Christmas is a long way off, but many of your clients should be planning big stocking stuffers in that spirit of giving that only tax law changes can motivate. Substantial gifts will be the optimal planning step for many clients.
Why should your clients be giving away assets now more than ever before? The generous $5 million gift- tax exemption that permits clients to shift large amounts of wealth is only on the books for two years. But there are several other great reasons that many clients should shift significant wealth now. There is also a progression of ways, from simple and inexpensive to more complex and costly, in which they can do so.
If this is truly a historic planning opportunity that may last for only a limited time period why are so few clients banging on your door asking for guidance? Misperception. Many clients have succumbed to the media sound bytes that suggest that if their estates are under $10 million they needn't plan. Others have focused on the unknowns of what will happen in 2013 with the estate tax and have opted to continue to procrastinate using uncertainty as their excuse.
Advisors need to better inform clients so that clients can use the uncertainty and perhaps temporary federal largesse to their advantage. President Obama has already proposed in his new budget reducing the estate-tax exemption to $3.5 million and other toughening of last year's estate-tax generosity.
WHY GIVE NOW?
Here's a few of the significant advantages that a large gift can bestow now:
* Taxing states. State estate tax remains a costly matter for many clients. Many states have decoupled from the federal estate-tax system and assessed a state estate tax on estates worth $1 million or less. In these states, a client who dies with an estate just under the federal filing threshold could be assessed more than $400,000 in state estate tax.
If a client gifts $5 million today ($10 million for a couple) and dies tomorrow, states could have nothing to tax on death. For older clients, giving today will translate into saving heirs tomorrow.
* Asset protection. Protecting wealth from claimants, divorce and other risks is a critical component of maximizing a client's overall wealth. Clients have pursued a range of asset protection tools but, until this year, most of the techniques have been constrained by one rather costly hurdle, the gift tax.
Assume that a physician client worried about asset protection titled her home as "tenants by the entirety" with her husband to gain a measure of asset protection under state law, and that her pension account was also protected under ERISA's anti-alienation provisions. But what can she do with her remaining $7 million of liquid assets? Options were severely limited because of the $1 million gift exemption. But now she could, subject to fraudulent conveyance and other issues, transfer up to $5 million in funds to a protective structure without a nickel in gift tax.
* Non-married partners. Tax law has always been biased against non-married partners, and some of that bias continues. The new portability rules that permit a surviving spouse to use the remaining unused estate-tax exemption of their deceased spouse applies only to married couples, not partners.
It is quite common for one partner to have more assets than the other and on death wish to transfer those assets to the surviving partner. The estate tax could wreak havoc with this objective because there is no marital deduction to shelter the transfer, even if they live as one economic unit (which was the theory behind the marital deduction). To further exacerbate the issue, state estate tax could take another pound of flesh.
In the past, complex trust and other leveraging techniques had to be used to address this issue. Now however, for many non-married partners, the $5 million gift exemption could be the ticket to equalize assets while both partners are alive. Perhaps better yet, the assets could be transferred into a trust to protect each partner, or to preserve assets if the relationship dissolves. More complex and less effective techniques won't be necessary if the asset base is under $5 million or so.
* Estate-tax savings. While no one knows what the future of the estate tax holds, a wait-and-see attitude may morph into a wait-and-pay result. If taxpayers can shift assets out of their estates now, using the newfound generous gift exemption, those assets can grow outside the reach of the estate- and gift-tax system.
Even better, if these assets are transferred now to a grantor trust, your clients will be in a better position if Congress rescinds some of its estate-tax generosity. With a grantor trust, the grantor is taxed on the income earned by the trust even though the assets of the trust are growing outside the grantor's estate.
This means your client could gift, for example, $2 million to a grantor trust, continue to pay tax on the earnings of the trust, yet the growth of the assets in the trust and outside his or her estate would essentially be tax-free. On the flip side, your client's continued payment of income taxes on trust earnings will burn assets in the client's otherwise taxable estate, thereby reducing future estate tax.
But there's more! If assets transferred are interests in a family limited partnership or closely held business, the valuation of the interests transferred may qualify for substantial discounts for lack of control or marketability.
These tax leveraging benefits are also on the tax chopping block under the Obama administration's budget proposals. So clients should try to lock in these discounts while they can. They may not be available after 2013 (or perhaps sooner if fiscal pressures reach a level sufficient to support a revenue raising bill).
HOW TO GIVE?
So your clients now see the light and are ready to plan aggressively. What options should they consider? To find the best answer, start simple and work your way up the complexity ladder.
* Just give it away. This is the estate planning corollary to "Just Do It." While it is simple and cheap, the drawbacks are obvious: no control, no protection for the heirs and the donor has to part with any rights or interests in the assets.
* Traditional trusts. Traditional trusts can provide protection if the donee divorces or is sued. They are a step forward, but your client may never see the funds again and can't exercise control.
* Grantor trusts. Grantor trusts are similar to traditional trusts, but as mentioned earlier, they allow your client to continue to pay income tax on the earnings inside the trust to maximize the leverage of reducing the client's estate.
* Self-settled trusts (in states that permit them). These trusts are estate planning dynamos. They are generally structured to provide the protections for heirs of a traditional trust and the tax benefits of the grantor trust, but with icing on top. The icing is that your client can give the assets away to the trust yet remain a discretionary beneficiary.
So an institutional trustee can in its discretion make distributions to your client of trust funds should the client need them in the future. In this way the client has given away the assets to reduce or eliminate state estate tax, protect the assets from claimants, provide protections for heirs and save future estate tax, yet they can still benefit.
Now is the time to act. Your clients can garner tremendous benefits from proactive planning today. These opportunities are already on the legislative chopping block, so the window may be short lived.
Martin M. Shenkman, CPA, MBA, PFS, JD, is an estate planner in Paramus, N.J. He is co-author of Estate Planning after the Tax Relief and Job Creation Act of 2010: Tools, Tips and Tactics, available at www.cpa2biz.com.