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With major changes to estate and gift tax rules on the horizon in 2013, affluent investors should consider taking action now to plan a financial legacy. Laws affecting estates and gifts are among many federal tax provisions set to expire at the end of this year. Without congressional action, 2013 may usher in a variety of new tax rates and exemption levels. As a result, right now may be the best time for individuals to take advantage of gifting strategies with the potential to maximize their legacy. An effective plan for transferring wealth among family members and heirs typically involves some form of gifting. Many think of gifting as something that is only triggered by death. But there are also strategies that allow individuals to pass along wealth during their lifetime through gifting.
limit will affect the calculation of the donor’s estate tax. Certain transfers are not considered gifts: •Direct tuition or medical payments •Transfers between spouses •Annual transfers that do not exceed the maximum allowed For those wishing to make gifts toward higher education and contribute to a 529 savings plan, there are additional tax advantages. A donor may make five years’ worth of gifts at a maximum of $13,000 per year, for a total of $65,000. As long as the transfers per recipient do not exceed the $13,000 annual exclusion amount (or $26,000 for spousal gifts), the total amount is not affected by taxes.
Rules about lifetime gifts
Individuals are allowed to make lifetime gifts up to a specific exemption amount without being subject to gift taxes. The current exemption amount is $5,120,000. Lifetime gifts are referred to as taxable gifts even though no taxes are due unless the lifetime exemption amount is exceeded. The donor is required to file a federal gift tax return (IRS Form 709). If the lifetime gift exceeds the exclusion amount, a graduated tax rate is applied beginning at 18% and eventually reaching a maximum of 35%. These rates are in effect for 2012. When someone dies, lifetime gifts are considered when determining whether federal estate tax applies to an estate. The amount you gift during your lifetime can reduce how much you can leave to heirs at death without being subject to estate tax. For example, if an individual made lifetime gifts of $2 million, in excess of the annual exclusion amount of $13,000, his or her estate tax exemption amount would be reduced by that same amount.
What is gifting?
The Internal Revenue Service (IRS) defines a gift as the transfer of property — any type of asset — while receiving nothing or something less than full value in return. Gifting may be used for many reasons such as providing financial assistance to family members or others, reducing the value of an estate before death, or shifting income from one taxpayer to another.
Understanding the federal gift tax
The IRS imposes a tax on gifts and limits the amount of assets that can be transferred between individuals without being subject to the tax. The maximum annual exclusion amount is currently $13,000 per donor per year, or $26,000 per couple. If the gift exceeds the annual exemption, the amount is applied to the donor’s lifetime gift limit. Ultimately, the amount applied to the lifetime
KEY GIFTING FIGURES FOR 2012 AND BEYOND
Current low asset valuations also prompt action
The fact that many asset values, such as real estate or ownership shares in a business, may be low right now provides an opportunity to transfer wealth to other family members before values appreciate. It may be an opportune time for donors to gift low-cost-basis assets that have the potential for appreciation.
BENEFIT OF GIFTING ASSETS THAT ARE LIKELY TO APPRECIATE OVER TIME.
2012: lifetime exemption amount 2013 and beyond:* lifetime exemption amount
$5,120,000 (maximum tax rate is 35%) $1,000,000 (maximum tax rate is 55%)
* Assumes expiration of Bush-era tax cuts after 2012 and no subsequent legislation.
Gifting strategies may skip a generation
Individuals may gift assets to younger generations, such as grandchildren, through a process known as generation-skipping transfers. The IRS imposes a separate tax on gifts that skip a generation and are gifted to grandchildren or, by law, someone who is at least 37.5 years younger than the donor. The most recent version of this tax was enacted in 1986 to prevent wealthy families from trying to avoid federal estate taxes when leaving assets to the next generation. By skipping a generation, these assets would not be subject to the potential estate tax burden that would ordinarily apply to the children. For 2012, the federal Generation Skipping Transfer (GST) tax exemption amount is $5.12 million. That level is scheduled to decrease to approximately $1 million in 2013. The new exemption amount will be set with an inflation adjustment, which has yet to be announced. The maximum GST tax rate for 2012 is 35% and is scheduled to rise to 55% in 2013. The 2012 exemption amount is at a historical high, presenting an opportunity for individuals to consider strategies that benefit younger heirs, such as grandchildren. One such strategy is the establishment of a dynasty or generation-skipping trust to transfer wealth to future generations. Assets held in these trusts are not subject to future estate taxes as long as they remain in the trust. These trusts can be funded with a combination of lifetime transfers, which may allow the donor to use the $5.12 million lifetime exemption amount for 2012. For those considering this strategy, it is particularly important to work with an attorney who is knowledgeable about specific state laws. Some states impose certain restrictions on these trusts, also known as a rule against perpetuities, which generally limit how long the trust can exist.
