New Federal Transfer Tax Laws – Estate Planning Opportunities and Pitfalls

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Act”) was signed into law in December of 2010, and its provisions are set to expire at the end of 2012.  The Act impacts many common estate planning techniques and presents opportunities to transfer wealth to younger generations at substantial tax savings.  Although a full description of these opportunities and techniques is beyond the scope of this newsletter, this article will briefly outline a few of the legal changes, problems, and strategies that individuals should be considering at this time.

Gifting Opportunity

The Act gives individuals a $5 million exemption from federal estate, gift, and generation-skipping transfer (“GST”) taxes through the end of 2012, and it sets the maximum estate and gift tax rate at 35% for that time period.  This means that a married couple can potentially gift up to $10 million to their descendants free of any federal transfer taxes this year.  The Act is set to expire at the end of 2012, and if Congress fails to act before that time, the transfer tax laws in 2013 will revert to pre-2001 levels (with a $1 million estate and gift tax exemption and a maximum tax rate of 55%).  The temporary increase in these exemption amounts creates an unprecedented window of opportunity to transfer wealth to younger generations and move assets out of one’s taxable estate in 2012.

Leveraging the Transfer of Assets

The time-sensitive opportunity for making lifetime gifts noted above is enhanced by the currently low interest rate environment, coupled with depressed asset valuations due to present economic conditions.  By making transfers at this time, individuals can utilize current transfer tax laws, which may permit discounting the value of closely-held entity interests for transfer tax purposes to take into account the fact that they are not controlling interests and are not readily marketable.  If a client intends to use valuation discounts as part of his or her gifting strategy, this may increase the attractiveness of transferring assets in 2012, since all indications point to continued governmental attacks and restrictions on valuation discounts in the family context in the future.

Another reason for making a current transfer would be to “freeze” the value of the transferred interest for transfer tax purposes as of the date of the gift.  Doing so before the economy improves (and the value of the interest increases) would remove any future appreciation from one’s taxable estate for estate tax purposes.  Although a detailed description of the various estate “freeze” techniques is beyond the scope of this article, a few of the strategies that you might consider discussing with your estate planning attorney are transfers to Grantor Retained Annuity Trusts (GRATs), the use of Family Limited Partnerships (FLPs), and sales to Intentionally Defective Grantor Trusts (IDGTs).

Need to Revisit Estate Plans

Formulas are often used in estate planning documents to maximize the use of the federal estate and GST tax exemption amounts available to an estate.  During 2012, such a formula may cause up to $5 million of assets to fund a trust or bequest that was originally intended to be limited to a much smaller exemption amount from a prior year.  A good example of this problem is the common use of formulas to divide an estate between a marital trust for a surviving spouse and a credit shelter trust for descendants.  The credit shelter trust typically receives the decedent’s remaining estate tax exemption amount, and the balance passes to the marital trust.  If an individual with an estate of around $5 million created her estate plan at a time when the exemption was $2 million, this plan made perfect sense, as the marital trust for the surviving spouse would receive the $3 million balance of the estate.  However, the effect of the new Act would be to cause the entire $5 million estate to pass to the credit shelter trust.  From a federal estate tax standpoint, this may be ideal because the assets in the credit shelter trust will be free from federal estate tax in both the estate of the decedent and in the estate of her surviving spouse.  However, if the credit shelter trust does not provide sufficiently for the surviving spouse’s benefit during his remaining lifetime, then the surviving spouse may be unintentionally disinherited.

I typically recommend that my clients review their estate plans regularly to determine if the plan needs updating due to changes in family circumstances, goals, tax laws, or otherwise.  The new Act provides many opportunities and potential pitfalls and could alter the ultimate distribution of many existing estate plans.  Please let me know if I can assist you in updating your estate plan or implementing any of these estate planning strategies.

If you have any questions or if you would like additional information regarding this article, please contact Gant McCloud at or (941) 364-2402.

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