Harold, an advisor in Pittsburgh, is at a golf outing, and his golfing partner's friend-a widow worth $20 million-asks the advisor what he thinks about the double jeopardy of this year's gift-tax-planning loophole.

"So, Harold, my advisor at Dewey, Cheatham tells me that I should make a gift of $4 million to my children and grandchildren this year on December 31," says the 76-year-old matriarch of a family fortune. "What do you think?"

The advisor looks at the woman and says, "I honestly have no idea what you're talking about."

Rest assured, readers of The Gluck Report, that I will not let you suffer such an embarrassing fate. Not on my watch!

It is now mandatory for an advisor to be conversant with the problems of the super-rich. It doesn't matter that most advisors do not work with ultra-high-net-worth individuals, that this rarified market represents less than 1% of Americans, or that this is one of the most technically complex aspects of wealth management. Despite all this, there is no excuse for an advisor to be unable to speak intelligently about the current estate-planning imbroglio.

If you don't know about the gift planning opportunity on December 31, then you're not keeping up with what you need to advise ultra-high-net-worth individuals. You don't deserve their trust or their business, and you are writing off a profitable and intellectually rewarding niche of the wealth management business. And that makes no sense!

Most advisors depend on referrals and word-of-mouth to get new clients. What if a client introduces you to an ultra-high-net-worth friend? What if you're at a cocktail party or golf outing and are asked a question about the most pressing wealth management issue affecting the ultra-wealthy right now? You are sure to blow such opportunities unless you know about the current trends in estate and gift planning. Even though it's convoluted, you need to know about it.

So I interviewed one of my best sources on estate planning, New York attorney Gideon Rothschild of Moses & Singer LLP, and he painstakingly explained the current dynamic and year-end opportunities. Here's the story:

Estate planning has been as dysfunctional as Congress for the last several years, but the havoc is coming to a head, and rich people have a messy estate-planning situation to deal with over the next two months.

The ultra-wealthy-people with a net worth of about $5 million and up-have incentive to make gifts on the very last day of the year. They can pay 35% in gift taxes to Uncle Sam instead of much higher estate-tax rates.

The wealthy must hold off on making gifts until December 31 because if they make a gift in 2010 and then die, it would be especially unfortunate-not only would they be dead, but they would have paid the gift taxes unnecessarily.

While I'm making light of an otherwise dark situation, advisors should be familiar with the planning opportunities of the very wealthy. While your niche may not be those with $5 million and up, what happens if you find yourself in a conversation with such an individual?

In other words, December 31 is, ironically, the "drop-dead date" for taking advantage of the 35% gift tax rate. If an ultra-wealthy person does not gift assets in 2010, then next year his or her estate will be subject to estate taxes, which carry a top tax rate of 55%. To avoid paying at that level, your client can make a gift in 2010 and pay a lower tax rate of 35% on the gifted amount. Basically, estate taxes are on sale, says Rothschild.

However, if the client dies in 2010 after making the gift, then paying the sale price-the 35% gift tax-will have backfired because there is no estate tax in 2010. If your client dies in 2010, his entire estate is free of estate taxes. So it would have been better to die without making the gift and paying gift taxes.

There are many variables, however, that make this already confusing situation mind-boggling. Let's break them down to make them easily understood.

Three Year Look-Back
If you die within three years of making the gift on December 31, the benefits of paying the gift tax on December 31 at the 35% rate are undone. The government will treat your estate as though the gift was never made. The gift taxes paid as well as the amount gifted will be added back to your estate and the estate must pay taxes on that money at then-prevailing estate-tax rates. Thus, if the individual making the gift on December 31 dies within three years, he is no better or worse off for it.

For instance, say you have a client with a taxable estate of $10 million. While there is no estate tax in 2010, the estate tax is scheduled to rise to pre-2001 levels, with a top rate of 55%. If your client makes a gift of $4 million on December 31, he reduces his estate by that same $4 million plus the $1.4 million he will pay in gift taxes. Making the gift reduced his estate from $10 million to $4.6 million.

Assuming your client lives more than three years, he'll owe estate taxes on just $4.6 million instead of on the full $10 million. Sure, he still needs to pay the gift tax, but that's at the 35% gift tax rate instead of the 55% estate-tax rate scheduled to be in place three years from now.

However, the three-year look back could come into play. If your client dies within the next three years, the $4 million gift and $1.4 million in gift taxes would all revert to his estate and would be taxed at then-prevailing estate-tax rates.

Client's Age And Wealth
The age and wealth of your client are crucial variables. A client with a $10 million estate in his late 80s may be more inclined to make a December 31 gift than a client with a $5 million taxable estate who is 65 years old. If you are in your 60s and have a $5 million or $6 million taxable estate, Rothschild says, you're not likely to feel comfortable handing away half your net worth because you have a pretty long life expectancy. But someone with $20 million or more, he says, can give away $10 million and still have ample savings remaining.

"And for a person who is 80 years old and who has that kind of money, then giving it away now makes a lot of sense," he says. "For someone like that, estate tax is on sale now." 

Older clients would also be susceptible to the three-year look-back triggered when they die, but the look-back should not play into their decision because their death will not have made their estate-tax situation any worse.

Estate-Tax Legislation
Estate-planning rules have been such a mess for the last few years that many advisors have given up on trying to make sense of them. Frustration with the complexities is only part of the problem. What's worse is that the rules could change, and that is a real wild card facing those thinking of gifting by December 31. By the time you read this story, the 2010 midterm elections are likely to have occurred. There could be more clarity, but probably not a lot more clarity.