$3,660,000 in appreciation of gift is out of the estate, resulting in a tax savings of more than $1,200,000! †
$4,660,000 (value of gift after 20 years)*
1Assumes 8% annual growth rate. 2Based on a maximum estate tax rate of 35%.
For example, consider a current $1 million gift that has an 8% annual growth in the value of the asset over 20 years. The asset would increase to $4.66 million, an appreciation of more than $3.5 million on the original gift. Assuming a taxable estate liable to a maximum rate of 35%, the estate tax savings from removing future appreciation of more than $3.5 million from the estate by previous gifting would be more than $1.2 million. Given the current exemption level and tax rates, donors may also benefit from certain advanced planning strategies. These include valuation discounts using Family Limited Partnerships or certain trust strategies such as dynasty trusts or grantor trusts. Of course, while these strategies remain available today, there is a risk that legislative action may eliminate or restrict them in the future.
Risks of a future lower gift tax exemption
The current exemption amount of $5.12 million is the highest on record and is slated to decrease to $1 million in 2013. Planning around the current level is not without risk. It is possible a “clawback” provision might apply in the future. If so, there may be an adjustment made at death if the prevailing gift tax exemption amount was lower at death compared with the value when the gift was completed.
For example, consider a gift of $5 million executed when the gift tax exemption is $5 million. If the gift and estate tax exemption was only $1 million at death, the difference in the two amounts would be “clawed back” into the decedent’s estate. While this type of “claw back” provision is a risk, it does not mean that it will likely be implemented in the future.
Another planning opportunity for 2012: making charitable gifts
Charitably inclined investors should not assume the level of tax benefits afforded to charitable gifts today will exist in the future. For example, in 2012 there are no income phaseouts on itemized tax deductions for taxpayers in higher brackets. This generally means that taxpayers will receive the full benefit of itemized deductions — such as charitable gifts and mortgage interest — regardless
of their income.* Income phaseouts on these types of deductions are scheduled to return in 2013. Additionally, there have been recent legislative proposals that would further limit the tax benefits of making charitable gifts. One example is to reduce the tax benefits for those in the highest brackets (currently taxpayers in the 33% and 35% brackets), meaning a charitable contribution deduction would be limited to not more than 28% of the amount of the contribution for those taxpayers. In an environment where the federal budget deficit is being heavily scrutinized, reducing these types of tax benefits is being seriously considered. As a result, investors may wish to accelerate charitable gifts into 2012 after consulting with their tax and legal advisors.
1Certain restrictions may apply if taxpayer is subject to the alternative minimum tax (AMT).
Choosing to gift during lifetime
Assets may be transferred during an individual’s lifetime as well as upon death. The following table outlines several considerations for making gifts while living.
CASE FOR GIFTING WHILE LIVING CASE AGAINST GIFTING WHILE LIVING
• Help heirs while you are still living. • Reduce estate assets now to avoid or minimize estate
taxes in the future.
• Donors lack control over the assets after the gift
has been completed, although trusts can help donors maintain some level of control over gifted assets.
» The gift plus its future appreciation is removed from
the estate of the donor.
• Loss of assets. There is the possibility that there will
be a future need for assets previously gifted to meet significant costs such as medical expenses, surviving spouse income needs, or helping settle future estaterelated costs.
• Minimize income taxes now. The gifting of incomeproducing assets can shift the tax burden to family members in lower tax brackets.
• Loss of step-up in cost basis on appreciated assets
at death. With gifting, the recipient typically assumes the original cost basis while heirs receiving assets at death generally assume date-of-death cost basis on inherited assets.
• Ability to use certain valuation discounts in transferring
family-owned businesses and farms.
» For example, gifts of closely held businesses may be
eligible for significant discounts in value, up to 30% in some cases, due to the fact that these ownership shares are not readily transferable in the open market. This is considered a “lack of marketability” discount. Also, these gifts may have limited rights attached, which would trigger a “lack of control” discount.
• Potential for asset value(s) to decline after a gift
has been made.
• Potential that federal estate tax may be repealed
in the future.
» This scenario may be unlikely due to the need
• Certain states tax estates but not gifts. Lifetime gifts
may help minimize certain state-imposed estate taxes.
for additional revenue to combat rising federal budget deficits.
• Asset protection. Gifting can shift assets to family
members with less creditor risk.
Numerous strategies focus on wealth transfer
Gifting may be a useful strategy for donors and is often used as a component to legacy planning. In addition to the strategies outlined, there may be other effective techniques of transferring wealth that may offer additional benefits. For example, individuals may consider intra-family loans or certain grantor-retained annuity trusts (GRATs) that will not result in a completed gift. Individuals considering advanced planning strategies, particularly around legacy and gifting, should work with a qualified estate planning attorney with knowledge of their specific situation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions.
Putnam Retail Management
Putnam Investments | One Post Office Square | Boston, MA 02109 | putnam.com
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