By Darlynn Morgan, California Estate Tax Attorney
On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Tax Act”). In a nutshell, it did five things: extended current unemployment benefits to 99 weeks, extended current income tax rates (the Bush tax cuts) for all taxpayers for two more years, made significant changes to the estate tax applicable to those dying in 2010, 2011, or 2012, modified the gift tax for 2011 and 2012, and modified the Generation Skipping Transfer Tax for 2010, 2011, and 2012.
This is Part 3 of a 3 part series in which we will look at how these temporary changes can affect your estate planning. Click at any time to go back to part one or part two.
Generation Skipping Transfers in 2011 and 2012
A generation skipping transfer occurs when some or all of your estate goes directly to a grandchild or a non-relative who is more than 37.5 years younger than you. This can happen intentionally: for example, if you skip the living parent (your child) and leave an inheritance directly to your grandchild, that is a generation skipping transfer. It can also happen unintentionally: for example, if an inheritance is in a trust for your child, he or she dies after you but before receiving the full amount and, under the terms of the trust, your grandchildren will receive their parent’s remaining inheritance. That, too, is a generation skipping transfer.
Skipping a generation can cause the inheritance to be subject to the “generation skipping transfer” (GST) tax. The onerous GST tax is equal to the highest federal estate tax rate in effect at the time of the transfer and is in addition to the federal estate tax. This tax exists because Uncle Sam wants the estate tax to apply when assets are transferred at every generation. So, if you skip a generation, you don’t skip the taxes that would have been paid.
For 2010, the GST tax exemption was $1 million with a 0% tax rate, because there was no estate tax. In 2011 and 2012, the GST tax exemption is $5 million ($10 million if you are married and you plan ahead) with a 35% tax rate.
Planning Tip: Remember, there is a possibility that Congress will not act before the end of 2012, and the GST tax exemption will decrease in 2013 to $1 million with a 55% tax rate. With this in mind, if you have a large estate, you may want to use a good portion (or all) of your $5 million GST tax exemption ($10 million, if married) in 2011 and 2012.
Planning Opportunities in 2011 and 2012
Being able to give up to $5 million ($10 million, if married) will allow many individuals to transfer as much as they would want to family members without having to worry about gift taxes. For those with larger estates, planning opportunities abound during this two-year period and, when combined with leveraging strategies, allow for huge amounts of wealth to be transferred. For example:
Using a grantor trust will allow you to transfer substantial additional amounts out of your estate over time. After transferring assets to the grantor trust, you still have to pay the income tax on the trust income, which further reduces your estate. And, by not having to pay the income tax, the trust assets can grow faster. In effect, every extra dollar of income tax you pay is a dollar transferred to the grantor trust.
Leveraging Transfers through Discounts Quite often, the value of transferred assets can be discounted due to a lack of control and lack of marketability. For example, if you transfer assets to a family limited partnership or limited liability company that you control, an outside buyer would pay substantially less than asset value for shares that have no say in how the business is run and that cannot be sold without your approval. Discounting values through planning strategies like this can leverage your $5 million exemption and further increase its value.
A very large amount of life insurance can be purchased with $5 or $10 million. If structured properly, the insurance proceeds can pass free of probate, income and estate taxes to younger generations.
Other Items of Interest
* Individual income tax rates will remain at current levels for two more years. If no action had been taken, the top income tax rate would have increased from 35% to 39.6%.
* Tax on long-term capital gains and qualified dividends remains at 15% for two more years. If no action had been taken, capital gains would have been taxed at 20% and dividends would have been subject to the individual ordinary tax rates.
Planning Tip: The danger of the Congress not extending those tax rates beyond 2012 is significant. Remember that the justification for not allowing income tax rates to increase at the end of 2010 was the state of the economy. If the economy is improved as the end of 2012 approaches, those reasons will not exist.
* The AMT (alternative minimum tax) exemption for a married couple was increased from $45,000 to $72,450.
Part 3- Conclusion
Now is the perfect time to move forward with your estate, retirement and disability planning.
The 2010 Tax Act provides tremendous planning opportunities to transfer vast amounts of wealth for families with estates of all sizes, but it is a limited time opportunity that expires on December 31, 2012. At the same time, individuals with estates of less than $5 million and married couples with estates of less than $10 million can focus on planning that concentrates on family goals and objectives without, at least for the next two years, having to jump through hoops to avoid federal estate taxes. Of course, state death taxes and income taxes must still be considered.
We are ready to help you define your personal and financial goals and desires, and take advantage of these unique planning opportunities. Contact me, your California Estate Tax Attorney at (949) 260-1400 for a consultation.