Congress has created a temporary “window” – between now and the end of 2012 – in which many people can save a lot of money in estate and gift taxes. You might be able to take advantage of this opportunity by transferring significant assets to a trust. But as they say on TV, hurry – this is a limited-time offer from the federal government.
During 2011 and 2012, the federal estate tax exemption will be $5 million, meaning the tax will be applied only to estates that are larger than that. Importantly, the lifetime exemption from the federal gift tax has also been raised, from $1 million to $5 million. The gift tax applies to transfers of assets. In general, any person can give any person up to $13,000 a year without there being any gift tax. If you give someone more than $13,000 in a calendar year, then the excess is subject to gift tax.
However, you also have a “lifetime exemption.” In the past, this amount was $1 million. That meant that over your lifetime, you could make up to $1 million in gifts over the $13,000 annual threshold without immediately paying a gift tax. This wasn’t a “freebie,” however. Any amount you used of your lifetime exemption would be subtracted from your estate tax exemption, such that when you die, your heirs might have to pay more in estate taxes. But in general, the benefits of using the lifetime exemption far outweighed the disadvantages.
Now that the lifetime exemption has been raised to $5 million, you can make gifts of up to $5 million without immediately paying gift tax. Even if you already used up your $1 million lifetime exemption in the past, you can now make up to $4 million in additional gifts. But this is true only if you make those gifts in 2011 or 2012. After that, the lifetime exemption goes back to $1 million.
Many people can benefit by putting significant assets into a trust in 2011 or 2012 that will pay income to their children, and ultimately benefit their grandchildren.
Here are some of the benefits:
- Suppose you transfer an asset worth $1.5 million to a trust today, and by the time you die, that asset has increased in value to $2 million. The entire increase — $500,000 – will go to your heirs without being subject to estate taxes.
- Suppose the asset also generates annual income. For instance, over the course of the rest of your life it might generate $300,000 in income. That entire $300,000 will also go to your heirs without being subject to estate taxes.
- Suppose you set up the trust so that your children receive the income, and when they die, the trust assets go to your grandchildren. The entire trust, regardless of how much it has increased in value, will go to your grandchildren without any estate taxes being due when your children pass away.
- You will also have protected the assets for your grandchildren, because they can’t be taken away if your children incur debts, are sued in a lawsuit, get divorced, etc.
What assets should you consider putting into a trust? Obviously, ones you don’t need to keep for your current or future support. Beyond that, it’s a great idea to contribute assets that are temporarily reduced in value and that have the potential for significant appreciation. In the current environment, real estate might be a good example.
In some states, it’s possible to create a “dynasty” trust, which continues to exist and benefit future generations such as great-grandchildren. Remember, too, that the $5 million gift tax exemption is per-person. So a married couple could contribute as much as $10 million.
One possible downside is that we don’t know what Congress will do after 2012. There is a small possibility that there will be a retroactive tax on lifetime gifts over $1 million. There are also state tax issues to consider. And of course, you don’t want to make gifts of assets that you will need to live on in retirement.
But in general, the benefits of using the “window” in 2011 and 2012 are very significant and should be considered by anyone in a position to take advantage of them.