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Making the Most of Your Exclusion




                 For 2012, the estate tax exclusion and gift tax exclusion is $5,120,000.  That means your estate will be tax free as long as it is valued below this amount.  The likelihood that this high exclusion amount will change at the end of 2012 is substantial.  We are looking at a reduced exclusion amount of $3,500,000 or even $1,000,000 and a possible estate tax rate of 45% beginning in 2013. 

             For much of the last decade, we witnessed the estate tax exemption increase ratably from $1,000,000, while the gift tax exemption remained frozen at $1,000,000.  Suddenly that changed in 2011, and the fear is that the exemption will change back to $1,000,000 just as quickly (on January 1, 2013, in a few short months from now).

             In order to ensure a client’s estate pays the minimum amount of estate tax, we strongly advise our clients to go through a life-style needs analysis.  They should look at the family considerations, strategically select assets, consider income needs, appreciation potential, fractional or joint ownership, and special use assets.   Then, these assets may be used for gifting, transfers, trusts, discounting, etc. to reduce the value of the estate.

               For instance, a closely-held business is often a good asset to transfer due to the benefits of keeping the business in the family, motivating the younger generation, using valuation discounts, using S-Corporation distributions to fund a purchase, and shifting appreciation and income to younger family members.  The benefits of gifting include (1) removing appreciation and income from our taxpayer/clients; (2) removing gift tax from estates; (3) the tax inclusive vs. tax exclusive nature of our transfer tax system; (4) state in heritance estate tax avoidance (not so much in Georgia); (5) lower income tax rates; (6) no GST recapture; (7) legislative concerns; and (8) possible phase-out of valuation discounts.  There certainly are disadvantages of gifting as well, including that the value of the gifted assets could go down, the loss of step-up in basis, loss of income, loss of control and possible recapture (i.e., clawback).  Life insurance on the donor’s life can be used to address potential recapture tax issues, at least until Congress clarifies whether and how recapture applies. 

             The new exemption amount ($5,120,000 or $10,240,000 for many married couples) can be used to “clean-up” gifts.  These would include (1) forgiving loans; (2) paying off children’s mortgages; and (3) equalizing family lines.  A complete review of a client’s assets and estate planning documents may reveal assets, interests, or powers that should be released or transferred in order to avoid inclusion of the asset or trust in a decedent’s estate.  These could be powers such as the power to vote stock in a controlled corporation that is held in a trust, the power to control the beneficial enjoyment of assets, or incidents of ownership of life insurance that could also cause inclusion of significant assets in a decedent’s gross estate.  Releases and non-qualified disclaimers can often be used even if the disclaimant is beyond any time restriction for a qualified disclaimer.  Another wise use of increased gift tax exclusion is to transfer any remaining general partnership interest held by the older generation in a Family Limited Partnership, or voting interests in LLCs and S-Corps.  Many split dollar arrangements and other loans regarding life insurance trusts can also be cleaned up with gifting.

             Multiple factors must be weighed in determining which strategies to employ for a client’s estate planning.  An economic analysis of various estate planning strategies can help focus the client and the estate planner on the components of the plan that will give the client the biggest bang for the buck. 

             Ann B. Burns of Gray, Plant, Mooty in Minneapolis, Minnesota presented a paper on a graduated approach to gifting, stating, “[a] graduated approach to gifting begins with a first step of making the gift, and then moves through the embellishments of adding grantor trust features, gift of discounted assets, allocation of GST exemption, and finally, an installment sale to a grantor trust.”   Each enhancement provides additional tax savings and net benefits to the family.   Ms. Burns continued, “the $20,000,000 client may become comfortable with only 1 or 2 steps.  The $200,000,000 client may employ them all…whether the gift is made outright or in trust…taking that step in 2012 is critical.”

             Using the high exclusion and gifting techniques are just parts of an estate plan.  The possibilities are nearly endless when you consider the attributes of family trusts, including pre-funding of the Credit Shelter Trust (the so-called Supercharged CST), giving the spouse more flexibility with the 5 and 5 power, a judicious use of power of appointments, and complementary trusts.  Note, the IRS prohibits reciprocal trusts, so, ideally, trusts created by spouses to benefit one another should be created at different times, with different assets, and with materially different terms.   

             Powers of appointment are also valuable tools that a spouse could exercise, i.e., a testamentary power of appointment over the trust to distribute trust assets to a trust for the benefit of the donor in the event that the beneficiary spouse predeceased the donor at a time when the donor needed additional resources. 

             Self-settled spendthrift trusts are another hot button topic.  In particular, the Alaska Trust Act and the impact of bankruptcy, including the Mortensen ruling in June of 2011, where a bankruptcy court ruled that an Alaska self-settled trust was not protected under federal bankruptcy law.  The court found that Mortensen intended to defraud his creditors because after funding his trust, he had insufficient assets and solvency to support his current and future debts.  Mortensen had filed for bankruptcy after the expiration of Alaska’s four year statute of limitations for self-settled trusts, but within the ten-year federal bankruptcy look-back period.

             Grantor trusts are an oft-used estate planning tool.  More recently, drafters are relying on Sections 674 and 675 of the Code to create grantor trusts.  These sections give the grantor or a non-adverse party the power to substitute assets within the trust, the power to borrow funds without adequate security, and an expanded power to add or remove a beneficiary beyond just providing for after-born or after-adopted children.  Rev. Ruling 2011-28 confirmed the IRS’ position (pro-taxpayer) that the power to substitute assets in an irrevocable life insurance trust works to create grantor trust status and does not cause inclusion in the grantor’s estate under Section 2042 of the Internal Revenue Code.  Of course, we rely on Rev. Ruling 2004-64 for its holding that a grantor of a trust, who is treated as owner of the trust for income tax purposes, pays the trust’s income tax, the grantor is not treated as making an additional gift.  In addition, the power to substitute assets is important in order to avoid carryover basis (by grantor purchasing or swapping for low basis assets from grantor trust before grantor dies). 

             Once the grantor trust is established, an installment sale to the trust may be set up.   Such a situation is generally preferable to GRATs, as there is no survivor risk, the trust can be set up as generation-skipping trusts, but technically there are no “do-overs” if the value of the assets goes down.  We have found that sometimes the parties can get together to renegotiate the sale price or the terms of the resulting notes when economic conditions or interest rates fluctuations dictate.  Generally, the sale to the grantor trust technique is the most beneficial technique for both $20,000,000 estates and $200,000,000 estates.

             This is merely a quick summary and explanation of the “happenings” in estate law currently.  As we mentioned above, each client needs to consider their life-style needs alongside an economic evaluation of their situation.  With a good understanding of the client’s full situation, we can tailor these estate planning strategies to minimize estate taxes and provide for your family as you see fit. 


*IRS regulations require that we inform you as follows:  Any U.S. federal tax advice contained in this communication is not intended to be used and cannot be used for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax-related matters. 



  • Mike Hoffman

    Mike is the founding and managing partner of Hoffman & Associates and oversees the general operations and personnel of the firm. He works primarily in the estate planning practice helping clients minimize the effect of the estate tax, ensure orderly transition of generations in family businesses, and maximize asset protections. Mike also devotes a considerable amount of his efforts to the business law and tax planning needs of the firm’s clients. He is licensed to practice in the States of Georgia, Ohio, and Tennessee, and is a Certified Public Accountant.

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