Uncertainty surrounding the estate and gift tax laws has created significant challenges for the estate-planning community. Reasonable minds may differ about the amount of the exemption and tax rates that should be adopted, but what’s most important is that Congress enact laws that will provide consistency and a set of well-defined and reliable rules. The estate-planning community has demonstrated its ability to respond creatively to take full advantage of the existing tax laws, whatever they may be, and will continue to do so with whatever laws are ultimately adopted—what the public and the practitioners really need, more than anything, is clarity and consistency.

Here are some of the planning ideas and considerations for the remainder of 2012 that I’ve been discussing with my clients. 

Gift Planning With Family Trusts

The $5.12 million gift tax exemption provides the unique opportunity for clients to make large tax-free gifts. However, not everything is driven by death and taxes, and some clients may, understandably, be hesitant to give away $5.12 million. For many clients, I’ve recommended making $5.12 million gifts into a family credit shelter trust for the benefit of the grantor’s spouse, lineal descendants and possibly charities, using the grantor’s generation-skipping transfer (GST) tax exemption to make the trusts GST tax-exempt. Thus, while the assets will be removed from the grantor’s estate, the spouse can have access to them at the discretion of an independent trustee.  
In addition, given President Obama’s proposal to effectively limit trusts’ GST tax-exempt status to 90 years, I’ve been structuring many gifting trusts as dynasty trusts in jurisdictions like Delaware or South Dakota, so that these trusts exist before the enactment of any proposed legislation.    

Loans to Family Trusts

For some clients with larger assets, I’ve implemented sales or loans into grantor trusts to take advantage of low interest rates. This freezes the value of assets in the grantor’s estate at the amount of the unpaid promissory note issued by the trust and shifts future growth into the GST tax-exempt trust. Over time, the leveraging opportunity and the obligation of the grantor to pay the income tax can be even more powerful than the $5.12 million exemption. Given the President’s recent proposal to dramatically alter the treatment of grantor trusts by causing them to be included in the grantor’s estate, clients have further motivation to take advantage of this opportunity while they can.

QPRTs With Large Residences

For clients who want to use the increased gift tax exemption, but who are uncomfortable parting with substantial liquid assets, I’ve been discussing qualified personal resident trusts (QPRTs). QPRTs may be useful in this situation because they provide an opportunity to absorb one’s gift tax exemption with a gift of a residence that might otherwise be too valuable with a lower gift tax exemption. For instance, if a 50-year-old client contributes a residence with a net value of $8 million into a 20-year QPRT in April 2012 (when the Internal Revenue Code Section 7520 rate is 1.4 percent), the resulting gift would be $4,841,280, which would absorb the client’s gift tax exemption. In contrast, if that same client wanted to gift that property into a QPRT with a $1 million gift tax exemption, he would need to select a term as long as 40 years (which would trigger a taxable gift of $905,440, assuming the same IRC Section 7520 rate applied) to make that same gift without triggering gift tax, but would have much greater risk of estate tax inclusion. 

Valuation Adjustment Concerns

While the increased gift tax exemption provides a great planning opportunity, it comes with increased gift tax risks associated with the possible revaluation of interests in hard-to-value assets. For instance, with a $1 million gift tax exemption, if a client gifted $1 million worth of interests in a closely held business, and that gift was subsequently increased by 10 percent to $1.1 million on audit, then gift tax would be owed on the $100,000 increase. If those same assumptions are made with respect to a $5.12 million exemption, the upside gift tax potential is increased fivefold. Thus, the increased exemption results in “higher stakes poker.” I’ve been asking clients with hard-to-value assets, what is less acceptable to them: having to pay gift tax out of pocket or possibly wasting some gift tax exemption? For clients who are more adverse to the risk of paying some gift tax, but nonetheless, want to make significant gifts, I’ve discussed making gifts of less than the $5.12 million exemption amount based upon the interest’s appraised value. In the event of an upward valuation adjustment on audit, there would still be some unused exemption to “absorb” some or all of the increase in value. Of course, if the value is accepted as reported, there’s the risk that some exemption will be wasted.  
I’ve advised clients who want to use their entire gift tax exemption, but also want to provide some protection against gift tax exposure, on the benefits of formula allocation clauses providing that the “pour-over” amount passes to a charitable beneficiary or, perhaps, a grantor retained annuity trust or marital trust (and the relative merits of these approaches). Of course, in the case of such pour-over planning, I’ve been careful to advise clients that if there’s a significant upward valuation, the pour-over vehicle may end up holding a significantly larger portion of the gifted assets than desired. With the very recent Wandry1 decision, however, there’s now favorable authority for making gifts of a fixed dollar amount of interests in an entity without the necessity for a charitable pour-over beneficiary.
At this point, not even Congress or the President has any way of predicting the future of the estate and gift tax laws, but we can still plan with the tools that we have. I believe that those clients who opt not to take advantage of this limited and unprecedented opportunity will regret that decision in hindsight. Of course, the larger exemption and gifting opportunity comes with some unique issues that need to be carefully considered.


1. Wandry v. Commissioner, T.C. Memo. 2012-88.