Williams McDaniel, P.C.

Under the tax act which passed in December of 2010, the federal estate tax exemption was set at $5 million per client ($10 million for a husband and wife).  Unlike the prior law, the exemption is structured to allow utilization of the entire exemption during life or at death.  For instance, if no taxable gifts are made during life and have a $5 million exemption at death.  Likewise, a $3 million gift can be made during life without gift tax leaving a $2 million exemption to be used at death.

Some practitioners are concerned that Congress, under pressure to address deficits, may roll back the $5 million exemption.  It is impossible to know what Congress will do.  Regardless, for high net worth clients, using the $5 million exemption today rather than saving it to use it at death may represent an excellent estate planning alternative.

Example

Assume Jill has an estate substantially in excess of $5 million.  Jill is 65 years of age and has a life expectancy of 20 years.  Making a large gift today and using the exemption removes all of the appreciation of the gifted property out of Jill's estate.  If the $5 million is not gifted, but grows at an annual return of only 3 ½%, then 20 years from now the $5 million will have doubled to $10 million.  Death taxes in excess of $2 million will be imposed on the appreciation.  With no gift, all appreciation will be included in Jill's estate.  If Jill makes the gift today, the gifted assets will be taken into consideration at her death as a prior gift.  However, the value will be frozen at $5 million.  The entire $5 million in appreciation will be excluded from Jill's estate.  Federal estate tax savings exceeding $1,750,000 are possible.  State death tax savings exceeding $450,000 are possible.

Even if the property only grows at a 2% rate, nearly $2.5 million is removed from the estate over a 20 year period.  If the property should grow at an 8% rate, over $13 million is removed from the estate.  Death taxes at approximately 40% are avoided.

A major consideration before gifting is who to gift to and how.  The assets can be gifted outright to children and/or grandchildren, or in trusts for children and/or grandchildren.  Consider also the possibility of a gift in trust for a spouse for life and then for children for life and grandchildren.  This is often called generation skipping planning.  Consider the following example.

Husband, whose estate is substantial, establishes a trust for the benefit of his wife for life.  Wife is to receive income from the trust.  Principal may be distributed to wife for her reasonable health, support and care and to maintain her accustomed manner of living.  Wife can be the Trustee.

At wife's death, the assets are distributed to the children and/or grandchildren as wife shall elect.  Absent wife's decision to the contrary, following the death of the wife the assets are held for the children for life and ultimately pass to the grandchildren.

From a federal gift tax standpoint, if the gift is less than $5 million (assuming no prior taxable gifts), there are no federal gift taxes to pay.  The assets are held in trust for wife for life.  They pass death tax free at wife's death on to children.  They can then be held in trust for children for life and ultimately pass tax free again upon each child's death to his/her children.

Gift Tax Issues

The only negative to this proposal is state gift taxes.  For Arkansas and Mississippi residents, there are no state gift taxes.  However, Tennessee residents must consider a state gift tax.  The state gift tax on a $5 million trust is substantial (approximately $450,000).  However, the trust can be structured in a manner to initially avoid the state gift taxes.

There are two ways to avoid Tennessee state gift taxes.  If a client owns real property located outside of Tennessee, such as Mississippi or Arkansas farm land, a transfer of this property into trust is not subject to State of Tennessee gift taxes.  Otherwise, the trust can be structured to qualify for a marital deduction (QTIP election) for state gift tax purposes.  This election effectively allows the trust to be established for the benefit of wife for life without incurring immediate State of Tennessee gift taxes.  The negative to this plan is that the assets are subject to state inheritance taxes at wife's later death if she is a resident of the State of Tennessee at that time.  But what if she is residing in Florida or another state with no inheritance tax at her death?  The tax is avoided.  Making a QTIP election does require an election on a State of Tennessee gift tax return. However, for this transaction to be complete, gift tax returns to both the federal government and the State of Tennessee are required.

Conclusion

Some estate planners are concerned that Congress will act in the future to reduce the exemption to an amount less than $5 million.  Accordingly, many practitioners are suggesting that we use the exemption now in order to avoid loss of the exemption later.  There is some risk in this action in that if Congress modifies the law, we do not know how they will modify it.  However, it is highly unlikely that Congress would come back and retroactively impose gift tax where none had been previously applicable.  There are a number of court cases that prohibit retroactive application of tax law.

The type of gift outlined in this article does not appeal to every client.  However, for high net worth clients, it is a technique that should at least be considered as a part of the estate planning process.

A. Stephen McDaniel, 2011
Williams McDaniel, P.C.
5521 Murray Avenue
Memphis, Tennessee 38119
901-767-8200
www.wmww.com