Estate & Gift Tax Considerations: No Action Brings Significant Changes


For the past two years, we have been waiting for Congress to address the estate tax. To date, Congress has taken no action. As a result, the estate tax has been repealed for 2010 (repeal of the estate tax for 2010 was provided in the Economic Growth and Tax Relief Reconciliation Act of 2001, the “2001 Tax Act”). The 2010 repeal has created a windfall for the families of certain wealthy individuals that died this year. George Steinbrenner died with an estimated net worth in excess of $1 billion. If Mr. Steinbrenner had died in 2009, his estate would have faced a potential tax liability of more than $500 million. Dan Duncan, a Texas oil tycoon, died with an estate estimated to be worth more than $9 billion. Had he died in 2009, his estate would have faced a potential liability of more than $4 billion.

While these wealthy families avoided very significant tax liabilities, the outlook going forward is not as promising for many families that have accumulated much more modest wealth. If Congress takes no action, the estate tax will return in 2011 with the same exemption amounts and tax rates that were in effect in 2001. Specifically, the exemption amount (i.e., the amount a decedent can pass free of estate tax to his or her heirs) will be $1 million. In 2009, the exemption amount was $3.5 million. Further, the top marginal rate will be 55%, versus 45% in 2009.

Most agree that an exemption amount of $1 million is too low and that it will pull too many families with relatively modest wealth into the estate tax web. However, there is no agreement as to what is an appropriate exemption amount or a top marginal rate. As a result, we continue to wait for Congress to act.

Some have facetiously stated that the best estate plan is to die prior to year-end. There are, however, several legitimate strategies individuals can utilize prior to year-end, and going forward, to reduce or eliminate their exposure to the estate tax. We summarize a few of these strategies below.

Annual Exclusion Gifts

In 2010, you may make a gift of $13,000 to any individual and certain trusts without any gift tax consequences. Married individuals may make gifts of up to $26,000. Gifts may be made outright or in trust and may be in the form of cash, securities, real estate, artwork, jewelry or other property.

Giving property that you expect to appreciate in the future is an excellent way of utilizing your annual exclusion gifts because any post-gift appreciation on such property is no longer subject to gift or estate tax. While the economic downturn has hit everyone, making gifts of assets with deflated prices may prove advantageous in the long-run as you are able to remove more assets from your taxable estate without incurring a current gift tax obligation. To take advantage of your annual exclusions for 2010, gifts must be made by December 31. Gifts over $13,000 or gifts that will be “split” between spouses must be reported on a gift tax return, which must be filed in April 2011. The annual exclusion amount will remain at $13,000 in 2011 ($26,000 for married couples).

Payment of Tuition and Medical Expenses

In addition to annual exclusion gifts, you may pay tuition and medical expenses for the benefit of another person without incurring any gift or generation-skipping transfer (“GST”) tax or using any of your estate or GST tax exemption. These payments must be made directly to the educational institution or medical facility. There is no dollar limit for these types of payments and you are not required to file a gift tax return to report the payments.

Lifetime Gifts Using Gift Tax Exemption

In addition to annual exclusion gifts and the payment of tuition and medical expenses, individuals are also allowed a lifetime gift tax exemption. The gift tax exemption amount is currently a flat $1 million and is scheduled to remain at that level through 2011. Many clients make use of their $1 million lifetime exemptions by gift strategies such as grantor retained annuity trusts, qualified personal residence trusts and other techniques that leverage the use of the exemption. Again, a gift of appreciating property during your lifetime removes all future appreciation from your taxable estate at your death.

Taxable Gifts

In prior years, we rarely recommended individuals make gifts that would generate a current gift tax obligation. However, 2010 presents an exception to this rule. In addition to repealing the estate tax for 2010, the 2001 Tax Act also reduced the gift tax rate for 2010 to 35%. In 2011, the highest marginal gift tax rate will be 55%. For those individuals with substantial estates who will be subject to estate tax regardless of the exemption amount, they may want to consider making taxable gifts in 2010 to move assets out of their estates at a reduced rate.

Generation Skipping Tax

In addition to repealing the estate tax, the 2001 Tax Act also repealed the GST tax for 2010. Generally, the GST tax applies to lifetime and death-time transfers to or for the benefit of grandchildren or more remote descendants. The tax is in addition to any gift or estate tax otherwise payable. The GST tax exemption amount for 2009 was $3.5 million. In 2011, the exemption amount will be approximately $1.35 million (indexed for inflation).

The repeal of the GST tax for 2010 provides additional incentive for individuals to make taxable gifts in 2010. By making taxable gifts to grandchildren and more remote descendants in 2010, the individual not only takes advantage of the reduced 35% gift tax rate, but they also avoid the GST tax altogether.

Take Advantage of Today’s Low Interest Rates

Interest rates remain at historically low levels. Low interest rates enhance the benefits of several gift and estate planning strategies. One such strategy is the “grantor retained annuity trust” or GRAT. A GRAT is an irrevocable trust to which a donor transfers property and retains the right to receive a fixed annuity for a specified term. At the expiration of the term, the property usually passes outright or in trust for the benefit of descendants or other named beneficiaries. The amount of the gift resulting from the transfer of the property to the GRAT is the present value of the remainder interest that passes to the beneficiaries at the end of the term. Under the valuation methods adopted by the IRS, the lower the interest rate at the time of the gift, the lower the present value of the remainder interest and the smaller the amount of the gift that must be reported to the IRS. Interests in closely held family businesses or marketable securities with high growth prospects are often ideal properties to transfer to a GRAT.

Low interest rates also make sales to “defective” grantor trusts more attractive. Under this strategy, a taxpayer creates a trust, typically for his or her spouse and descendants. The taxpayer then sells assets to the trust taking back a note requiring the trust to repay the taxpayer in installments. The trust is structured so that it is ignored for income tax purposes, resulting in no income tax consequences upon the sale. The interest paid on the note is typically at the applicable federal rate, published for the month of the sale. The lower the interest rate on the note, the greater the amount of assets that will accumulate in the trust free of estate, gift and GST taxes.

For more information, please contact a member of the firm’s Wealth & Succession Planning Practice at 312/840-7000 or at

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