A Sea Change for Gift and Estate Planning

How CPAs and their clients should prepare for uncertainty after 2012 for the estate and gift tax.

July 2011
by Paul Bonner/Journal of Accountancy

Martin Shenkman, Esq., CPA/PFS, is the author of numerous books and articles on tax and financial planning, including the AICPA-published Estate and Related Planning During Economic Turmoil and with Steve R. Akers, Estate Planning After the Tax Relief and Job Creation Act of 2010: Tools, Tips and Tactics. His firm, Martin M. Shenkman PC of Paramus, N.J. and New York City, specializes in serving tax and estate and business planning needs of high-net-worth individuals, professionals, owners of closely held businesses and real estate developers.

Shenkman is also a frequent lecturer on financial planning, on which he is regularly quoted in a wide range of media. Recently, he spoke with the JofA on gift and estate tax and how CPAs can advise their clients to help them make sense of the recent changes in gift and estate tax, deal with uncertainty ahead and make the most of current opportunities.

JofA: How should CPAs and their clients prepare for uncertainty after 2012 for the estate and gift tax?

Shenkman: The single most important point is not to dismiss planning as something that now only pertains to the ultra-wealthy. Planning remains vital for most clients. Practitioners are well aware that in 2013, what’s on the books now is that we’re going to have a $1 million gift and estate tax exemption (the GST [generation-skipping transfer] exemption will be $1 million, too, but inflation-indexed) and we’re going to have a 55 percent tax rate. Very few practitioners really believe that’s going to happen, but it cannot be dismissed when consulting with clients. What will happen, I don’t think anybody truly knows. So a lot of people are believing we can “wait and see,” until maybe mid-2012 or late 2012, what to do before we act. And that could prove to be a very big mistake. Wait and see may become “wait and pay.” The safer and smarter approach is to proactively plan flexibly, so that whatever changes occur, the client will be in a better position than if no planning had been undertaken.

Meanwhile, the situation now offers a golden planning opportunity. The gift exemption is $5 million, the highest it’s ever been in history, which permits huge wealth shifts. Besides the scheduled reduction of that exemption, there have been proposals to restrict GRATs (grantor retained annuity trusts) to a 10-year term. And the current practice of discounting values of private partnership interests or other forms of equity for lack of marketability or control may face restrictions as well. The Obama administration has already proposed reducing the gift exemption to $1 million.

There’s also an economic imperative to planning. Interest rates have started to rise and as that happens, the leverage from note sale transactions, GRATs and other techniques diminishes. The economy is still very soft, so that you may still get some historically favorable valuations.

Let me point out several opportune client scenarios for which practitioners should try to help plan for current gifts. If you have a client who lives in one of the almost 20 states, give or take, that have decoupled from the federal estate tax system, that client may face a substantial estate tax at the state level even though he or she might have no federal tax. Because of the $5 million federal gift exemption, if you have a client in his or her late 80s or who is ill, for example, who lives in New York, which has a $1 million exemption, that client may be able to simply gift away assets today, with no federal gift tax, reducing them to, say, $995,000. When that client passes away, there’s no New York estate tax. They have almost a half-million-dollar savings. It can be that simple (but watch for changes in state estate or gift tax laws). Many clients who are candidates for this type of planning won’t be willing to part with such a large portion of their wealth. There are several options. First, gift something substantial but less than the maximum necessary. The savings can still be substantial. The other approach, which is more complex and costly, is really the optimal planning technique for many clients. Gift the assets to a domestic self-settled asset protection trust (DAPT). These are typically formed in Alaska, Nevada, Delaware or South Dakota. The client can remain a discretionary beneficiary of an independent trustee and thus benefit from his or her assets if needed. Yet the assets should be removed from his or her estate. While there are risks with this planning, the risks of doing nothing certainly could be much more costly.

The second category of client is — I would use physicians as the key example, but it applies really to a broad array of clients. Anyone who is concerned about asset protection, lawsuits, malpractice, divorce or other litigation should plan aggressively now, because this is a golden opportunity to shift wealth. The $5 million gift exemption permits tremendous asset protection planning. The DAPT noted above might be one approach. The third category is gay or lesbian partners or other non-married couples. In the past, where you had one partner with more wealth than the other, shifting wealth from that partner to the less wealthy partner has been a very complicated process, often requiring complex and expensive planning techniques to avoid incurring a gift tax. But with a $5 million exemption, you may be able to simply set up a trust for that other partner and shift wealth and you’re done.

JofA: What about a possibly awkward transition with the changes between 2010 and 2011?

Shenkman: One of the most important issues is that the zero GST, generation-skipping transfer tax, in 2010 gave many clients a unique opportunity to do things they’d never done before. So, for example, if you had a pot trust that was not GST-exempt but could make distributions to a grandchild or other skip person, a lot of clients or trustees would have made those distributions to grandchildren to shift assets out, because even if it was a GST transfer, there was no GST tax.

The problem and challenge for practitioners is, first of all, to ferret out those transfers, because clients may not realize what needs to be done in order to report them on the trust income tax returns. It’s not just the gift tax return you have to focus on, but it’s the income tax returns as well. You now had a distribution out of a trust. You’ve got to report that on the Form 1041 [U.S. Income Tax Return for Estates and Trusts], not just the Form 709 [United States Gift (and Generation-Skipping Transfer) Tax Return]. And the gift tax returns for 2010 are extremely complex and different from any other tax year. Most practitioners extended 2010 gift tax returns for this reason and still have to face the issues they raise. Determining whether or not to affirmatively allocate GST exemption, to opt out of the automatic GST allocation rules, how to report purported gifts that may have been rescinded, qualified severances used to take advantage of 2010 law and other issues will have to be addressed.

This article has been excerpted from the Journal of Accountancy. View the full article here.

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Paul Bonner is a JofA senior editor. To comment on this article or to suggest an idea for another article, e-mail him or contact him at 919-402-4434.