By Dennis Delaney

Incentives, credits and deductions within the U.S. tax system are currently in the spotlight, and most advisors are aware that unprecedented exemptions for gift and estate taxes are set to expire on December
31. Less clear, however, is how families can manage their assets to capitalize on the credits before the window closes.

In 2011, the federal gift, estate and generation-skipping tax exemptions rose to $5 million per individual ($10 million per couple) from $1 million, a significant jump that gave high-net-worth families an opportunity to move more money out of their estates without incurring taxes. Changes to those credits are almost certainly coming, although there is a possibility that they could be extended.

Seizing this opportunity before it vanishes should be a priority for taxpayers who can afford to part with the assets, and the urgency is increasing. Even if the exemptions are extended, the tax rate may not stay at its current level, which is the lowest since 1934. The top rate is set to increase on January 1 from 35 percent to 55 percent.

It is a striking scenario: $10 million in cash, property, or business assets given as a gift on or before December 31 is free from federal tax. Just one day later, it may cost the grantor millions.

Despite this fact, surprisingly few families have capitalized on the gift tax exemption. According to Bloomberg, "fewer than 10 percent of clients [of CPAs surveyed] with at least $10 million have used even part of the exemption or plan to by December."

Inaction is often rooted in a simple lack of direction. In this case, the question for many families is not whether to use the credit, but how to capture its potential by building the most effective financial plan.

Trusts are a significant part of such a plan. They are often viewed as complicated vehicles, and families can be understandably frozen by a number of concerns. Emotions are a factor, as people often delay the unpleasant task of planning for their own mortality. Moving money out of the estate can seem to be a premature action, as they wonder if they may need that money due to unforeseen circumstances. There is also a misperception that trusts are rigid vehicles, when in fact they can be created to be extremely flexible and tailored to a family's needs.

Most powerful, though, is the fear of rushing into a decision that will cause a loss of control over family assets or prove to be a disincentive to the drive and entrepreneurship of younger family members. But the right trust language in the right location with the right trustee can actually keep grantors empowered, put their minds at ease and minimize tax exposure.

Choosing The Right Vehicle

The concern over losing control and personal values is justified, and it reflects one of the major difficulties in maintaining wealth over generations. There are vehicles that are designed specifically to help address these and other issues, including:

Quiet Trusts

Families often worry that the development of their children's or grandchildren's work ethic will be hindered by even the hint of a pending inheritance. With a Quiet Trust, the beneficiary does not necessarily have the right to learn of its existence, much less its value or terms. Most states require that significant disclosure be made to beneficiaries at regular intervals, such as letting them know the trust's value. States that authorize Quiet Trusts, on the other hand, enable owners to decide when disclosures will be made (e.g., when a beneficiary reaches a certain age) and what information will be provided.

Dynasty Trusts

New developments in trust planning are also working in favor of families that are ready to make a major gift to provide resources for future generations. The Rule Against Perpetuities (RAP) was for decades a restrictive law that required private trusts to expire roughly 90 to 120 years after creation. Some states, notably Alaska, Delaware, New Hampshire, and South Dakota, have completely abolished these rules, while others have chosen not to abolish it altogether, but to lengthen the terms.

The decline of the RAP places greater emphasis on Dynasty Trusts, which can run indefinitely and heighten the importance of long-term planning that anticipates changes. This is as important for private trusts as it is for charitable trusts; when the trust is expected to extend across multiple generations, the environment around it is likely to change. Owners and trustees must work together to anticipate shifts that may occur and account for them in the trust. In this way, they can maintain better control, allow for changes in trustees, have confidence that their legacy will stay true to their original intentions, and make the transfer of wealth a gift that sticks.


Family Limited Partnerships

More complex vehicles also come into play in devising the right strategy. The New York Times reported a spike in popularity for family limited partnerships that are constructed to distribute wealth.

"A family limited partnership was once a rather esoteric way for wealthy families to centralize the management of real estate and various pots of money. But this is not a normal tax year," the Times wrote. "The arcane device has suddenly become popular because of the scheduled expiration of the $5.12 million gift tax exemption.

Choosing The Right Location

It is critical to note that each state has its own set of trust laws that dictate which kind of vehicles can be housed there. A trust's location can therefore make a tremendous impact on the amount of flexibility enjoyed by owners.

New Hampshire, Alaska and Delaware are recognized as leaders in this respect. Each of these states offers Quiet Trusts. They also offer "self-settled asset protection" trusts, which can allow trustees to make trust assets available to the donor, even after they have been given to the trust. The donor for these trusts is designated as an "eligible" beneficiary and can request distributions from the trustee. With a self-settled asset protection trust, a donor can establish an irrevocable trust and name him or herself as a beneficiary, giving the trust assets an enhanced level of protection from creditors.

Massachusetts is an interesting case in trust law. For a host of reasons, the state has long been a leader in addressing trust issues. Prominent families established their wealth in trusts in the state generations ago, when the landscape was different and trustees and financial institutions were primarily regionally focused.

The state recently took a step forward by enacting the Uniform Trust Code (UTC) to gain parity with a number of other states. In adopting the UTC, Massachusetts did not introduce novel trust tools, but
the state did make it easier to modify the text or substance of a trust, relocate it to another state, or remove a trustee.

This will potentially open the door for longstanding Massachusetts trusts to relocate and be modified to better address current circumstances.

There are ample reasons for families to consider a change. As financial institutions have grown over the decades, the original trustees may have evolved into entirely different organizations. Whether they became multi-national operations or shifted their focus to emphasize other services, their offering and the relationship may no longer align with a family's expectations. Until 2012, the stringent trustee removal law in Massachusetts made these factors largely irrelevant, as changing trustees required significant expense and hard evidence of incompetence or malfeasance.

Seizing Opportunity Ahead Of The Deadline

When considering the gift and estate tax or examining their trustee relationship, families can feel daunted by the trust environment. It is no easy task to build and maintain a vehicle that can adequately address their assets and their personal values. Solutions abound, though; the landscape is complex, but it is also navigable with the right knowledge.

The urgency to act is real. Not only is the December 31 deadline looming, but depressed asset values and low interest rates make this is an ideal time to implement giving strategies that will help wealth appreciate over time.

Waiting too long to act may leave a donor sorely disappointed. On a practical front, appraisers are seeing a rush on their valuation services because the IRS requires that an appraisal take place for gifts of any assets other than cash or publicly traded securities. These illiquid assets may be a preferred choice for gifts because they could have a smaller impact on the grantor's cash flow and current lifestyle. Grantors who wish to investigate their options but delay the ultimate decision as long as possible should nonetheless commission the necessary appraisals, transfer the assets to a revocable trust, and be ready to complete the gift transaction on December 31 by converting the trust to an irrevocable trust if the exemption is, in fact, headed for expiration.

Simply put, gifts that make sense today could be more painful to part with in January 2013. Making the right move at the right time can have a material impact on the portfolio for generations to come.

Dennis Delaney is a partner in the law firm Hemenway & Barnes (