To gift or not to gift?

I have been hearing a lot about the expiration of the “Bush tax cuts” and changes in the estate and gift tax laws, and how people should be making substantial gifts this year. What does this mean? Is this true

Many clients have heard in the media that the window to make tax-free gifts is closing, and that they should be gifting all their assets. Unfortunately, those articles and reports do not effectively explain what the changes will be and how they will impact you.

Currently, an individual may transfer $5.12 million during his lifetime or at death without incurring any federal transfer tax. The tax rate on transfers above the exemption amount is at an historic low of 35 percent. A married couple can transfer a combined $10.24 million because of a newly introduced concept of “portability,” allowing a surviving spouse to “carry over” the unused exemption of a dead spouse. This high exemption amount expires on Dec. 31, 2012, when the federal exemption drops to $1 million at a 55 percent tax rate.

This presents a unique opportunity to transfer a large amount of assets free of transfer taxes, the current low interest rates, and the current depressed asset values, but gifting is not right for everyone. Many clients do not have an objective of shielding their children’s inheritance from estate taxes, feeling that they should be content with the net result of their hard-earned wealth. For family business owners, it could be a unique opportunity to implement business succession planning at valuation discounts.

Considering whether to gift depends on many factors, including: the nature and extent of the client’s assets, the cost basis at which he required those assets, whether he is ready to give up control, the family dynamic, and the personalities of the children or other individuals whom he would entrust with his assets. The assessment should address whether a gift makes sense, which assets should be gifted, whether conditions should be placed on transfer of assets, whether a trust should be used to hold the gifted assets, and the terms and structure of that trust.

Some of these issues are contemplated in greater detail:

• Will the estate tax exemption be lowered? This depends, in part, on politics. President Obama has proposed a $3.5 million estate tax exemption at a rate of 45 percent, with a lifetime gift tax exemption of $1 million. If he wins in November, he will still need to convince Congress to enact his proposal. If the Republicans take control of Congress, they will either insist on keeping the exemption at $5 million at a 35 percent rate, or compromise with President Obama.

• Are you ready to give up control? In general, enjoying estate tax savings techniques requires that the donor give up some control over assets. Giving a substantial portion of your wealth to another individual leaves you without any legal guarantee that he will use the money to pay for your care, or return the money at your request. Not everyone is ready to put himself at someone else’s mercy.

If, having contemplated the benefits and drawbacks, you or a client decide to make substantial gifts, some strategies include:

• Outright gifts. This is appropriate only in certain situations, as it is not always appropriate to give significant gifts to minor children or grandchildren without putting asset protection in place against potential creditors or future ex-spouses. There may also be generation-skipping tax consequences to making outright gifts to a younger generation. Keep in mind that anyone can gift $13,000 per year to any individual ($26,000 from a married couple) and can pay unlimited medical and educational expenses. Annual exclusion gifts remain an effective way to decrease your estate without using up any of your lifetime exemption, wherever it winds up. As noted above, New York State does not impose a transfer tax, but has a very low estate tax exemption of $1 million. Thus, making annual exclusion gifts can help to reduce the size of your taxable estate.

• A living trust can be drafted for the benefit of intended beneficiaries or a class of beneficiaries (i.e., descendants, grandchildren, nieces and nephews, etc.). The trust terms can be tailored to dictate when and how specific distributions can be made, and can be structured as “Grantor Trusts” for income tax purposes so that any trust income is picked up on the grantor’s individual return. Devising a trust and the appropriate trust terms requires time, attention, and careful planning.

Deciding whether to take advantage of estate planning techniques requires an individual assessment of your own situation. Before undertaking a drastic restructuring of your assets, you should fully understand the mechanisms and consequences of doing so, and feel comfortable with the transfers and structures you are implementing.

It is essential that you consult with your accountant, tax planner, financial advisor, and attorney before undertaking any change in your estate plan.

Alison Arden Besunder assists new and not-so-new parents with their estate-planning needs. Her firm assists clients in Manhattan, Brooklyn, Queens, Nassau, and Suffolk Counties. You can find her on Twitter @estatetrustplan and on the web at www.besunderlaw.com.