Taxes that are largely a concern of the very rich will soon affect far more people unless Congress steps in.
The impending drastic changes in the estate and gift tax laws are prompting a flurry of activity as 2013 draws near. Family members are making financial gifts, creating trusts and considering other tax-minded moves.
Financial advisers and trust and estate attorneys have been flooded with requests for assistance in the final months before the record-high exemption for both taxes is scheduled to plunge to $1 million from $5.12 million on Jan. 1.
If unaltered, the value of any estate in excess of $1 million will be subject to the estate tax, at a top rate of 55 percent next year, before passing to family or other heirs. Currently the top rate is 35 percent, starting at a level more than five times higher.
“There’s been a little bit of a frenzy all of a sudden,” says Janis Cowhey McDonagh, a principal with New York accounting firm Marcum LLP. “People are saying ‘Wait a minute, this is really going away. I need to do something before the end of the year.’ ”
The concern may not stir sympathy among most middle-class Americans, but it’s a pressing issue for many in costly locations where it’s not unusual for household assets to surpass the million-dollar mark.
The new rates would affect roughly 55,000 estates next year, according to Congress’ Joint Committee on Taxation, compared with fewer than 4,000 under current rates.
“If you live in a major city and you have a home and a vacation home, you can easily have more than $1 million in assets without being what’s thought of as ‘filthy rich,’ ” says Martin Shenkman, an estate planning attorney in Paramus, N.J.
An example cited by Fidelity Investments underscores the impact of the potential change. A single person or married couple with an estate of $3 million could face a $945,000 federal estate tax bill next year. Under current law, that bill is zero.
Heightening the 11th-hour tax commotion are the near-identical drops in the lifetime gift tax exemption and the generation-skipping transfer tax. The latter is imposed on grandchildren or others who are 371/2 years younger than you.
Wealthy families who are set up to pass along millions to their children and grandchildren are scrambling to give away or otherwise set aside huge chunks of their assets in the next two months. The aim is to lessen their future estate tax liability and spare their heirs much larger bills.
Both the gift and estate tax rates could be revised further after the November elections. President Barack Obama prefers an estate-tax exemption of $3.5 million and a top rate of 45 percent. Republican challenger Mitt Romney wants to eliminate the estate tax but retain the gift tax as is.
But congressional action would still be needed to enact any changes, which is why taxpayers with million-dollar estates are scurrying to make changes now.
Here are some of the key strategic moves that can be made, with the assistance of attorneys and advisers, to gain a tax advantage before the laws change:
Give away cash
For the time being, taxpayers can gift as much as $5.12 million during their lifetimes without paying taxes. That total is above and beyond the $13,000 annual gift-tax exemption that many taxpayers are aware of. That exclusion allows you to make an unlimited number of gifts of up to $13,000 each year without incurring any taxes.
But gifts much larger than that will be needed between now and year-end to make a difference in estate and tax planning.
At the extreme wealthy end, McDonagh says one couple she’s advising wrote separate checks for $5 million to their adult children recently. It’s money the children would have inherited anyway, and now will be tax-free.
People who aren’t quite so affluent can benefit from smaller but still substantial gifts. Many parents make large loans to their children to buy a home or for some other purpose. Calling it a simple cash gift, or forgiving a previous loan, can shrink the estate tax bill.
Put it in a trust
A fear of giving away too much and ending up short-handed later in future years has caused “gifting paralysis” among many well-off people who could benefit, says estate planning attorney Todd Angkatavanich, a partner at Withers Bergman LLP in New Haven, Conn. That procrastination has turned into a late-year rush to action.
Those who are still reluctant to make outright gifts to beneficiaries may wish to consider transferring assets into trusts, which can give the donor more of a say in how they are distributed. A trust is an arrangement in which an individual turns over property or assets to a trustee to hold for beneficiaries, generally with tax savings in mind.
Among the many, often-complex options: An irrevocable trust can benefit children and grandchildren. One type, a grantor retained annuity trust or GRAT, provides for annual payments to the donor for a fixed period of time before the assets go to the beneficiary as a tax-free gift.
A spousal lifetime access trust sets assets aside for a surviving spouse that can still be accessed if needed, with limitations. And a self-settled trust makes the person who created it the beneficiary, but the money is controlled by an independent trustee.
“Locking up some money in a trust is a great asset protection tool,” says Shenkman.
Give away a home
A real estate investor in her 50s, another of McDonagh’s clients, gave her Manhattan apartment outright to her daughter and now rents it back. A good pension, solid income and relatively low valuation of $400,000 gave her client the confidence to make the move in order to save on future estate and gift taxes, McDonagh says.
Giving a primary residence or vacation home to a child often is done through a qualified personal residence trust, or QPERT. The trust is irrevocable but specifies that you can maintain use of the property for a certain number of years. The property is then valued at a discount because heirs don’t get immediate use.
Retaining the right to live in the house makes it a “have-your-cake-and-eat-it-too” scenario for those who have expensive homes but are concerned about leaving themselves with too few resources, says Jim Cody, director of estate and trust services for investment advisory firm Harris myCFO in Palo Alto, Calif.
A wild card to consider in the year-end tax scramble: State laws on estate taxes differ from federal ones. Twenty-two states have either an estate tax, an inheritance tax, or both. It’s another reason why anyone trying to take advantage of current federal laws should seek help from an expert.
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