It’s clear to me that no changes will be made to federal transfer tax laws this year. As we’re all aware, the 112th Congress agrees on very little. It seems inconceivable that, in the period preceding the November elections, Congress and President Obama will concur on transfer tax legislation. The House of Representatives won’t approve a bill that would increase rates and/or decrease applicable exclusion amounts. Sixty Senators and the President won’t agree to retain the current 35 percent rate and $5.12 million applicable exclusion amount and generation-skipping transfer (GST) tax exemption or repeal the estate tax system altogether. No one inside the Beltway will blink before the end of the year, because each side of the political spectrum believes it has a chance to have significantly greater influence on legislation after the November elections. This sad state of affairs will persist at least until January 2013, and, depending on the results of the November elections, could continue indefinitely thereafter. In the meantime, gridlock will continue to reign supreme.
Clients should consider making sizable gifts, but may wish to defer close to year-end
I believe we will emerge on Jan. 1, 2013 with a $1 million exemption for estate, gift and GST tax purposes (the GST exemption being indexed for inflation), a 55 percent maximum transfer tax rate (along with a 5 percent surtax on estates valued between $10 million and $17.184 million) and frustrating uncertainty regarding how the Internal Revenue Service and the courts will handle clawback and apply the sunset provision of the 2001 Tax Act.1
No one can reliably predict who will prevail in the upcoming elections. Many developments can occur between now and Nov. 6 (for example, in worldwide political and military activities, the economy, the price of gasoline, unemployment and the Supreme Court’s decision on universal health care), which could have a massive impact on the election’s outcome. Accordingly, it’s impossible to know how transfer tax laws will evolve in 2013. There are many possibilities. At one end of the spectrum, we could see wholesale repeal of the estate, gift and GST tax regime. At the other end, the $1 million estate, gift and GST tax exemption, along with the 55 percent marginal rate, could be left in place. As an example between those two poles, we could see reinstated the transfer tax laws as they exist today (that is, a $5.12 million applicable exclusion amount and GST exemption, 35 percent rate and portability of unused estate tax applicable exemption amount between spouses). Alternatively, Congress and President Obama, if he’s reelected, could enact the transfer tax elements contained in the Administration’s Budget Proposal set forth in the General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals (also known as the Green Book) released in February. We would then have a $3.5 million estate tax applicable exclusion and GST exemption amount, a $1 million gift tax applicable exclusion amount, a 45 percent top tax rate and portability of unused estate tax applicable exemption amount between spouses. If any changes in the transfer tax laws are enacted after Jan. 1, those changes may or may not be made retroactive to Jan. 1.
I’m advising most of my estate-planning clients seriously to consider making inter vivos gifts in trust2 before year-end to the extent necessary to use their gift tax applicable exclusion amounts and GST exemptions. From a tax perspective, there’s no disadvantage in making such gifts. It’s true that, in the unlikely event all transfer taxes are repealed, the donor’s control over assets placed in trust will have been unnecessarily relinquished, but no tax will have been unnecessarily paid. If the transfer tax laws as they exist today are extended indefinitely, making such inter vivos gifts in trust may or may not turn out to have been unnecessary. If the value of the gifted assets grows inside the trust, the post-transfer appreciation in the value of, and net income generated by, such assets, which could have been subject to estate tax in the donor’s estate, will pass free of estate tax at the donor’s death. If the estate tax exemption amount declines after Dec. 31 and a higher exemption amount hasn’t been reinstated by the time of the donor’s death, an amount equal to the difference between what was transferred in trust (along with all post-transfer investment return on the trust assets) and the exemption amount at the date of the donor’s death will have been extricated from the transfer tax system (unless clawback applies, in which case the donor will have had the interest-free use of gift tax on the amount transferred from the date the gift tax return was due to the date the estate tax return is due).
Even a client who believes he can’t afford to part with the amount necessary fully to use his 2012 gift tax applicable exclusion amount and GST exemption, should perhaps consider making such a gift in trust. The client could designate a third-party trustee and retain the potential to receive distributions in the trustee’s sole and absolute discretion. A trust designed in this fashion would allow the client to “have his cake and eat it too.” The trust property would be available to the client if he needed it, and its value would be excluded from his taxable estate at death. As an added bonus, depending on the state in which the trust is established and other factors, the trust property may be shielded from the settlor’s creditors’ claims.
Finally, it’s understandable that some clients won’t want to rush into making a large transfer to an irrevocable trust. It’s not imperative that such a transfer be made long before the end of the year. By deferring pulling the trigger until close to year-end, a client and his advisors may take into account whatever tax and economic circumstances may exist at the moment when a decision must be made.
1. Section 901 of the Economic Growth and Tax Relief Reconciliation Act (P.L. 107-16).
2. To be precise, in a multi-generational trust that’s a grantor trust for income tax purposes. See Charles A. Redd, “The Perfect Storm,” Trusts & Estates (January 2012) at p. 9.