$5,120,000 Gift Tax Exclusion: What are You Still Waiting For?

Dear Clients, Colleagues, and Friends,

We have about six months left before the new year and the expiration of many of the Bush Tax Cut rules that we have all enjoyed for almost a decade. But the most significant of all of the expiring tax laws is the reduction of the $5.12M gift tax exclusion to $1M. Why should you care? Because transferring up to $5M out of the estate and growing it at 6% per annum means you liberated almost $30M of wealth from death taxes for multiple generations–and it’s 100% legal.

Nevertheless, many affluent families are reluctant to make gifts of this size because, under conventional gift structuring, if the donor’s future financial circumstances change for the worse, there isn’t a way for the gifted assets to be gotten back. Or is there?

There are several ways in which one can take advantage of the larger gift exclusion and still be in position to access the gifted assets if needed. If the assets are not needed, do not bring them back into the taxable estate. Here is what you can do:

HYCET TrustSM: This is the so-called “Have Your Cake and Eat It Too” trust whereby, pursuant to certain IRS public and private rulings, a taxpayer may establish a trust in a qualifying jurisdiction (NV, AK or the Cook Islands), appoint an independent (but friendly) trustee, and the taxpayer may be included as a “discretionary beneficiary” in the HYCET Trust and have access to the trust assets, if needed. The gift of $5.12M is treated as a completed gift and removed from the estate at the death of the Trustor.

Spousal Support Trust: This trust includes the husband (or the wife, as the case may be) as the Trustor and the wife and kids as the beneficiaries, and if the gift to the trust is “separate property of the husband/donor” the trustee can make very liberal distributions to the wife (or the husband, if the design is reversed) if resources are needed from the trust. The gift of $5.12M is treated as a completed gift and removed from the estate at the death of the Trustor.

HYBRID HYCET Trust: This is the little sister of the HYCET Trust wherein the Trustor/donor is not immediately named as a trust beneficiary but in which the trustee possesses the power to add the Trustor/donor as a beneficiary in the future if the need should arise.

What to Fund the Trust With: Cash and securities are the easiest and most efficient asset class with which to fund the gift to the trust. However, those with closely held businesses, real estate investments and other private equity or closely held entities generally will qualify for substantial discounts when valuing the gift to the trust. Discounts in the 30% to 40% range or more have been used when valuing the amount of the gift. These discounts should be supported by a competently prepared valuation report in case the IRS were to challenge the manner in which the valuations were determined.

Many of our clients who establish the completed gift trust will continue to have a taxable estate, as the assets remaining in their taxable estate exceed the available gift exclusion. To provide the liquid assets to pay the taxes as the last to die, the trust would purchase a life insurance policy using the cash flow from the assets gifted to the trust. Premium financing is a popular method to pay the premiums, as the trust would pay interest only, at rates below 3% on the funds borrowed to pay the premiums. This way, the trust can leave the bulk of its assets in its portfolio of investments and just pay the annual interest. At the death of the insured, the insurance company issues two checks, one to the lender and one to the trust, so the trustee will have the necessary cash to pay the projected estate taxes.

Time to take advantage of this unprecedented gift tax exclusion is running out. Your lawyer will be exceedingly busy as the year winds down and may not be able to prepare the structure if you wait until the last minute to do your planning.

If you would like more information on these or other effective year end tax planning strategies, please feel free to contact us.

Jeffrey M. Verdon, Esq.

Jeffrey M. Verdon Law Group, LLP