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gift tax

To give or not to give in 2011 and 2012 . . .
that is the estate planning question

Gifting has always been an important part of estate planning. And now that the gift tax exemption stands at $5 million ($10 million for married couples filing jointly) and the top gift tax rate is 35%, the tax environment is especially favorable for making large gifts.

But because these levels are scheduled to expire after 2012, the question of whether you should maximize your gifts to your children or other loved ones this year and next is a good one. Let's take a look at a few answers.

A limited-time offer?

Determining whether you should give away assets now depends, in part, on what you believe will happen to gift and estate taxes in 2013. If you expect Congress to allow the estate tax to revert to levels prescribed by pre-2001 tax law – with the exemption shrinking to $1 million and the top tax rate jumping to 55% – you might view the current law as a limited-time offer to transfer substantial amounts of wealth tax-free.

On the other hand, if you think Congress will make the $5 million exemption and 35% tax rate permanent, there's less pressure to act now. Of course, there's another advantage to transferring wealth sooner rather than later, even if the exemption amount and tax rate stay the same: After you make a gift, any future appreciation in the gifted asset's value is shielded from gift and estate taxes (though there may be an income tax disadvantage if the recipient wishes to sell the asset).

Determining whether you should give away assets now depends, in part, on what you believe will happen to gift and estate taxes in 2013.

Is there a risk of recapture?

You might be worried that, if you make large gifts now – but by the time you die the exemption has been reduced – some or all of these gifts will be "recaptured" and subject to estate tax. This recapture – or "clawback" – risk is a legitimate concern because of the way estate tax is calculated: Previous taxable gifts are added back into your estate (at their date-of-gift values), estate tax is computed on the total (based on the exemption amount and tax rate in effect on the date of death) and the tax is reduced by any gift taxes previously paid.

Many estate planning advisors believe that Congress didn't intend tax-free gifts made in 2011 and 2012 to be subject to estate tax in later years if the exemption amount is reduced. There's even a provision in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act (the law that established the 2011 and 2012 gift tax exemption and rates) that appears to address this issue. Unfortunately, it's not yet clear how this provision will work, and it will take further guidance from the IRS to know for sure. In the meantime, taking advantage of the $5 million exemption remains a good strategy if you can afford to make large gifts now.

Where do FLPs and GRATs fit in?

If you decide to make the most of the $5 million exemption, consider using tools that allow you to leverage your gifts, such as family limited partnerships (FLPs) and grantor retained annuity trusts (GRATs). With careful planning, you can use these vehicles to transfer assets to family members at discounted values for gift-tax purposes, allowing you to transfer greater amounts of wealth tax-free.

Some lawmakers wanted to reduce or eliminate the tax benefits of FLPs and GRATs, but Congress omitted those proposals from the 2010 Tax Relief act. It’s possible that similar proposals will be introduced in the future, however, so it may be a good idea to take advantage of these tools soon.

Preparing for an uncertain future

With the gift tax exemption currently at an all-time high, lifetime giving can be a particularly powerful tool for tax-efficient transfer of wealth. But estate planning in uncertain times can be a challenge, so it's a good idea to build flexibility into your plan to deal with whatever surprises Congress throws your way. One gifting strategy that isn't affected by changing tax rates and exemption amounts is making nontaxable gifts.
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