Using the 2012 Gift Tax Exemption to Reach Client Goals

January 10th, 2018

Originally Posted: 10/01/12 | WealthCounsel Quarterly | Laura French, JD, LLM (Tax)

As experienced practitioners, we have all used the annual and lifetime gift tax exclusions to benefit our clients and help them reach their financial and planning goals. In 2012, Congress has afforded a unique opportunity for all of us to transfer wealth using this year’s lifetime gift tax exclusion. This article will explore a few ways you can utilize the exclusion to better serve your clients.

Tax Gift Exemption

Non-Traditional Couples

In working with non-traditional couples not afforded the tax benefits of traditional marriage, estate-planning attorneys have a great tool (with a short shelflife) at their disposal. Unmarried couples, whether same-sex or opposite-gender, do not receive the unlimited marital deduction. As experienced planners know, the unlimited marital deduction provides a fantastic starting point to begin to minimize their married clients’ federal estate tax liability.

In the past, when an unmarried couple has wanted to equalize their assets (for estate tax or any reason), gift tax considerations may have prevented the transfer of property. This year, the $5,000,000 gift tax exclusion allows a high net worth partner to gift assets to the less affluent partner, thereby lowering the individual estates of each partner and hopefully eliminating (or at least minimizing) estate taxes. At the death of the first partner, a lifetime asset protection trust may still be suitable to preserve the first partner’s unified credit exemption, while allowing the surviving partner to benefit from the asset protection trust. So, in some respects, the 2012 gift tax exclusion lets planners get a little closer to using traditional planning for non-traditional couples by affording an opportunity to equalize assets.

Saving a Plan

The 2012 gift tax exemption can be used to save an estate plan from well-intended, but poor, advice. Consider the case in which an elderly individual designates her spouse as direct beneficiary of an account. Of course this designation is made without the review and advice of counsel, and the banker doesn’t think twice about making the change. Not too long after, the wife dies, and her spouse comes to see you about funding the bypass trust. In your analysis, you recognize the account should have funded the bypass trust.

Instead, you are in the unenviable position of informing your client that his wife’s designation well, bypassed, the bypass trust. The account now belongs to him. Further, the husband’s own estate is teetering at the 2013 unified credit exemption before the addition of the assets he inherited from his wife. The client cannot make a disclaimer because he has received benefits since his wife’s passing. So as the advisor, you go to the drawing board, analyze the assets, take a look at the husband’s age and health and conclude that utilizing the 2012 gift tax exemption may help your client to minimize his federal taxable estate while preserving the couple’s original intentions. The husband decides to gift the account, which has appreciated in value, to family members while also choosing other assets to gift. The planning goal is to reduce the husband’s taxable estate using the 2012 gift tax exemption.

Preserving a Legacy

Another way to use the 2012 gift tax exemption is to fund an irrevocable trust. One example is to use the irrevocable trust to hold farmland that has been in the family for generations. Despite the drop in real estate values, the size of the farm and its unique location means that it is a highly valuable asset. Your client may gift all or part of the farmland into an irrevocable trust using the 2012 gift tax exemption. As in other examples, the goal is to minimize estate tax liability on the client’s death. In this circumstance, however, the separate goal is to preserve the farmland keeping it intact. The client will not have liquid assets to pay estate tax liabilities, so the best option for him is to gift now, enjoy grantor trust status for income tax purposes, utilize the $5,000,000 gift tax exclusion, and assure himself that his family’s legacy is preserved for generations to come.

Conclusion

Of course, no one can predict what the U.S. Congress will do in the future, so we must plan the best we can for our clients using the facts and laws available to us today. I encourage you to be creative in helping your clients to adopt the best plan they can today, with the knowledge they will work with you to revisit and adjust the plan as changes in the law and family circumstances warrant. However, planners and their clients do need to be aware of the potential pitfalls of utilizing the 2012 gift tax exclusion. First, in gifting away assets the client must be secure in the decision after full discussion of the potential risks and benefits. The client must be comfortable in the knowledge that he or she will not need the assets in the future. Next, the client must be advised of the possibility of a “clawback,” meaning that if the $5,000,000 exclusion falls back to a lower amount, then at death the client’s estate may be subject to tax on the amount gifted in 2012. Finally, all tax aspects of transferring particular types of property or financial assets must be fully evaluated by a qualified estate planner and tax professional.

It is important to remember several things. Gifting for estate tax reduction should typically be done using appreciated assets. It should only be done following a comprehensive tax review, and with consideration of a possible clawback (meaning that if the $5,000,000 exclusion falls back to a lower amount, then at death the client’s estate may be subject to tax on the amount gifted in 2012). All aspects of transferring particular types of property or financial assets must be fully evaluated by a qualified estate planner and tax professional. And finally, gifting should be only be done when it is affordable, and the client is fully informed of all implications and is willing to undertake gifting as a planning option. Don’t gift away your future, but don’t miss the unique planning opportunity that is the 2012 gift tax exemption.