Estate Planning Opportunities for 2011 and 2012 - Leveraging a Gift

On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, or the "2010 Tax Bill,” impacting the federal estate taxes regime. The 2010 Tax Bill created several estate planning opportunities that can only be taken advantage of in 2011 and 2012. The biggest potential for estate planning is in the gift tax area.

The 2010 Tax Bill re-unified the gift tax exemption of $1.0 million in 2010 with the federal estate tax exemption, $3.5 million in 2009, while also raising the exemption level to $5.0 million. For 2011 and 2012, anyone can give up to $5.0 million gift tax free. Any additional amount gifted over $5.0 million will be taxed at up to a thirty-five percent (35%) gift tax rate. It is also retroactive; an individual who has made taxable gifts in excess of $1 million prior to 2011 (and paid gift tax on the gifts) receives a credit to gift out an additional $4 million.

The annual exclusion for gift is still available and an individual can make annual tax-free gifts of $13,000 ($26,000 if married) to as many individuals as you wish each year. An individual can still make unlimited gifts for tuition and medical expenses if given directly to the institution. Charitable gifts also are not subject to an exemption level. The generation skipping transfer ("GST")1 tax is also unified with the gift and estate tax at $5 million.

What will make gifting an even more powerful tool will be the ability to leverage gifts to transfer even more than the $5 million cap amount through the use of several estate planning techniques. Two planning techniques, Grantor Retained Annuity Trusts ("GRAT") and Family Limited Partnerships ("FLP"), allow even greater opportunity to transfer wealth through the use of discounting of the gifts. The leverage comes when the value of transferred assets can be discounted due to a lack of control and marketability. For example, if you transfer assets to a family limited partnership that you still control, an outside buyer would pay substantially less than market value for shares he/she cannot sell without your approval. This creates a discount in the gifting amount. In other words, a larger gift can be transferred to the FLP using up a smaller amount of the gift tax exemption. This estate planning technique and discount is similar to a qualified residence personal trust, or QPRT, I described in the June 2010 The Future Estate.

While the 2010 Tax Bill did not place restrictions on GRATs and FLPs, many estate planners predict that future estate tax legislation will likely place limits on the attractiveness of GRATs and FLPs.

There are two issues with gifting. Creating a GRAT, FLP or QRPT is a highly sophisticated planning tool and consulting an estate planning attorney in drafting the correct documents is essential. This level of estate planning can also be very expensive. A basic GRAT could easily run over $10,000 in legal fees, and that doesn't include other professionals' fees, like an appraiser's fee. Further, the IRS takes a very hard look at the discount rate used on these transfers. Using a large discount value could trigger an audit.

The second concern is that, in 2013, the gift tax exemptions are scheduled to drop back to $1.0 million. There is a concern the IRS could cause "retroactive gift tax liability for deaths after 2012," by clawing back the amount of the gift above the $1.0 million exemption. However, there are a number of noted tax authors and commentators that have said that the 2010 Tax Bill does not generate a "claw back" tax obligation. Of course, that is not a guarantee from the IRS.

Even if the experts are wrong and there is a "claw back" on the gift tax exemption level any gift tax paid would reduce a decedent's estate tax owed when they pass away. For 2011 and 2012, the gift tax rate and estate tax rate are the same, but, in 2013, the estate tax rate is schedule to return to fifty-five percent (55%) with a $1.0 million exemption rate. Additionally, any future appreciation on the amounted gifted would be outside of the estate.

The 2010 Tax Bill did not impact the ability convert an IRA to Roth IRA, donate up to $100,000 per year tax free from an IRA disbursement to a public charity for someone over the age of 70 and , create charitable estate plans including establishing a charitable remainder trust or receive life insurance death benefits from a spouse free of the estate tax.

The Basics of Estate Planning: Power of Attorney

When I meet with clients, I describe estate planning as a three-legged stool. The first leg is a last will and testament that plans a decedent's assets after death. A few months ago, I described the second leg - advanced medical directives - that allows a person to plan and appoint another person to speak in their behalf if that person cannot communication to make healthcare decisions. The third leg of the estate planning stool is the power of attorney ("POA") that allows a person to appoint another person to act in their stead to make certain financial decisions.

The mechanics of a POA are very simple. A person, called the principal, creates a legal document giving someone, called the agent or attorney-in-fact, powers to act in the principal's place. Those powers can be extremely diverse, from only dealing with one issue to spanning all the normal financial powers a person can have. The agent is in a fiduciary relationship with the principal, and the law requires the agent to act in the best interests of the principal. The agent must also be completely honest with and loyal to the principal in their dealings with each other.

There are two basic forms of POAs that govern financial decisions. The first is typically called a regular power of attorney. In a regular power of attorney, the powers vested in the agent by the principal are revoked if the principal becomes incapacitated, incompetent or dies. The other form of POA is the durable power of attorney ("DPOA"). A DPOA is effective from the moment of execution of the document. A DPOA will also be in effect when the principal becomes incapacitated. A DPOA can also become effective when the principal becomes incapacitated, but the DPOA must expressly state that requirement. This is sometimes known as a "springing" power of attorney. No matter what, a DPOA ends at the death the principal.

