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Estate and Gift Tax Planning Ideas to Consider Before the End of 2010

Trusts & Estates Law Alert Amalia L. Todryk

2010 has been a year of uncertainty for estate planners. Many of us never thought that Congress would allow the federal estate tax to disappear on January 1st, but it did. Congress could act before the end of the year and re-enact the estate tax retroactive to January 1; however, as the year draws to a close, it becomes less likely this will occur. As the following table shows, there is one thing that appears to be certain today and that is that if Congress does nothing, the cost of transferring wealth will increase in 2011.

Calendar Year 2009 2010 2011 
Estate Tax Exemption  $3,500,000 N/A $1,000,000 
Highest Estate Tax Rate  45% 0%  55% 
GST Exemption  $3,500,000 N/A  $1,000,000 
GST Tax Rate  45% 0%  55% 
GST Tax Exemption  $1,000,000 $1,000,000  $1,000,000 
Highest Gift Tax Rate 45% 35% 55%
Gift Tax Annual Exclusion $13,000 $13,000 $13,000
State Death Tax Credit/Deduction Full Deduction N/A Full Credit
(i.e., many states will once again
have a state estate tax)

While times are uncertain, you can still take advantage of many planning opportunities before year-end to transfer wealth to your desired beneficiaries. A brief summary follows.

1. Consider Gifting Strategies.

With the federal gift tax rate at an historic low of 35%, you will want to consider making taxable gifts (either outright or in trust) before December 31 if you have already used your $1 million lifetime federal gift tax exemption. You may be reluctant to pay a gift tax; however, the maximum federal gift tax rate is scheduled to increase to 55% in 2011. In addition to the low rate, another advantage of making a taxable gift now is that any future growth in value of the gifted asset will be out of your estate, and the gift tax paid will also be out of your estate if you survive three years after making the gift.

Even if you are not interested in making a taxable gift, it remains important to make annual exclusion gifts before the end of the year. For 2010, the annual gift tax exclusion allows each donor to give up to $13,000 to an unlimited number of individuals without any federal gift tax. Because the exclusion applies per donor, spouses can give combined gifts up to $26,000 to a single individual. Having an annual exclusion gifting program in place is a great way to transfer wealth to the next generation with no transfer tax cost. It is likely that there will be an estate tax in the future, and each year you do not make annual exclusion gifts is an opportunity that is lost permanently.

Like the estate tax, the generation-skipping transfer ("GST") tax also does not apply this year. An example of a transfer that would be subject to the GST tax in other years is a gift (greater than the annual exclusion amount) from a grandparent to a grandchild. In 2011, the GST tax is scheduled to come back at a rate of 55%. Therefore, you still have a small window of opportunity to make gifts to grandchildren (and more remote generations) without having to deal with the GST tax.

2. Consider Transfers from Irrevocable Trusts.

If you or a family member is a beneficiary of an irrevocable trust that is not exempt from the GST tax, distributions from a non-exempt trust to beneficiaries who are two or more generations below the creator of the trust will be subject to the GST tax in 2011. However, the same distribution would not be subject to the GST tax
in 2010. An example is an irrevocable trust created by your parents for your benefit and the benefit of your children. Because the GST tax does not apply through December 31, the trustee of a non-GST exempt trust should consider making distributions before the year-end to beneficiaries who would otherwise be subject to the GST tax.

3. Consider Creating and Funding a GRAT.

A grantor retained annuity trust ("GRAT") is an irrevocable trust to which the grantor makes a single contribution of assets (cash, stock, business interests or the like) and retains the right to an income stream (i.e., annuity) from the trust for a set term of years. If the grantor survives the term, the assets remaining in the trust are distributed to the trust beneficiaries, often the grantor's children. If the grantor does not survive the term, all or a portion of the assets will be included in the grantor's estate.

If you contribute assets to a GRAT, the taxable gift is determined by subtracting the present value of the annuity interest, which you retain from the fair market value of the assets contributed. GRATs can be designed so that the value of the taxable gift made to the trust is minimal or even zero, and this is easier to achieve with today's low interest rates. If you survive the term of the GRAT and the trust assets have grown in value, the growth in value passes to your children (the remainder beneficiaries of the trust) free of gift tax. If the assets do not grow in value, there will be nothing to pass to the remainder beneficiaries; however, you will not have used a substantial portion, if any, of your $1 million lifetime federal gift tax exemption in trying to make the gift.

GRATs are often designed with shorter terms, such as two years, to increase the likelihood that the grantor will survive the term, and that the GRAT will be beneficial.

Many believe that Congress will take action before year-end (or in 2011) to reduce the effectiveness of GRATs. Congress might require that all GRATs have a minimum 10-year term, or will prohibit structuring a GRAT with a remainder interest (taxable gift) valued at zero. Either of these changes will make GRATs a less attractive gift planning device.

In the current low interest rate environment, with many assets depressed in value and the likelihood that Congress will curtail the future use of GRATs, now is the time to consider creating a GRAT to take advantage of this valuable estate planning vehicle before it is too late.

4. Consider Triggering Capital Gains Before Year-End.

If you are considering selling appreciated stock which you have held for a year, or other long-term capital gain property, you may want to do so before year-end in order to benefit from the current 15% capital gains rate. Under most of the tax proposals currently under consideration in Congress, capital gains tax rates will increase in 2011.

This alert is intended as a general summary of legal matters and not as specific advice to any particular client. If you have any questions concerning the subject matter of this update, please contact Amalia Levit Todryk at (414) 277-3041 / or your local Quarles & Brady attorney.