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Financial Planning > Tax Planning

The Benefit of Transferring Wealth by Year-End

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With U.S. gift- and estate-tax rates slated to rise on Jan. 1, it may be wise to gift assets before year-end.

No one is sure what President Obama and Congress will do about transfer taxes, but if they don’t act, transfer taxes will automatically revert to 2001 levels at the end of this year, raising the maximum rate from 35% to 55% and decreasing the lifetime exclusion for an individual from $5.12 million to $1 million.

A couple that hasn’t previously used any exclusion could potentially act together to transfer $10.24 million (twice the maximum $5.12 million exclusion) to a trust without incurring any gift tax.

You first need to determine whether you have achieved your core capital—the money you’ll need to cover living expenses, adjusted for inflation, for as long as you may live. Once you know the amount of your core wealth, you also know how much “excess capital” you may have.

A Valuable Opportunity

The real value of making a large gift now does not come, as many people assume, from simply getting $5.12 million (or $10.24 million for a couple) out of your estate. As the display above suggests, the most basic benefit comes from getting the future growth of the wealth out of your estate. Note that the chart is not showing the expected growth of the gifted assets (which in typical markets would be much larger than $5 million after 40 years), but instead the expected benefit of avoiding estate tax on that growth.

To measure the estate tax benefit, we make the conservative assumption that Congress will allow the tax rate and exclusion to revert to 2001 levels in 2013. We also assume that the amount of the gift—$5 million in this case—will be “clawed back” into the grantor’s estate and subject to estate tax when the grantor dies. Most practitioners do not believe that “clawback” will happen as illustrated, but even if the gift is treated in this worst possible way, it will still provide a benefit of more than $5 million over 40 years.

Paying Income Taxes for the Next Generation

A second major tax benefit of making a gift today comes from taking advantage of the so-called “grantor” trust rules. By making the gift into a grantor trust, you get to pay all income taxes on the trust’s investment income, even though the trust itself remains outside your estate for gift and estate tax purposes.

Paying income taxes for your kids’ trust is an economic gift that benefits them, but is not treated as a gift under federal tax law. The chart demonstrates the potent effect of this option, which effectively doubles the benefit of the gift. Note that the grantor trust option is not available for transfers made at the donor’s death (the donor must obviously be alive to pay income taxes for somebody else) and may not be available for lifetime gifts in the future, as the 2012 budget proposals seek to limit this kind of planning.

Wealthy Americans who haven’t taken advantage of the generous gift-tax exclusion need to consider action before year-end. Using conservative estimates for future market returns and tax policy, a $5 million gift could produce a cumulative inflation-adjusted benefit of more than $12 million over the next 40 years for your children and succeeding generations of your family.


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