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When the Gift Tax Exemption Ends, Should I Change My Will?

Aug. 24, 2012
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They say the only certainties in life are death and taxes. So what happens when the two collide?  Turns out, the answer is anything but certain. Changes to estate and gift tax exemptions expected at the end of this year are throwing both estate attorneys and those planning their end for a loop.

What is the estate tax?

As defined by the IRS, the estate tax is a tax on your right to transfer property after your death.

In the simplest sense, the estate tax involves accounting for everything you own at the time of your demise (called your taxable estate), subtracting any deductions, and then paying a certain percentage on the remainder in taxes. It works in tandem with the gift tax, which taxes gifts in order to prevent people from simply giving away their fortunes in the last years of life.

In its current form, the estate tax is highly progressive, meaning only those with high net worth tend to pay it. Since the 2010 Tax Relief Act signed by President Obama, owners of large estates have enjoyed a pretty sweet deal—estate and gift tax exemptions allow estates worth less than $5 million ($10 million for couples) to be passed along without paying a cent in taxes.

The Tax Policy Center estimates that the top ten percent of income earners pay almost the entirety of the tax—over half is paid by the richest 1 in 1000.

What is changing?

All of that could change by the end of the year, however, and the impact could be felt beyond the Bruce Waynes of the country.

Assuming no other action by Congress, at the end of 2012 the current lifetime gift tax exemption will expire: the $5.12 million individual exemption enjoyed in 2012 will fall to $1 million in 2013, while the top tax rate will jump from 35% to 55%.

Most don’t expect the high rates and low exemption to stick, but it’s hard to predict exactly what the end result of congressional negotiations will be.

The future may well depend on the outcome of the November elections. In the past, President Obama has favored a $3.5 million exemption and a 45% top rate. Mitt Romney, meanwhile, promises a complete repeal of the estate tax.

Of course, there’s always the chance Congress does nothing at all.

In 2009 for example, the gift-tax exemption was set to expire. While estate planners anxiously awaited a renewal, Congress never came through. No estate taxes were levied in 2010, and the year will be remembered for macabre news stories suggesting people hasten death in order to cash in on the tax benefits.’s Recommendation

If no deal is reached, the lifetime gift tax exemption will fall from $5.12 million per person to only $1 million, taking the exemption from something only ultra-wealthy families consider to something families with a home, some savings, and a healthy business may have to plan for.

It’s no coincidence that estate planners are seeing more business than they ever have and are preparing for a last minute panic.

Avoid the rush and consult a financial planner as soon as possible.  Creating a viable financial plan can take months. Add in time for valuations of assets and all the necessary paperwork, and you come perilously close to the December 31st expiration deadline.

In the meantime, it’s important to remember there are a number of other means by which to gift your estate, tax-free. Individuals can give up to $13,000 to another person per year before incurring gift taxes or counting against their lifetime limit. Tuition or medical expenses for others, as long as they are paid directly to the institution are also tax-exempt, and tax-free gifts can still be made to spouses and charitable organizations.

As a final word of advice, make sure to an accredited estate tax practitioner. The IRS itself considers the laws on estate and gift taxes to be “some of the most complicated in the Internal Revenue Code.

Expert Recommendations:

Keith Davidson, a partner at Albertson & Davidson LLP and adjunct professor at Chapman Law School, had this advice:

“We don’t know for certain what will happen at the end of 2012 because it is possible that the estate and gift tax exemption will be reset to $1 million, or it could be higher if Congress chooses to act before the end of the year. Many experts believe the exemption will be lowered to $3.5 million. If you have an estate worth more than $1 million, now is the time to consider making gifts to children or other family members, which can be done in trust so that the children don’t have control of the money. There are also ways to structure the ownership of assets in order to reduce their value for estate tax purposes, such as using LLCs owned by family members. And there’s a way to use insurance to help offset the tax at a much lower cost using an irrevocable life insurance trust.”

Andrew O’Donnell, a partner at Mirick O’Connell law firm, had this advice:

“Do what you can afford, but don’t let the tax tail wag the dog, and don’t put yourself at financial risk by giving away more than you can afford. Also, be aware that if the IRS applies a clawback approach you will not obtain most of the tax benefits that you hoped to achieve with the gift (although the appreciation on the gift may still escape estate tax at your death) and the gift, once made, cannot be undone even though it did not achieve its intended tax benefits.  So go into the transaction with your eyes wide open. Finally, be aware that there is an income tax cost to large gifts because of the requirement that the donor’s basis in the gifted assets carry over to the recipient, so that if and when the recipient ultimately sells the property the deferred gain that was built into the asset when the donor gave it away will be taxed to the recipient along with any other appreciation that occurred subsequent to the gift. Despite the risks, for those who can afford to make large gifts the upside is still significant, especially with assets that have strong appreciation potential for the long-term, like stock in a growing family business or real estate. I would not delay in moving ahead with these gifts.”

Michael Specht, a CPA with Metis Group, said he is seeing an uptick in client interest:

“The potential change in the gift tax exemption has created a flurry of activity and interest from clients. The first question they are asking is how does it impact me, and is there anything that I ought to be doing about it. The first question that I am asking them is if they are prepared to be giving away property at this point in time. The gift tax exemption, while currently unified with the estate tax exemption, will apply only if they are prepared to give away property. Clients who heretofore have not had a mindset to transfer property while alive are not likely to be as concerned.”


Gift image via Shutterstock