Alternatively, it's possible to leverage the lifetime exemption by funding a trust with all or part of the tax-free amount and selling significantly more assets to the trust in return for a promissory note with interest. You must charge a minimum rate of interest set each month by the Treasury, called the applicable federal rate, to avoid potential gift tax and income tax consequences. But these rates are very favorable and less than family members would have to pay for a bank loan.
By wrapping assets in a family partnership before you make a gift or sale to the trust, you can discount their value, making the transaction even more attractive. And there's a temptation to get pretty aggressive with these discounts for gifts during the next two years; if you go overboard and have to settle an IRS audit, you can apply some of your unused exemption amount to soak up the excess.
Of course putting all these strategies into action doesn't come cheap. We're talking at least $5,000 for a GRAT (some advisors would snicker that this price is woefully low), and at least 10 times that for the partnership/sale combo. So all the financial advice now being dished up about today's unique planning opportunities might not be totally altruistic.
But a more pressing question is whether this really is an opportunity at all--even for the precious few who are dying to go broke in order to save estate taxes. Remember, the opportunity assumes that Congress will do nothing in 2013, so that the tax-free amount will automatically revert to $1 million per person and the rate on the excess will go up to 55%.
True, in that case, making gifts in 2011 and 2012 will have been a bargain--or even a free ride. Query: If you blew through the $5 million exemption and the tax-free amount drops to $1 million, would there be gift tax due retroactively for people who gave away more than that in 2011 and 2012? The possibility of such a clawback, as it's called, seems extremely remote. But I've had a number of questions about it from readers and it is being bandied about on professional Internet discussion groups and at conferences.
More importantly, we should not lose sight of the fact that what will happen in 2013 is a wildcard. Congress could easily extend the current rates or repeal the estate tax altogether. And in that case there will have been no urgency to make large lifetime gifts.
Those now pitching opportunities--and those taking the bait--should also consider what has become of the great opportunity that advisers were pushing last year (not to ruin the story or anything, but ultimately it wasn't).
For most of 2010, wealth advisers were recommending their clients purposely incur a 35% gift tax, since the tax was scheduled to increase to 55% in January. Then, under the new law, the amount that anyone can transfer tax-free during life went up from $1 million to $5 million. So it turned out that by simply waiting until 2011 to make gifts, it might have been possible to avoid gift tax altogether.
What's more, under the new law the tax on transfers that exceed the limit stayed at 35%, instead of going up to 55%, so paying tax in 2010 wasn't a good deal for this reason either. Darn!
As 2011 dawned, lawyers had a touch of chagrin to compound their New Year's hangovers. Their clients had a nasty case of donors' remorse. (For more about the struggle to legally undo these gifts, click here). As George Santayana, the American philosopher, once famously said, "Those who cannot remember the past are condemned to repeat it.''
This article is reprinted with permission from Forbes.com. Deborah L. Jacobs, a lawyer and journalist, is the author of Estate Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide (DJWorking Unlimited, 2009). An update to the book, on how the new tax law affects your estate plan, can be downloaded from the Web site www.estateplanningsmarts.com. To view a replay of a Webinar by Jacobs on the estate tax, click here.