Go Ahead…Make Your GiftMay 15, 2012
From an estate planning perspective, several favorable provisions came out of The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (“the 2010 Act”) on December 17, 2010. Most notable was the increased $5 million per person estate tax exemption. This was sweetened by the addition of spousal portability, allowing a surviving spouse to utilize the deceased spouse’s unused exemption. Less acclaimed, but certainly not less significant, was an increase of the lifetime gift tax exemption from $1 million to $5 million per person. Both the estate and gift tax exemption are indexed for inflation, raising their levels to $5,120,000 for 2012. These amounts represent historical highs for both exemptions. However, there is one problem. They are temporary levels with each set to revert back to $1 million per person in 2013 without interceding legislation. This provides an opportunity for timely and relevant wealth transfer planning, especially with lifetime giving.
Lifetime gifts to family and other beneficiaries is a very effective way to reduce the estate tax burden of a wealthy family. The combination of lower asset values, historically-low interest rates and increased exemptions can be a perfect recipe for deploying several simple and complex gifting techniques. One technique gaining attention that could be a good wealth transfer solution is the lifetime credit shelter trust. Typically many families employ a family trust or credit shelter trust in their testamentary estate documents to take full advantage of the first spouse’s estate tax exemption at their death. A trust is funded at death with the amount of the deceased spouse’s exemption amount and supports the surviving spouse for their lifetime, eventually passing to the first spouse’s descendants with no estate tax. For someone passing away during 2012, $5.12 million in assets could fund such a trust for the benefit of a spouse and descendants. But, if the law does not change, this same trust would only receive $1 million in 2013.
A lifetime credit shelter trust is a similar trust created during a donor’s lifetime rather than through a will at death. The donor makes lifetime gifts of assets to an irrevocable trust for the benefit of their spouse and other descendants. Just as in a typical credit shelter trust, the spouse and beneficiaries can receive discretionary distributions of income and principal for their health, education, maintenance and support. The main gifts to the trust would be treated as taxable gifts and use a part or all of the donor’s lifetime gift tax exemption, although additional gifts to the trust could be made using the donor’s gift tax annual exclusion. Gifting in 2012 vs. 2013 could potentially result in an additional $4 million funding for the trust. There are some potential pitfalls with the strategy that must be considered. Each spouse can create a trust for the other. However, diligent care must be taken to ensure the trusts avoid the application of the “reciprocal trust doctrine” which can cause the effective loss of the tax benefits from the gifts made to the trusts. To avoid the doctrine, the trusts should not be identical, and should have variations in their provisions and the timing of their creation. Another potential issue is that, since the gifts are made during life, retirement assets such as 401(k)s and IRAs cannot be used to fund the gifts. This could disqualify those whose net worth is primarily comprised of retirement plans. Additionally, the original donor’s ability to indirectly benefit from the gifted assets could end should the recipient spouse die first, as the assets would then pass to other beneficiaries. Therefore the donor should not need to rely on the gifted assets to support his or her lifestyle.
A lifetime credit shelter trust could be a tremendously useful tool for your family to take advantage of a unique window of opportunity while providing access to assets for support. However, careful planning with your estate planning attorney is essential in determining the relevance, appropriateness and proper execution of such a strategy for your particular situation.