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Pending Expiration of Tax Relief Act Warrants Review of Wealth Transfer Plans

February 13, 2012

Continued Uncertainty in the Federal Estate Tax Law Makes This a Good Time to Review and Revisit Wealth Transfer Opportunities

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Tax Relief Act”) made significant changes to the federal estate, gift and generation-skipping transfer (“GST”) tax law, including increasing the federal estate, gift and GST tax exemption amounts[1]. For 2012, these exemptions are $5,120,000 and the top tax rate above the exemptions is 35%.

However, the 2010 Tax Relief Act only applies for 2012. If Congress does not act before the end of this year, the estate, gift and GST tax exemptions will revert to $1,000,000 (the GST exemption will be somewhat higher because it is indexed for inflation) and a top tax rate of 55% (the 2001 levels) for 2013 and beyond. There is no guarantee that Congress will act, especially given the current political climate. In addition, there are several proposals before Congress that would adversely affect transfer tax planning, including placing limits on the availability of discounts and restricting the use of grantor retained annuity trusts (discussed below).

Therefore, the opportunity is now for taxpayers to utilize the increased exemptions in order to reduce taxes. Some effective wealth transfer techniques include:

1.                    Gifts – The simplest way to utilize the increased gift tax exemption is to make a gift, either outright or in trust, to a beneficiary. Your estate is reduced by the amount of the gift and all subsequent income and/or growth on the gifted assets is removed from your estate. Although taxable gifts are added back to your estate for federal purposes, that does not apply for state purposes. Thus, if you live in New Jersey or New York, both of which have a state-level estate tax and no gift tax, gifts can save a significant amount of tax. The donee of the gift receives your income tax basis, so only high-basis assets should be gifted.

2.                    Loans to Family Members – You can make a loan to a child or a trust for their benefit. The minimum interest rate required by the IRS on loans is at a historic low (.19% for February 2012). If the loan proceeds are invested and earn a return that is greater than the interest rate on the loan, the excess is removed from your estate with no gift being made.

3.                    Grantor Retained Annuity Trusts (GRATs) – With this technique, you transfer assets to a trust and receive an annuity over a term of years. No gift is made because the actuarial value of your annuity is equal to the value of the assets transferred. If the assets appreciate or generate income at a higher rate than the IRS’s assumed rate of return (1.4% for February 2012 - also a historic low), the GRAT will succeed in transferring wealth to the beneficiaries at the end of the term with no gift being made.

4.                    Qualified Personal Residence Trusts (QPRTs) – You make a gift of a personal residence but retain the use of the residence for a term of years. The value of the gift is reduced by the retained interest, and may be further reduced if the residence is owned by more than one person (i.e., spouses) and a discount for a fractional interest is applied. QPRTs are attractive in light of the depressed real estate market, but they work better in a high interest rate environment. An analysis of a depressed market must be compared with the negative effect of lower interest rates.

5.                    Irrevocable Life Insurance Trusts – Life insurance proceeds can be sheltered from being taxed in your estate. The increased gift tax exemption allows you to obtain larger policies with higher premiums and/or to prefund future premium payments.

6.                    Family Business Entities – Discounted gifts of minority interests in family business entities, more specifically Family Limited Partnerships (FLPs) and Limited Liability Companies (LLCs), can be made to family members, but you maintain control of the business. Given the increased exemption, more wealth can be passed down to future generations.

7.                    Sales to Intentionally Defective Grantor Trusts – You create a trust that purchases assets from you in exchange for a promissory note. If the assets appreciate in value or generate income higher than the interest on the promissory note, this gain or income is passed to the remainder beneficiaries of the trust with no gift being made.

The foregoing are only some of the planning techniques that can be utilized to take advantage of the increased federal estate, gift and GST exemption. Given the temporary availability of the increased exemption levels, now is the time to explore and, if appropriate for your own personal financial situation, implement a plan to make lifetime asset transfers in order to reduce estate taxes before the window of opportunity presented by the 2010 Tax Relief Act may close.

Please contact your estate planning attorney at Wolff & Samson PC (see below) if you have questions or would like more information.

Tax, Trusts and Estates Department at Wolff & Samson PC:

David L. Schlossberg
Member of the Firm
Phone (973) 530-2010
Email dschlossberg@wolffsamson.com

Sean M. Aylward
Member of the Firm
Phone (973) 530-2105
Email saylward@wolffsamson.com

Roxanna E. Hammett
Member of the Firm
Phone (973) 530-2039
Email rhammett@wolffsamson.com

Carl B. Levy
Of Counsel
Phone (973) 530-2035
Email clevy@wolffsamson.com

Christopher DeFilippis
Associate
Phone (973) 530-2046
Email cdefilippis@wolffsamson.com

Farah N. Ansari
Associate
Phone (973) 530-2044
Email fansari@wolffsamson.com

[1] For a detailed discussion of the 2010 Tax Relief Act, see our December 2010 Estate Tax Alert: http://www.wolffsamson.com/news_events/329-new-2010-federal-law-makes-significant-changes-federal-estate-gift-and.