FALL 2012 ESTATE PLANNING


The final quarter of 2012 is upon us. We are therefore contacting you about year-end estate planning. Should you want to take advantage of the increased gift tax exclusion or generation-skipping transfer tax exemption before January 1 rolls around, we encourage you to get the process started now while we still have plenty of capacity to get the work completed.

Much of what we are describing in this letter was also in our newsletter earlier this year. However, we feel that the opportunities are worth restating at this juncture.

Using Potentially Expiring Gift and Generation-Skipping Transfer Tax Benefits.

Lifetime Gifts Using the $5 Million Gift Tax Exclusion. For the balance of this year, you can make gifts of up to $5,120,000 without paying any gift tax (reduced, of course, by any prior gifts you may have made using your lifetime gift tax applicable exclusion). After December 31, the gift tax exclusion is scheduled to drop to $1,000,000. This may be a once in a lifetime gifting opportunity. At the very least, it is the proverbial “bird in hand” that perhaps should not be allowed to fly away. Even if you are not sure that you want to use the exclusion, it is probably worth a brief meeting to consider the opportunities to simplify your estate planning, such as by using the higher exclusion to forgive debts from family members or to prefund future commitments, such as commitments to provide for the education of family members.

This year, some of our clients have set up trusts to which they have gifted their personal residences or vacation homes and then rented them back. In most cases, paying rent is not much different from the expense burden of owning the residence. If the residence is in a trust, the residence can be protected from creditors while also shifting future appreciation out of the donor’s estate. Other clients are setting up trusts for the benefit of their spouses. These are just a few examples of ways to use the current $5,120,000 exclusion without necessarily depleting sources of income.

Using the $5 Million Generation-Skipping Transfer Tax Exemption. Like the gift tax exclusion, the generation-skipping transfer (GST) tax exemption has been temporarily increased to $5,120,000 (that is, $5,000,000 inflation indexed). Some of our clients are making use of their increased generation-skipping transfer tax exemptions by gifting family assets to trusts that can be sheltered from estate tax for many future generations while providing current benefits to children (or even to a spouse). This may be a unique planning opportunity, as the GST tax exemption is scheduled to go back

down to about $1,400,000 on January 1.

Another possible use of the increased GST tax exemption is to make a “late allocation” of GST tax exemption to an existing trust, and then possibly to reform the trust (if necessary) so that it will not be included in the taxable estate of any trust beneficiary. Thus, old estate planning vehicles can be “juiced up” to provide greater long term protection and tax savings for the family.

Low Interest Rates – It Can Hardly Get Better than This!
Family Loans. Did you know that in October 2012, you can make nine-year loans to your children or other persons at only .93% interest? In fact, three-year loans can be made at .23% interest. Long term loans (which are loans maturing in more than nine years) can be made at 2.36% interest. This is truly amazing. As prevailing interest rates rise, which they absolutely must at some point, the rates permitted for related party loans will rise as well. This is another one of those “birds in hand”.
There are many ways to take advantage of these low interest rates to transfer wealth to your children, grandchildren or others. You could refinance loans for children or grandchildren who are paying high interest rates on credit card balances, automobile loans, or even home loans is a great way to take advantage of this low interest rate environment while helping out family members who may be suffering from reduced credit availability or high debt. If you are like some of my clients, you may like the idea of low interest loans, but you do not like the idea of being a lender to your own family members and possibly having to enforce the obligation. For these clients, we have been able to set up trusts that are taxed like a revocable trust but which are Trusteed by a third party who is responsible for making and collecting loans to family members. Essentially, the trust becomes a family bank but the client does not need to play the banker. This is just one possibility if you are uncomfortable with the concept of making loans.
Grantor Retained Annuity Trusts (GRATs). We have told you about the wonders of Grantor Retained Annuity Trusts (GRATs) in many prior newsletters and we are amazed that more clients do not implement them. They have been the source of some of our biggest tax-free wealth transfers for our clients of the past 10 years.
As a reminder, a GRAT is a trust to which you transfer assets that you expect to appreciate over a given term (at least two years, but as long as you wish). Properly structured, the value of what you transfer to the GRAT is deemed to be zero or very nearly zero because you will retain the right to recover those assets plus interest at a federally published rate (referred to as the “Section 7520 Rate”). The excess appreciation on the transferred assets will pass to your children or other beneficiaries (or continuing trusts for their benefit) without the imposition of any further gift or estate tax.
The 7520 Rate is presently ridiculously low (in fact, the lowest it has been since the rate was first published about 20 years ago): only 1.2% for transactions completed in October 2012. That is, all the investments need to do is produce a return of more than 1.2% per year and all of that “excess” income and appreciation will pass to remainder beneficiaries gift tax free when the GRAT ends. For example, if you put $1,000,000 in a five-year GRAT in October 2012 and if the GRAT assets grew at a 4% rate each year (income plus appreciation), at the end of five years, the remainder beneficiaries would receive just over $100,000 of residual value gift tax free and without using any (or only a few hundred dollars) of your $5,120,000 gift tax exclusion. We have had clients fund GRATs with $5,000,000 of assets for five years that provided their residual beneficiaries $4,000,000 of gift tax free return at the end of the GRAT term. These are simply amazing vehicles with very little downside.
Charitable Lead Annuity Trusts (CLATs). CLATs are like GRATs except that the annual annuity is paid to charity rather than to the creator of the trust. For clients of ours with current charitable intent, these trusts can be an outstanding means to provide for annual distributions to charities that they support anyway, and to use the value of those distributions to make discounted gifts to their children. This is all very straightforward and safe. It is described clearly by statutes and is just a numbers game. No hocus pocus. And the numbers are very taxpayer favorable in a low interest rate environment.
For example, if in 2012 you were to transfer $1,000,000 to a charitable lead annuity trust that is set up to pay $30,000 per year to your favorite charity with the remainder to your children, and if the trust produces an annual return of 5% over that 20-year period, then at the end of the 20 years, your children would receive more than $1,600,000 free of gift tax. However, because you obtain a gift tax deduction initially for the charity’s 20-year annuity interest, the gift you must report in 2012 is only $458,000, not $1,000,000. Further, you will continue to receive the $30,000 income tax deduction each year that the distribution is made to charity. This can be just an extraordinary way to “do well for your family by doing good for the community”.
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We hope that you have found this Newsletter informative. Please do not hesitate to call us if you have any questions or you need assistance with the completion of any new or pending projects.
With kindest regards,

Henderson, Caverly, Pum & Charney LLP