The Most Important Moment for Estate Planning?

As a prominent attorney recently stated, “If you love rollercoasters, there are only two places to go: Cedar Point in Sandusky, Ohio, or a visit to your estate planner.” The laws concerning the estate tax (also known as the “inheritance tax” or “death tax”) have been in flux for over a decade. The estate tax is a tax on inheritance. The bad news is that the estate tax rate has ranged in recent years from 35% to 55%. The good news is that not all inheritances are subject to tax. Each individual has an estate tax exemption. The exemption is the amount of inheritance that you can exclude from the estate tax. For decedents dying in 2002, the exemption was $1,000,000. In 2004, the exemption increased to $1,500,000, then to $2,000,000 in 2006, and to $3,500,000 in 2009. The exemption was unlimited (which is another way of saying there was no estate tax) in 2010.

In 2011, the exemption was scheduled to take a huge dip, reverting back to $1,000,000. In December of 2010, Congress passed and President Obama signed legislation that created a temporary increase in the exemption to $5,000,000 in 2011 and $5,120,000 in 2012. However, without further legislation, the exemption will automatically drop to $1,000,000 on January 1, 2013.

In addition to the estate tax, there is a gift tax. The idea behind the gift tax is to prevent taxpayers from avoiding the estate tax by giving away their assets during life. Although there are many caveats and exceptions, the general rule is that each lifetime gift reduces the estate tax exemption dollar for dollar. For example, if you give away $100,000 during life, your estate tax exemption is reduced by $100,000. Furthermore, if you make a gift that is in excess of your estate tax exemption, you owe gift tax.

With these general rules in mind, many estate planners are advocating making gifts now, prior to January 1, 2013. The idea is to take advantage of the much higher estate (and gift) tax exemption that is currently available before the window of opportunity closes. The pros of this course of action are obvious. Right now, you can gift away much more than you will be able to in 2013, which will reduce the size of your estate upon death.

There are cons to this kind of planning as well. For one, you must be comfortable with the concept of gifting. If you do not want to – or can’t afford to – part with certain assets, then this kind of planning might not be a good fit for you. Secondly, if the estate tax exemption really does drop to $1,000,000 in 2013 and you made gifts in 2012 in excess of that amount, will the IRS try to recapture the difference from your beneficiaries (a concept known as a “clawback”) or will your gift be grandfathered in? Finally, what if Congress ends up extending the $5,120,000 estate tax exemption in 2013 and beyond? You will have spent time, effort, and money – and given away significant assets – for possibly no benefit.

Although there are potential problems to making gifts in 2012, it is worth considering these possibilities if your estate is likely to exceed $1,000,000 upon death. As such, I am holding a free seminar about this topic entitled, “Opportunities and Clawbacks – Taking Advantage of the Once-in-a-Lifetime 2012 Estate/Gift Tax Rules,” on Saturday, October 27, 2012 from 10:00 to 11:30 am at 700 Jewell Avenue, Pacific Grove. The seminar will cover these unique 2012 issues but will also cover general advanced estate planning gifting strategies that will always be relevant regardless of what happens to the estate tax exemption. Please RSVP at 831-920-0205.