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Bay Area families are running out of time to take advantage of the generous gift tax exemption in place this year. Now is the time to leverage any gifts into ones that hold greatly increased potential value for the recipients. Get started now »
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Bay Area families that have yet to take advantage of the current gift tax exemption are running out of time. As of midnight on December 31, 2012, the $5 million exemption disappears and will be replaced by a $1 million exemption. As it stands right now, gifts in excess of $1 million given after January 1, 2013, will be taxed at a whopping 55% top rate!
Last year, Congress raised the gift tax exemption from $1 million per year to a whopping $5 million per year ($5,120,000 per person, to be precise). In addition, the estate tax rate has been reduced from 55% to 35%. However, the increased exemption and reduced rates will last for only the 2011 and 2012 fiscal years, making it imperative to act now to create and revise estate plans to take advantage of these extraordinarily favorable terms.
According to the IRS, the gift tax occurs when a person or estate transfers money or property to another either for nothing or for something less than the full value of the property. Congress passed the tax specifically in response to wealthy individuals trying to avoid the estate or “death” tax by giving away their assets prior to death. Before this year, the relatively low threshold of the gift tax exemption discouraged large pre-death bequests.
I have previously said that those with a high net worth should do advanced estate planning beyond a basic will. The generous gift tax exemption currently in place makes now the best time to leverage any gifts into ones that hold greatly increased potential value for the recipients. Some strategies include:
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LLC: Starting a LLC and then making a large gift to capitalize the company. It’s important to note that the process of creating an LLC takes time; all the necessary documents have to be drafted and then approved by the Secretary of State. A prudent planner would need to begin the process right away if he wishes to take advantage of the favorable exemption.
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FLP: Related to starting an LLC is the pooling of assets into a Family Limited Partnership. I have previously discussed the benefits of such partnerships here.
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Trusts: Another option involves placing certain gifts in trusts. We advocate using various kinds of trusts to protect assets from creditors and con artists alike. This article from the Wall Street Journal contains an excellent rundown of the various trusts one can create to take advantage of the gift tax exemption. Some trusts, such as the Grantor Retained Annuity Trust can be structured so that there are no gift tax consequences.
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Real estate: Real estate, much like closely held businesses, is notoriously hard to value and can greatly increase in worth over time. One only needs to look at the massive increase in home values in the Bay Area over the past 25 years (or the dip for the past several) to know how volatile the real estate market can be. Home prices may be lower now, but can increase in value substantially over the next decade or two, increasingly the value of the gift for the recipient. The current economic environment, in which many asset values are depressed and interest rates are at historic lows, actually makes this a perfect time to make gifts, since these factors can really help maximize the benefits of gifting.
Even if you can only afford to give smaller gifts between $1 million and $4.999 million (small being a relative word), it would still be wise to take advantage of this generous exemption before the year’s end and the $5 million ceiling expires. If you have not yet tried to take advantage of the exemption, you need to act quickly. The likelihood of Congress extending this exemption is widely seen as unlikely given that it is an election year.
Creating a gift plan that will suit your individual needs takes time. Appraisals, business valuations, and trust documents must often be created in order to ensure the gift tax exemption is applied properly in your situation. Talk to your California gift-planning attorney right away if you want to take advantage of the exemption before it ends.
Source: “The $5 Million Tax Break,” by Anne Tergesen, published at WSJ.com.
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All the best,
I have written before about a few ways someone in the Bay Area can protect his or her assets [link: http://www.calprobate.com/services/asset-protection/] from creditors. I want to expand here a bit on the idea of a family limited partnership (FLP), and how this might be a beneficial estate management arrangement for you.
How a FLP Works
A family limited partnership functions much like a holding company, with general and limited partners who have an interest in the partnership. This allows family members to pool resources and assets into a single entity that is easier and less costly to manage.
For the sake of illustration, let's create a very simple two-person partnership: A mother, the general partner; and her daughter, the limited partner.
Suppose in this example that mother and daughter have an equal 50-50 interest in the partnership (usually that would not be the case – in most cases mother would be the “general partner” with a 1% interest and daughter would be the “limited partner” with a 99% interest). Because daugther is only a limited parter, she lacks any control over the assets or their marketability - only the general partner may acquire or sell assets in the partnership.
This offers two very useful forms of protection.
Protection From Creditors
Suppose in our case that the daughter, the limited partner, has outstanding debts. Her creditors could theoretically obtain a “charging order” (a court order to pay over any distributions) for part of her interest in the partnership. However, the creditors could only receive distributions from this interest when the general partner distributed anything. The daughter has no control over distribution.
Therefore, should her mother, the general partner, simply never distribute anything, her daughter's creditors could simply be left with a taxable income yet no cash distributions.
Protection From Some Taxes
Now, suppose the mother would like to contribute $200,000 cash to the partnership. After she has made the contribution, she gifts half of the contribution to her daughter’s share. If mother had given her daughter $100,000 directly, the fair market value of the gift would be $100,000 and it would be fully subject to gift taxes.
But mother didn’t give her daughter $100,000 – instead, she gave daughter a gift through the limited partnership, and there are restrictions on daughter’s ability to use that $100,000. Because of those restrictions that $100,000 gift is worth something less than it would have been if the mother had simply handed her daughter $100,000 in cash. As a general rule, the more restrictions there are on a gift, the less it is worth.
The fact that the limited partner has no control over the assets means her claim to that $100,000 might not be so valuable to anyone else. Once that lack of control is factored in to the valuation, fair market value for that gift in the partnership might only be $95,000. Therefore, the gift tax would be based on the $95,000 value.
While this exchange is perfectly legal, it needs to be noted that only a qualified appraiser can evaluate the fair market value of the limited partner's interest. It is also useful to note that gifts of cash within a limited partnership are usually appraised at “almost” the same value as the cash itself but that gifts of other types of property (such as land) are sometimes discounted by 15% to 40%.
If you require such arrangements to protect the your assets, you require experienced legal counsel to help you do it correctly. Put our expertise to work for you, and protect the assets that you have worked so hard to build! Contact us at (650) 325-8276 to explore your situation and execute the strategy you need.
All the best,