Authored by: Neeli Shah

While the 2010 Tax Act signed by President Obama on December 17, 2010 creates significant opportunities, it also creates dilemmas for wealthy families who are considering whether and how to take advantage of such opportunities.  The 2010 Tax Act raises the tax-free limit on lifetime gifts from $1 million to a hefty $5 million ($10 million for married couples) before a gift tax applies.  When it does, the rate is a maximum of 35%.

Many wealthy families are contemplating whether they should rush to make large gifts to their kids during the next two years in order to save future estate tax or wait and see.  From an estate planning perspective, lifetime gifts leave less in your estate for the government to tax, and if the gifted assets increase in value after you have gifted them, you will not owe tax on the appreciation.  For those who want to implement this strategy, the new law offers more flexibility than ever before.  You can apply the $5 million limit during life, when you die or some combination of the two.  Planning opportunities are real and substantial, including zeroed-out GRATS, Family Limited Partnerships (FLP), Irrevocable Life Insurance Trusts, and installment sales of FLP interests to grantor trusts to leverage the valuation discounts available for FLP interests.  These strategies will effectively permit wealthy individuals to pass far more to their heirs than the $5 million estate tax exemption.

And any part of the exemption that you don’t use yourself can be carried over by a spouse who survives you – a new rule called portability.  The one proviso is that the executor of the estate of the first spouse to die must file an estate tax return, even if no tax is due.  So if you don’t get around to making those gifts, your spouse can pick up where you left off.  Keep in mind though that this opportunity is only available until 2012.  If Congress doesn’t act before then, not only will portability lapse, but the exemption amount will revert to $1 million and the tax rate will increase to 55%.

On the flip side, there is the possibility that Congress will either repeal the estate tax entirely in 2013 (unlikely) or continue the present laws after that time (fairly likely).  If you blew through the $5 million exemption and the tax-free amount drops to $1 million, can there be a retroactive tax at death for people who gave away more than that in 2011 and 2012?  The possibility of such a clawback, as it’s called, seems extremely remote.  But it’s being bandied about in professional Internet discussion groups and at conferences.  While there is no right or wrong answer, it’s important to be familiar with the political backdrop and the temporary nature of the estate and gift tax laws when making such gifting decisions.