A principal can provide a number of powers to an agent. Most powers may include any of the following:

  • Buy, manage, or sell real estate
  • Diswclaim interests to avoid estate taxes
  • Employ professional assistance
  • Enter into contracts
  • Enter safety deposit boxes
  • Exercise stock rights
  • File tax returns
  • Handle bnkuing transactions
  • Handle matters related to government benefits
  • Handle transactions involving securities
  • Maintain and operate business interests
  • Make gifts
  • Make transfers to revocable trusts
  • Purchase life insurance
  • Settle claims
Since an agent's powers could be vast, a principal should be careful in selecting an agent. If necessary, the principal should include any desired restrictive clauses in the power of attorney document.

It is important to recognize the value of being able to assign these decision making capabilities to a trusted family member or friend, especially in the case of durable powers of attorney that continue to be legally binding in cases of incapacity. These documents can save caregiving family members and friends a great deal of time, frustration and money.

Estate of the Month: The A, B, X of What not to do in Probate

A few years after graduating from college, I remember hearing the reports of the grandson of Malcolm X pleading guilty to the juvenile equivalent of second degree manslaughter for starting a fire that killed his grandmother, Dr. Betty Shabazz. That was back in 1997. It is now 2011, almost 14 years have passed since Dr. Shabazz's death. According to a New York Times article, her estate still has not been closed. At her death, Dr. Shabazz's estate was alleged to be worth about $1.4 million. But, her estate includes a vast treasure of unpublished works written by Malcolm X, potentially increasing the value of the property disbursed to the heirs.

Dr. Shabazz died leaving behind 6 daughters and no estate plan. This has generated accusations of inappropriate dealings, irresponsibility, mental incapacity and fiscal mismanagement of the estate among the sisters. But, a number of basic planning and probate administration missteps have exacerbated the problems causing the estate to languish on. In fact, Dr. Shabazz estate could be a case study of what not to do.

First, Dr. Shabazz died without a will. Though some family members believed there to be a will, no will was found among the ashes of her house or any other location. If a will did exist, it was likely destroyed in the fire. This is a prime example of making sure estate planning documents are stored in a safe place or informing a trusted person of the location of the will. (Click here for more details on storing a will.)

Because there is no will, the estate assets will be divided under New York's intestate succession. Given that a large percentage of the estate's assets are in the form of intangible assets, like the unpublished letters and other similar documents, it is harder to financially qualify the value of those documents - not impossible, just harder when you compare the ability to value a particular stock's price on the day of the decedent's death. Trying to divide the hard-to-value intangible assets six ways equitably is complex and costly because of the need to bring in high level appraisers to value the assets. There is also the added issue that most of the documents would likely be worth more together than sold separately.

The take away is if your estate has a large amount of assets that are hard to price, like a unique piece of artwork, make sure there is a will governing the disbursement of those assets. As Dr. Shabazz's estate demonstrates, feuding over the unpublished documents has resulted in wasting estate assets.

Second, two of Dr. Shabazz's daughters were appointed personal representatives to administer her estate. Naming or appointing two people to administer an estate usually results in conflict down the road, if the two personal representatives do not get along. It seems like a good idea at first blush to have two personal representatives. Most testators feel naming two representatives will make sure each one keeps an eye on the other one. Of course, naming two personal representatives for this reason means the testator cannot trust one of the personal representatives and must name a watchdog. It also ignores the fact that most probate offices can be asked to supervise the accounts of a decedent's estate.

Further, each representative will have a view on how the estate should be administered, how assets will be marshaled or disbursed and potentially double charging the estate for personal representative fees. In Dr. Shabazz's estate, there are allegations of the personal representatives advancing shares of their inheritance to their sisters and prepaying themselves commissions even when their lawyers advised against it.

It is better to name/appoint one personal representative that places all the responsibility in one place. The probate courts and register of wills do an excellent job of ensuring that a personal representative acts in their fiduciary capacity. Believe me, if the personal representative is not doing their job a beneficiary will make someone aware of the issue.

Third, one of the responsibilities of a personal representative is to act in a timely manner. Because the administration has dragged on for almost 14 years, a number of problems arose. The estate racked up over a $2.0 million tax bill, including penalties and interest. That is more than the tangible value of the estate and double the original tax bill. Acting in a timely manner would have eliminated the interest and penalty portion of the estate tax bill. It would also have reduced the professionals' fees (lawyers and accountants) the estate accrued over the years in administering the estate.

Third, one of the responsibilities of a personal representative is to act in a timely manner. Because the administration has dragged on for almost 14 years, a number of problems arose. The estate racked up over a $2.0 million tax bill, including penalties and interest. That is more than the tangible value of the estate and double the original tax bill. Acting in a timely manner would have eliminated the interest and penalty portion of the estate tax bill. It would also have reduced the professionals' fees (lawyers and accountants) the estate accrued over the years in administering the estate.


1 The GST tax imposes a tax on both outright gifts and transfers in trust to or for the benefit of unrelated persons who are more than thirty-seven and half (37.5) years younger than the donor or to related persons more than one generation younger than the donor, such as a gift from a grandparent to a grandchild. The generation-skipping tax will be imposed only if the transfer avoids incurring a gift or estate tax at each generation level.



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