “freebie,” however. Any amount you used of your lifetime exemption would be subtracted from your estate tax exemption, such that when you die, your heirs might have to pay more in estate taxes. But in general, the benefits of using the lifetime exemption far outweighed the disadvantages.

Now that the lifetime exemption has been raised to $5 million, you can make gifts of up to $5 million without immediately paying gift tax. Even if you already used up your $1 million lifetime exemption in the past, you can now make up to $4 million in additional gifts.

But this is true only if you make those gifts in 2011 or 2012. After that, the lifetime exemption goes back to $1 million. Many people can benefit by putting significant assets into a trust in 2011 or 2012 that will pay income to their children, and ultimately benefit their grandchildren. Here are some of the benefits:

  • Suppose you transfer an asset worth $1.5 million to a trust today, and by the time you die, that asset has increased in value to $2 million. The entire increase — $500,000 – will go to your heirs without being subject to estate taxes.
  • Suppose the asset also generates annual income. For instance, over the course of the rest of your life it might generate $300,000 in income. That entire $300,000 will also go to your heirs without being subject to estate taxes.
  • Suppose you set up the trust so that your children receive the income, and when they die, the trust assets go to your grandchildren. The entire trust, regardless of how much it has increased in value, will go to your grandchildren without any estate taxes being due when your children pass away.
  • You will also have protected the assets for your grandchildren, because they can’t be taken away if your children incur debts, are sued in a lawsuit, get divorced, etc.

What assets should you consider putting into a trust? Obviously, ones you don’t need to keep for your current or future support. Beyond that, it’s a great idea to contribute assets that are temporarily reduced in value and that have the potential for significant appreciation. In the current environment, real estate might be a good example.

In some states, it’s possible to create a “dynasty” trust, which continues to exist and benefit future generations such as great-grandchildren.

Remember, too, that the $5 million gift tax exemption is per-person. So a married couple could contribute as much as $10 million.

One possible downside is that we don’t know what Congress will do after 2012. There is a small possibility that there will be a retroactive tax on lifetime gifts over $1 million. There are also state tax issues to consider. And of course, you don’t want to make gifts of assets that you will need to live on in retirement.

But in general, the benefits of using the “window” in 2011 and 2012 are very significant and should be considered by anyone in a position to take advantage of them.

More implications of the new tax law from Congress
The new tax law, which temporarily raises the estate and gift tax exemptions to $5 million, has many important implications. Almost everyone should have their estate plan reviewed in light of this significant change.

Here are just a few of the other important consequences:
Many wills that were drafted years ago need to be revised right away. Frequently, these wills were set up to avoid taxes by giving children an amount of property equal to the estate tax exemption, and having the rest go to the surviving spouse. For instance, if the exemption amount were $600,000, then $600,000 would go to the children (or to a trust for the children), and the rest would go to the surviving spouse (or a trust for the spouse).

But in 2011 and 2012, the exemption amount has been dramatically increased to $5 million. So in some cases, the result will be that the entire estate goes to the children, and little or nothing goes to the surviving spouse.

If you have a will with such a provision, it would be wise to review it now so you don’t wind up accidentally disinheriting your spouse. Similarly, if you have a pre-nuptial or post-nuptial agreement with provisions tied to the federal estate tax (such as that one spouse must leave the other a fraction of his or her federal estate), then you might want to have that agreement reviewed as well.

Unmarried couples might want to make gifts to each other in 2011 and 2012.
In general, a person can make unlimited transfers to a spouse without being subject to gift or estate taxes. But the same is not true of unmarried couples; if one partner dies and leaves everything to the other partner, the federal estate tax will apply. So a wealthy partner might want to make transfers to a less wealthy partner before the end of 2012.

A few states allow gay couples to get married under state law, but these couples might want to consider making gifts as well, because they’re not considered “married” for purposes of the federal estate tax.

Many power of attorney documents allow an agent to make large gifts. This was often a good idea back when the estate tax exemption was much smaller, because it allowed the agent to use lifetime gifts to avoid taxes. But now that the exemption is $5 million, these gifts might not be as necessary, and you might want to reconsider allowing your agent to have this significant power, at least for now.

If you have a very large life insurance policy, this might be a good time to put it into a life insurance trust. These trusts can be very effective at saving taxes, but in the past many people with large-value policies couldn’t transfer them to a trust without incurring gift-tax problems. With the $5 million exemption, this might now be much less of an issue.

If you’ve set up a grantor trust in the past, you might want to review it. One benefit of a grantor trust is that the trust income can benefit your children or grandchildren, but you can pay the income taxes on it. This effectively reduces your estate tax, because the money for the income tax comes out of your eventual estate. But with the estate tax exemption at $5 million, saving estate taxes might not be such a priority, and you might want to reconsider paying the taxes yourself. For example, if a trust protector has the power to change the income tax treatment of the trust, you could ask that the treatment be changed for now.

A number of people recently converted a traditional IRA to a Roth IRA, and paid the resulting income tax upfront, in order to reduce their taxable estate. Again, with a $5 million exemption, this might not be such a priority, and you might consider undoing the conversion and saving the taxes. (However, before undoing a conversion, please keep in mind that the $5 million exemption only lasts for sure through 2012. After that, it’s slated to return to $1 million. Congress might well change that figure – but there’s no guarantee.)

The very wealthy might want to consider putting more than $5 million into a trust. They would immediately have to pay a 35% gift tax on any amount over $5 million. On the other hand, that might be preferable to keeping those assets and having them be subject to a possible 55% estate tax when they die.

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