Congressional Inaction on Estate Tax Continues: Opportunities for 2010 Gifts

Update on Estate and GST Repeal; Opportunities for Gifts Before Year End

Last year we notified you of the one year repeal of the estate and generation skipping transfer (GST) tax in 2010. We anticipated that Congress might address this one year repeal in 2010, but Congress has yet to take action.

As Congress returns from the November elections, it remains unclear if it will take any action before year end. What is clear, however, is that if Congress takes no action -- so that the tax laws as currently enacted remain in effect -- there are unique opportunities to make gifts in 2010 that may not be available in future years.

The Benefit of Making Gifts in 2010

Although there is no estate or GST tax in 2010, gift taxes remain in effect. However, the 2010 gift tax rate of 35% is the lowest rate since 1934. Significantly, the gift tax rate in 2009 was 45% and the gift tax rate in 2011 will be 55% (unless Congress acts to change this). Also, the estate and GST tax rates and exemptions return to the higher levels of 2001: the top estate tax rate returns to 55% (even more for larger estates) and the estate tax exemption returns to $1,000,000 (compared to $3,500,000 in 2009).

As a result, making gifts in 2010 may make sense. A simple example illustrates this point. Assume that an individual, who has used up his or her lifetime gift tax exemption, wishes to make a $2,000,000 gift to someone other than his or her spouse or charity:

• If the gift is made in 2010: The gift tax, payable at a 35% rate, would be $700,000. Because gift taxes are payable by the person making the gift, the cost to the individual to get $2,000,000 to the beneficiaries is $2,700,000. Assuming that the individual survives three years from the date of the gift, none of the $700,000 gift tax payment will be subject to estate tax at the individual's death. If the gift appreciates in value after the date of the gift, all of the appreciation escapes estate taxation as well.
• If the gift is made in 2011: The gift tax, payable at a 55% rate, will be $1,100,000 -- $400,000 more than if the same gift were made in 2010.
• If no gift is made: When the individual dies, both of the following remain in the individual's estate, subject to estate tax (potentially at a 55% rate): (1) the $2,000,000 plus the amount of appreciation until death; and (2) the amount of the gift tax payment in these examples.

Gifts to Grandchildren

Even more dramatic savings can be achieved in 2010 if the intended beneficiary is a grandchild. This is because the GST tax -- which is a separate tax from the gift tax -- is also suspended in 2010. Unless the law changes, gifts to a grandchild made after 2010 (in excess of exemption amounts) will be subject to both gift and GST tax. In contrast, gifts to a grandchild (in excess of exemption amounts) made in 2010 will only trigger gift tax.

Often a grandchild may be too young to personally receive a large gift, or there may be another reason to not give a grandchild complete control over a gift. Instead, the gift is made to a trust for the grandchild. However, a 2010 gift to a trust for a grandchild presents special issues:

• Creating a new trust in 2010: The initial gift to a new trust for a grandchild will avoid GST tax if made in 2010. However, there is a risk that a distribution from the trust to a grandchild after 2010 will be subject to GST tax (the law is unclear at present).
• Existing trusts: A gift in 2010 to an existing trust for a grandchild (or a trust for both a child and grandchild) is also likely to present special issues and, under specified circumstances, may not be appropriate.

One alternative to using a trust is to make a gift of an interest in a limited partnership or limited liability company, as these can often prevent the grandchild from misusing the gift.

Finally, if there is an existing trust with a grandchild as a beneficiary, and the trust terms permit distribution to the grandchild, this may be a good time for the Trustee to consider making the distribution by year end. Such a distribution would not be subject to GST tax, whereas the same distribution after 2010 could be.

Conclusion

At this time, no one knows what the estate, gift and generation skipping transfer taxes will look like in the future. Congress may yet act by year end, making the gift tax strategies described above less attractive. On the other hand, if there is no change -- and if you have been considering making gifts to beneficiaries -- the remaining two months of 2010 may be the ideal time to act. We invite you to contact us to discuss these unique planning opportunities.