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To Give or Not To Give Before Dec. 31 - November 2012

November 02, 2012

For gifts made in 2012 and individuals dying in 2012, the estate tax exemption, gift tax exemption and generation-skipping transfer tax (“GSTT”) exemption are all $5,120,000 (less prior taxable gifts).  This exemption applies to each donor/decedent.  In addition, the surviving spouse of a decedent who died in 2011 or 2012 and who did not fully utilize his estate tax exemption can use his or her deceased spouse’s unused exemption (“DSUE”).  This opportunity is frequently referred to as “portability.”  If we “fall off the fiscal cliff” with respect to estate and gift taxes, then as of January 1, 2013, the estate tax and gift tax exemptions will each be $1,000,000 per donor/decedent (less prior taxable gifts); the maximum estate tax rate will increase from 35% to 55%; and the surviving spouse will no longer be entitled to DSUE.  NOTE:  Because portability expires December 31, 2012, it becomes even more important for each spouse to have at least $1,000,000 of assets in his or her name; thus, enabling  the estate of the first spouse to die to take full advantage of his or her estate tax exemption.   

In addition, effective January 1, 2013, the GSTT exemption is uncoupled from the estate and gift tax exemptions.  The GSTT exemption is adjusted for inflation, whereas the estate and gift tax exemptions are not.  It has been projected that for 2013, the GSTT exemption will be  $1,430,000.  Before deciding, as many have, that Congress will act; that the estate tax exemption will be raised to at least $3,500,000; and therefore, that there is no reason for you to make any gifts before December 31, 2012, you should consider the following unique opportunities that are available in 2012:

    1.  As a result of the economy, the value of many assets is depressed.  Assets whose values are expected to return to pre 2008 values (i.e., to appreciate between the date of gift and the date of the donor’s death) can be perfect assets for giving because the post-gift appreciation is removed from the donor’s estate. 

    2.  One of the downsides to receiving a lifetime gift as distinguished from an inheritance of the same asset is that the donee succeeds to the donor’s tax basis.  Once again, however, because of the economy, a number of individuals have assets, the tax basis of which equal or exceed their fair market value or contain very little gain. 

    3.  Effective January 1, 2013, dividends will be subject to ordinary income tax rates instead of the favorable capital gain rates they have enjoyed for the past several years.  In addition, a 3.8% surtax will be applied to interest, dividends and gains if your modified adjusted gross income exceeds certain thresholds:  $250,000 for a married couple filing a joint return ($200,000 for a single return).  Therefore, by giving an asset that produces investment income or gains that are subject to the 3.8% surtax to someone whose modified adjusted gross income is below these thresholds, the surtax can be avoided. 

    4.  There is considerable talk that discounts for fractional interests in assets or for interests in closely-held entities will be statutorily eliminated or significantly reduced.  At the present time, total discounts of 30% - 35% are frequently seen.  If, for example, a 10% interest in an entity whose full value is $10,000,000 is eligible for a 30% discount, the value of the 10% interest for gift tax purposes would be $700,000 instead of $1,000,000 (i.e., an additional $300,00 in value escapes the transfer tax system).

Although the greatest benefit to making major gifts in 2012 is derived from gifts in excess of the estate tax exemption in the year of the donor’s death, there are several advantages to making a gift in 2012 whose value is less than the estate tax exemption in the year of the donor’s death.  One of the more obvious benefits is that if one makes a gift of approximately $1,000,000 in 2012 and has not made any previous taxable gifts, then, absent a substantial understatement of value, even if the gift tax return is examined and the value of the gift is adjusted upward, payment of gift tax will not be required.  If you have an asset whose value is currently depressed and whose income will not be needed, you should seriously consider gifting the asset no later than December 31, 2012.  If you have such an asset or assets, you should contact your tax advisor immediately, as the end of the year is rapidly approaching. 

To take advantage of the 2012 rules, the gift must be completed on or before December 31, 2012.  If you are making a cash gift either to use the $13,000 per donee in 2012 ($26,000 with the spouse’s consent) annual exclusion for present interest gifts (generally gifts made outright and free of trust), the check must be actually cashed or deposited by the donee and cleared by the donor’s bank in the normal course of business to avoid any challenge.  Better practice is to have the check deposited in sufficient time to clear the donor’s bank no later than December 31.  Alternatively, the delivery of a cashier’s check to the donee or a wire transfer to the donee’s account is sufficient to complete the gift in the year in which the cashier’s check is purchased or the wire transfer is made.  The rule as to when a gift of stock is completed depends upon the manner in which it is gifted.  If you hold the physical certificate for stock in a closely-held company or a publicly traded company, then the gift is complete when the stock certificate and a fully executed stock transfer power or other assignment is delivered to the donee.  With respect to stock held in street name, the gift is complete on the date the brokerage firm transfers title, which is typically three business days after the day the brokerage firm receives the instruction. 

If one needs the current value of an asset or a stream of payments for a definite period of time, the current low interest rate environment makes it an extremely good time to sell assets for their true fair market value (or via a part gift part sale) to a family member.  The interest rate that must be charged on the note payable to the seller is the applicable federal rate (“AFR”) as determined by IRS.  By way of example, the November 2012 AFR on a note payable in monthly installments for no more than three years is .22%; on a note payable in monthly installments for more than three years, but no more than nine years is .89%; and on a note payable in monthly installments for more than nine years is 2.38%.  Such a sale freezes the value of the asset (i.e., any post sale appreciation is removed from the seller’s estate) and provides the seller with a stream of payments until the note is paid in full.  There are more sophisticated techniques that are particularly appropriate in the present economic environment, such as a sale to an intentionally defective grantor trust; a grantor-retained annuity trust; or a charitable lead trust, which are beyond the scope of this article. 

To the adage “nothing is certain but death and taxes,” one can add that the estate, gift and GSTT taxes for 2013 will differ from those in 2012 and that the difference will most likely involve a tax increase.  Therefore, if one has an asset, the income from and appreciation from which is not needed, he should contact his tax advisor to explore the most efficient means for giving or selling such asset and the timing (i.e., whether the transfer should be made prior to December 31, 2012 to take advantage of expiring tax benefits). 

A husband and a wife who have combined estates in excess of $2,000,000 (double the $1,000,000 estate tax exemption that becomes effective January 1, 2013), should at least consider using all or a portion of the $13,000 ($26,000 if a split gift election is made) per donee annual exclusion for present interest gifts.  The annual exclusion is in addition to the estate and gift tax exemption.  Present interest gifts may be made in cash or in kind subject to the timelines discussed above.  The per donee annual exclusion for present interest gifts cannot be accumulated, and therefore any unused annual exclusion for 2012 is lost forever. 

This article has only touched the proverbial “tip of the iceberg” and is intended as food for thought rather than advice in any specific situation.  Each individual’s situation is unique, and therefore any final decision about the implementation of gifts should be made in consultation with your tax advisor.

Written by Jo Ann Blair-Davis.