(Also a basic discussion regarding gifting and estate tax laws)
As a person ages, it is inevitable that one contemplates the consequences of death. Some contemplate more than others. For someone with any amount of wealth, the consequences merit thought and planning. When someone dies without this thought and planning, the assets are split under state law (intestate) using some basic principles that some ancient legislator devised. These have formulas and protocols for people with and without spouses and children.
There are three obvious reasons for the planning:
- Ensure you are provided a comfortable living during your lifetime.
- Basic good sense in providing for an orderly and efficient transfer, in the manner you best intend.
- Reduction of gift and estate taxes.
Our firm works with people in developing the plans. We do not prepare wills or trusts, nor work in the probate courts. However, we do often have a good understanding of your financial affairs and understand the tax laws. Thus, we can work with your attorneys in the process.
In developing the plan, the first point (basic good sense) can involve gifts during your life and your spouse’s life and gifts at death. With the way the economy has performed recently, many people simply worry that that they will have enough to carry them through the duration of their lives and choose not to gift much. But there is reason to reconsider a bit.
People with wealth worry about estate taxes, sometimes called death taxes. There has been mayhem in the gift and estate tax area of recent history. As it stands now, our federal statutes allow a unified $5 million lifetime exclusion to individuals from lifetime gifts and estate taxes; this is boosted to $10 million for married couples. The exclusion includes lifetime gifts made in excess of stipulated amounts ($13,000 per person, $26,000 per married couple in 2011). However, this exclusion changes dramatically in the near future.
In an unprecedented “horse trade” in late 2010, in which President Obama swapped health care reform forever for tax cuts for two years, the Republicans only bargained out a two year increase (to $5 million per person) from the previous statute’s $1 million per person exemption ($2 million per married couple).
So, only in 2011 and 2012, under federal gift and estate tax law, you can exclude $5 million per person or $10 million from a married person’s estate. On January 1, 2013, you can only exclude $1 million per person or $2 million for a married couple from estate tax. Federal estate taxes are assessed at a maximum of 35% under the current law and up to 55% in the 2013 reversion.
I should note here that the states’ gift and estate tax statutes do not necessarily mirror the federal tax statutes. For example,Minnesotahas retained a $1 million exemption throughout the federal mayhem.
One little quirk in Minnesota law is that that Minnesota does not tax gifts; Minnesota only potentially taxes your heirs when you die. Thus, it makes sense to gift sometimes, versus die with the money in Minnesota, just to save Minnesota estate tax.
If you are a married couple with somewhere in between $2 million and $10 million, or think that your assets might be that much at death, what do you do? Spending it is an option. Doing nothing is always an option, but can be the most costly for your heirs in the long run.
My crystal ball has been a bit cloudy lately and I am having difficulty seeing through the primary and general elections in 2012 to predict a subsequent tax bill. Most estate planners are having similar difficulty. Some (mostly Republicans) are saying the estate tax should be eliminated; others (mostly Democrats) are quietly thinking the reversion may not be so bad. Moderates in each party might contemplate a “happy medium”, like a $3 million unified exemption, might occur, but there is not much “happy medium” talk lately inWashington.
I have some clients at that time in age when they are somewhat satisfied they have enough, but aren’t sure. They wish to use their $5 million exemption, but are reluctant to give the assets away. Can you give the assets away to utilize the exemption, but recoup them if you need them? That is always the question. What can be done?
There are a few people that are quietly gifting some money away, to their children and or grandchildren. There might be an implied agreement that the money will be invested, not spent. But mom and dad can retain no ownership and there can be no binding legal agreement to get it back. There is usually a non-documented thought process that might infer that if there is an unforeseen issue for mom or dad, the kids will gift back to mom or dad, if necessary. That concept takes a lot of trust.
At a certain time in one’s life, one’s children are what they are, at say age 50 or 60. Some can handle gifts prudently; some not. It is not unusual that one must treat children differently, even as adults. What this means is that some might get gifts paid to them directly; some might have the funds put in trust or paid to them in small increments. These are hard decisions.
The creation of a trust for your children or grandchildren that will hold the gifted assets until mom and dad’s death, or some term certain might give mom and dad some comfort that all or some of their money will not be wasted during their lifetime. But mom and dad can retain no ownership and there can be no binding legal agreement to get it back. The gifts can, however, be held and invested. There might still be some implied agreement like that referred earlier.
One of my clients has suggested a small twist on this. It is called a reverse Grantor Retained Annuity Trust “reverse GRAT”. This is a bit fancy, but it simply involves mom and dad putting some amount in trust (with some potential intermediate steps) and retaining an annuity from the trust, which is clearly defined. There are some uncertain tax issues with this arrangement, although some are very clear. You might look at this link to a relevant article by Deborah Dunn.
There are several ways to put different creative twists into this sort of planning. My gut feeling on this is that the $5 million amounts will be reduced, but my crystal ball isn’t sure. If you are considering a gift, and particularly, if you are one of those that feels estate and gift taxes are only going to get higher, please feel free to discuss with us or your attorney. First make sure you remember the obvious reasons for planning I mentioned above.
Signing off,
Joel
