Brock, Clay, Calhoun & Rogers on Transferring Wealth – LIVING WELL Magazine

TRANSFERRING WEALTH:

NARROW WINDOW, BIG OPPORTUNITY

By Ann Watkins, Attorney at Law, Brock, Clay, Calhoun & Rogers, LLC, North Atlanta LIVING WELL Magazine

Estate tax planning may not be the most stimulating topic of discussion in normal times, but for those of us who plan around estate and gift taxes for a living, recent events have been a veritable roller coaster ride. Our hearts are still pounding and we are breathless with anticipation as to what lurks around the next bend. OK, maybe that is a slight exaggeration. But the times are interesting, and the opportunities for our clients to make tax-free transfers of vast amounts of wealth have never been – and may never be – greater.

A Not So Brief History of the Modern Transfer Tax System

What many commentators refer to as the “death tax” is, technically speaking, not a death tax at all. Our government does not tax us for dying (thank goodness!), but rather taxes us for transferring wealth, either during our lives or at death, in significant amounts. We may make lifetime gifts or transfers at death to our spouses (assuming they are U.S. citizens) in unlimited amounts, but transfers to our children, grandchildren or other non-spouse beneficiaries will trigger a tax if those transfers exceed a certain amount.

I have been an estate planning attorney for almost 30 years, and for most of that time the parameters within which we planned remained fairly constant. Only the tools and techniques we used to help our clients transfer as much wealth as possible within those parameters changed from time to time. Beginning in 1976, and for a period of 20 years thereafter, our government instituted and maintained a unified transfer tax system for lifetime gifts and transfers at death, providing a transfer tax credit which shielded transfers of up to $600,000 (whether made during life, at death, or a combination thereof) from tax. Non-spousal transfers above that amount incurred tax at a graduated rate that topped out at 55% (or even 60%, for aggregate lifetime and death transfers exceeding $10,000,000).  In 1986, Congress layered on a generation-skipping transfer (GST) tax, imposing yet another level of tax on transfers to grandchildren or other recipients in generations two or more younger than that of the transferor. The GST tax was implemented with a $1,000,000 exemption (indexed for inflation), with transfers in excess of this amount taxed at 55%, on top of the estate tax. The result was that the combined tax rate on certain transfers (for example, the transfer of a retirement plan account – with its embedded income tax liability – to a grandchild) reached upwards of 90%.

Measures of Relief in More Recent Years

By the mid-1990s, it was abundantly clear that not only the “wealthy” were being caught in the transfer tax net. An individual who died owning a home and a relatively modest retirement account was likely to leave a taxable estate. In 1997, Congress adopted a plan to phase-in an increase in the amount covered by the unified credit from $625,000 in 1997 to $1,000,000 in 2006 (and after), with a maximum tax rate of 41%. Then, with the passage of another set of legislation in 2001, Congress again altered the playing field. The 2001 law accelerated the increase in the transfer-tax exemption amount to $1,000,000 in 2002, and provided for further increases in intervals, culminating in a $3.5 million dollar exemption and a 45% flat tax rate in 2009, and total repeal of the estate and GST taxes (but not the gift tax) in 2010. During this run-up, however, the gift tax exemption amount stayed constant at $1,000,000, the rationale being that large gifts unfettered by tax would undermine the income tax system by allowing wealthy donors to shift income tax liability to donees in lower income tax brackets.

The Sunset Effect 

For budgetary reasons, a “sunset” provision was added to the 2001 law when it was passed providing that, unless Congress acted again in the intervening 10 years, the estate, gift and GST taxes would all be restored at their 2001 levels on January 1, 2011, meaning basically a $1,000,000 exemption and maximum tax rates of up to 60%. Throughout that decade, few if any estate tax practitioners seriously believed Congress would fail to act. But January 1, 2010 rolled around bringing the one-year repeal, and as month after month passed with little discussion and no action from Congress, we all braced for a return to the bad old days.

Congress Acts at the Eleventh Hour

Congress came through in the nick of time and passed a new law (the 2010 Tax Relief Act) on December 17, 2010. This law provides a generous $5,000,000 estate tax and GST tax exemption amount, and a flat 35% tax rate, but more importantly (and surprisingly) reintegrates the estate tax and the gift tax, so that the full exemption amount may be applied to lifetime gifts if an individual so chooses. Even individuals who previously used some or all of their gift and/or GST tax exemptions in previous years now have at least $4,000,000 ($8,000,000 per couple) of additional exemption available. However, the 2010 Tax Relief Act is another temporary measure and is set to expire on December 31, 2012.

Why Large Gifts and Why Now

Clearly, the tax environment for transferring wealth in this country has never been (and may never be) more favorable. We now have the combined advantages of the highest transfer tax exemptions ($5,000,000) and lowest transfer tax rates (35%) in history. A gift of an asset removes not only the present value of that asset but also all future appreciation on and income attributable to that asset from the eventual taxable estate. Also, since asset values (particularly those for residential and investment real estate) are presently quite low, the opportunities to freeze the values of these assets for transfer tax purposes are especially attractive. Moreover, most of the estate planning tools we honed over the past few decades (such as family limited partnerships and grantor-retained annuity trusts) are, at least for the moment, still viable parts of the estate planning arsenal. Consequently, an individual may be able with proper planning to transfer much more than $5,000,000 in assets to loved ones without incurring tax. The powerful reality is that trusts established for grandchildren and more remote descendents today, applying some or all of the $5,000,000 gift tax and GST tax exemptions, will result in vast amounts of wealth accumulating and growing transfer tax free for generations to come.

This window of opportunity may only be open until December 31, 2012, when the provisions of the 2010 Tax Relief Act will expire. Without further legislation the gift tax and GST tax exemptions (as well as the estate tax exemption) will revert back to $1,000,000 with a maximum tax rate of 55% effective January 1, 2013. Will Congress let this happen? History demonstrates anything is possible. It also seems clear that full repeal of the estate, gift and GST taxes is no longer being promised or anticipated. If the transfer tax exemption amount does revert to $1,000,000 (or something less than $5,000,000), will the tax avoided on a large gift now be recaptured at death? This result is possible, but unlikely. And the donor of the gift (or his estate) would in any event pay no more in tax in the end than if the gift had not been made.

Not Just For the Wealthy

Admittedly, not everyone has the wherewithal, much less the motivation, to give away millions of dollars in assets. Estate planning is not just for the super wealthy, however, and no one can afford to be complacent, especially when a window of opportunity presents itself in this era of extreme uncertainty. There is no time like the present to consult an estate planning attorney and explore available opportunities.

Ann A. Watkins is an attorney with Brock, Clay, Calhoun & Rogers, LLC. Located at 49 Atlanta Street, Marietta, Georgia, you may reach the firm at 770-422-1776. For more information visit www.brockclay.com.