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Although it seems certain that the estate tax will be reinstated in 2011, it’s impossible to know whether the estate tax rate will be 55%, as it is currently scheduled, or if Congress will impose a different rate before next year. Many of our clients are making plans now to implement taxable gifts this year in an effort to avoid what may be much higher estate tax rates in 2011. In doing this, they will pay the 2010 applicable 35% gift tax now instead of paying what could be higher estate taxes later. As a result of the uncertainty, however, there are a variety of estate funding techniques being implemented in an attempt to avoid unnecessary taxes and we’d like to talk about the options with our clients.
While the gift tax rate is lower in 2010, some clients are waiting to make their gifts very late in the year, as late as December 26th or the 31st, due to concerns about the risk of dying unexpectedly in 2010. If they make a taxable gift now, and then die before Congress changes the laws, they will have paid a gift tax rate of 35% when their assets could have been passed through their estates in 2010 without being subject to estate taxes.
The risk in waiting until the end of the year is that Congress may enact a gift tax at a rate higher than 35% before clients are able to make their gifts. This has some clients considering making their taxable gifts now, but instead of gifting directly to family members, they are creating trusts for their family members who are beneficiaries. A trust has provisions that allow the beneficiaries to disclaim the gift, an act known as ‘reversing’ the gift, and sending that property back to the original owner as if the gift never occurred. This type of flexible technique gives the family the opportunity to decide later (reversing must be done within nine months of the gift) whether the gift will be implemented as planned or reversed later depending on the laws passed in Congress.
Making Plans Based on What We Know
When approaching the estate-tax conversation with our members, we hear many of them say they don’t want to make changes until they know for certain what the exemption will be for 2011. Since we do not know if the federal government is going to make changes to the current exemption for 2011, and we do know that it is scheduled to be $1 million, we are recommending that our clients plan according to those facts.
The most important factor is coming up with a plan based on a $1 million exemption and to implement that plan. If the exemption turns out to be higher in 2011, then we can make necessary adjustments to accommodate after that occurs.
The last thing we want to see is one of our clients with a $5 million net worth without an effective estate plan. If the exemption remains at $1 million in 2011 and a client dies on the first of January, their heirs will suffer a huge tax bill, potentially forcing the family members to liquidate assets at an inopportune and unfortunate time just to pay the taxes due.
Transfer Now at Lower Market Values
The uncertainty around the estate tax situation in Congress cannot be cause for individuals to halt progress on the implementation of their estate plans. Other factors make now an excellent time to transfer assets to the next generation through gifting or intra-family sales. Many commonly transferred assets, particularly real estate and businesses, are at suppressed values in the current market . Plus, the AFR rate – the rate charged on intra-family loans – is at historic lows. Gifting assets at these historically low values enables individuals to transfer or remove more assets out of their estates than would have been appropriate or cost-effective a few years ago.
Current advice includes transferring assets at the lowest values via intra-family sales in order to freeze the estate value. Because the asset, which is typically real estate or ownership in a business and could increase in value in the future, is replaced in the estate by an intra-family promissory note of a fixed amount, the asset’s value is stabilized.
Another important factor to take into consideration is the opportunity to transfer partial interest in an asset to take advantage of the discounts on the gift or sale, allowing even more value to be transferred. The discounts can range from 10% to 40% depending on the percentage of the asset being transferred.
So while the uncertainty around estate taxes is unclear, we do know that designing and implementing an effective estate plan is still necessary. In addition, we know that now is an excellent time for planned asset transfers to occur for some of our clients. Please give our investment representative a call and schedule an appointment to make or continue your estate planning efforts.