By Janine Racanelli
Many people are aware of the dramatic gifting opportunities created by the 2010 tax law changes that enacted the current low gift tax rates and high gift tax exemption amounts. But not everyone who can take advantage has acted. This failure to act is understandable given the level of uncertainty around what Congress might do with the U.S. transfer tax system. However, economic analysis suggests it may be unwise to wait.
Because gift tax exemptions are at their highest level since 1932 – currently at about $5 million per individual or $10 million per married couple – gifting now may create substantial economic benefits for your heirs. But it’s important to consider how the tax landscape might evolve this year, as well as the risk and reward tradeoffs associated with making a substantial gift.
To help you determine how much—and even whether—to gift now, here are some of the major scenarios and considerations to take into account:
The gift and tax exemptions sunset at the end of 2012 as scheduled. If you can afford to gift now, it is likely to be a positive choice. This is particularly true if estate tax rates increase from the current 35% to 55%, and the current individual lifetime gift tax exemption level of $5 million decreases to $1 million—as they are both scheduled to do on January 1, 2013. If your assets grow at a rate of 5% a year over 20 years, a gift of $5 million in 2012 could double the amount your heirs receive.
The gift and tax exemptions are extended. Even if Congress were to extend today’s favorable transfer tax rules, gifting $5 million now would be more beneficial than leaving the same amount as a bequest—as long as the gifted assets appreciate in value. So at what point would it be better to transfer the assets as a bequest rather than a gift? A bequest would only be better if both the current transfer tax system is kept at the same historic rates and levels AND your asset values drop significantly in value. Otherwise, you are likely much better off gifting the assets this year.
The gift and tax exemptions are extended and asset values drop. Even the loss of benefit resulting from lower returns could be offset by a sufficiently large decrease in the lifetime gift tax exemption. Research shows that if the exemption level drops to $1 million, it would still be more beneficial to make the $5 million gift today even if the transferred asset values decreased at an annual rate of 5% over 20 years.
There are also ways to boost the benefits of gifting. Many people make gifts to trusts rather than outright so that assets can be managed, controlled and invested by someone other than their heirs. The benefit can be significantly boosted if an irrevocable grantor trust, once funded, buys assets from the donor in a tax-free exchange for a note, or if the trust borrows and reinvests the loan proceeds.
With today’s low interest rates, these transactions are more likely than ever to bolster the benefits of gifting. That is because adding leverage generally results in more wealth passing to heirs as long as investment returns exceed the interest rate on the note. Unsurprisingly, the more leverage you add and the higher the returns the assets generate, the greater the benefit to heirs— but also the greater the risk that the strategy will not work.
The Time to Act is Now
People considering whether to use their lifetime gift tax exemption of $5 million before 2013 have much to consider, including:
- The extent of their wealth and ability to make the gift
- The nature of the assets they might gift and the likelihood they will appreciate in value
- The most suitable investment strategy for those assets
Clearly, the issues are complicated. Crafting the right plan for an individual takes time. Only five months remain until the current exemptions levels are set to expire. No one knows what Congress will do next about transfer tax reform. If you can afford to gift in 2012, now is the time talk over your options with your legal and tax advisors.