The 2001 tax-reform law ratcheted up the estate-tax exemption from $1 million in 2006 to as much as $3.5 million in 2009. Meanwhile, it reduced the top estate-tax rate from 55% to 45% in 2007. In 2010, the estate tax has completely phased out and no estate taxes are owed by people who died this year.

Sure, these rules made no sense. With health care and the financial crisis occupying the legislative agenda, however, estate-tax reform was simply not a priority.

Throughout 2010, observers watched to see whether Congress would retroactively impose estate taxes. While it would have been unusual, many thought that the Democrat-controlled Congress would not allow the one-year elimination of estate taxes in 2010 to stand. However, once Congress convened for the elections without re-imposing the estate tax, the threat of retroactive action had passed.

Although on-again, off-again reform proposals in recent years have left observers with a case of whiplash and dissuaded advisors from trying to figure out how estate tax rules will change, it seems likely that reform will indeed come in 2011. Most observers say Congress must act in 2011 because the estate-tax laws that will otherwise remain in effect will leave the top estate tax rate at 55% and the estate-tax exemption at $1 million. "That's unpalatable to both political parties because the middle class will be hit by estate taxes," says Rothschild.

While most bets are that Congress will now act to reform estate taxes, what exactly Congress will do remains unknown. Pay-as-you-go legislation enacted by Congress makes it very difficult for legislators to cut estate-tax provisions without simultaneously passing provisions to replace the lost revenue. If the Senate votes to eliminate all estate taxes or just specific provisions of the estate tax, it must pass revenue-raising measures to offset the dollars the Treasury would lose. Otherwise, the cuts have to be passed with at least 60 votes in the Senate.

"It looks to me like the best case for Republicans is getting 52 seats in the Senate," says Rothschild. "And it's going to be difficult for Republicans to get eight votes from Democrats. So we're going to see lots of horse trading."

Rothschild believes it's likely that discounts on family limited partnerships will be eliminated as part of the legislative wrangling, as well as the use of grantor retained annuity trusts (GRATs). These two estate-planning techniques can provide valuable revenue offsets in any deal aiming to increase the estate-tax exemption so that the tax will not hurt middle-class heirs.

Rothschild says that in addition to making gifts, advisors should be advising clients to use these two estate-planning techniques before the year ends. With asset values slammed by the economic recession, he says it's wise for business owners, investors in real estate, and other asset holders to place assets in a family limited partnership and discount the value of those assets because of the illiquidity of the FLP. The discounting, along with depressed asset prices, can result in huge estate-tax savings, though the strategy is likely to be barred by revenue-seeking legislators aiming to boost the estate-tax exemption. 

GRATs, the other estate-tax-saving technique likely to be targeted by reform in 2011, are attractive these days because of the combination of depressed asset values and low interest rates. It's a popular way of passing money to children and grandchildren tax-free. President Obama's fiscal 2010 budget proposal last year and his 2011 budget proposal again this year suggested reining in GRATs. Nothing happened, of course. But GRATs are unlikely to survive 2011 estate-tax reform. If a client has been thinking of a GRAT, now is the time to act.

With a GRAT, a grantor puts assets into a trust and gets an annuity payout. After two to three years, typically, anything left in the trust goes to the grantor's children or other trust beneficiaries. The annuity rate is based on the government's applicable federal rate (AFR), which is low, especially with low prevailing rates. At the end of the annuity payout period, the children receive the excess return above the AFR tax-free. 

Another simple year-end technique, says Rothschild, is to simply loan money to a trust. With the current applicable AFR at 1.7%, for example, a wealthy client can loan $5 million for up to nine years to a trust established for the benefit of his children. The trust could pay interest on the loan to the client at the 1.7% AFR, but any earnings beyond that rate can build up tax-free. So if the $5 million loan to the trust earns 400 basis points more annually than the 1.7% AFR, that amounts to $200,000 a year, and at the end of nine years the $1.8 million can pass to the client's child tax-free.

Generation-Skipping Tax Break
Not only is there no estate tax for 2010, but there also is no generation-skipping tax (GST). Next year, assuming Congress does nothing to revise GST rules, grandparents who have exceeded their $1 million lifetime gift tax exemption will face an extra-heavy burden on gifts to their grandchildren-a 55% gift tax rate plus a 55% GST tax rate. Grandparents have between now and the end of the year to consider making a gift to a grandchild to avoid the 55% GST and higher gift tax rate.

Grandparents must, however, be mindful: The grandchildren receiving their gifts should not be minors. Grandparents also have to consider otherwise that they might be giving control of the gifts to adults who are very young.

The reason the grandchild cannot be a minor is that gifts for GST tax purposes must be made directly to an individual. When a gift is made to a child under 18, the vessel holding the assets must be a custodial account or trust so it can be controlled by an adult. When the child turns 18, the money in the custodial account or trust would be distributed to the child and it would then be subject to the 55% GST levy-defeating the purpose of making the gift now.

In addition, grandparents making a gift to a grandchild who is 18 or 19 are giving full control to somebody who may invest it all in a dot-com company, an oxygen bar or a tattoo parlor. But under the right circumstances-where you have an older, more mature grandchild-it's a sensible strategy that will allow you some final days to avoid GST.   

Editor-at-large Andrew Gluck, a veteran financial writer, owns Advisor Products Inc., a marketing technology company serving 1,800 advisory firms.