Obama Wins! Now What?

Dear Clients, Colleagues, and Friends,

The Obama victory and a democrat controlled Senate will translate into higher gift and estate taxes when the law sunsets at the end of 2012 and no prospect for an estate tax repeal, at least for the next 4 years. Now that the election is over, we expect a rush by those who were expecting a President Romney and with him, an extension of the Bush tax cuts and a repeal of the estate tax next year.

On the income tax side, the significant increases in rates already baked into the law for January 1st may actually occur. This could be a significant burden upon single individuals who earn more than $200,000 per year and married couples who earn more than $250,000 per year.

The scheduled income tax increases include a highest bracket of 39.6% instead of the present 35%, plus a 3.8% extra tax on interest, dividend, net rent, and other passive income to the extent that the taxpayer has total earnings exceeding the $200,000 and $250,000 thresholds.

In the estate tax arena the chips are even higher, as the present $5,120,000 gifting and estate tax exemptions would drop to $1,000,000 on January 1! This is why so many clients have been working with us to make gifts exceeding $1,000,000 in value to make use of all or part of the $5,120,000 temporary gifting allowance, an opportunity which may never exist again during our lifetimes. In addition to this, the estate tax rate, which is now only 35%, would jump to 55%. Yikes!

Many clients do have a concern that if they gift too much away they could run out of assets. Popular solutions to this have been (1) have a spouse as a beneficiary of the trust and assume that as long as the spouse is alive the donor can derive indirect benefit by being supported by the spouse while the spouse is being supported by the trust, and (2) the HYCET Trust® which we form in an asset protection jurisdiction, since the IRS has ruled in at least two cases that the donor can be a discretionary beneficiary and actually receive the benefit of trust assets if and when ever needed.

Hopefully, there will be a political compromise with respect to both income and estate taxes between now and year end. But most experts who have significant political/legal observation histories feel that this will probably not be sorted out until 2013, with the compromise to be retroactive to January 1, 2013.

Our esteemed Special Tax Counsel, Professor Jerry Hesch, suggests that every affluent family and business owner consider putting an irrevocable trust into place which can hold assets that would not be subject to federal estate tax, but would be considered as owned by the grantor for income tax purposes.

This is because two very important estate and gift tax provisions that presently exist for these trusts would be eliminated if President Obama’s February 2012 budget suggestions are adopted, which are as follows:

  1. Presently the grantor can pay the tax on dividends, interest, and other income earned by such a trust, so that the trust can grow faster to increase the assets that would pass free of estate tax.

Under President Obama’s proposal, this type of trust would be subject to estate tax on the death of the grantor. Professor Hesch observed that trusts of this type existing before the end of this year probably would be grandfathered. The effect of being able to pay the income tax on behalf of this type of trust, and be able to sell assets or discounted family interests to this type of trust in exchange for a low interest note, has an incredible mathematical value.

2. Presently this type of trust can be used to avoid estate tax not only at the grantor’s level, but also at the level of generations of descendants going for as long as 365 years for a trust established in Nevada.

President Obama’s proposal would limit this “generation skipping dynasty” trust effect to 90 years.

In addition, many clients are making sure that they make their sales of family company interests and investment real estate held in closely held entities like FLPs and LLCs to these types of trusts before year end because we can presently value non-voting or minority interests in family entities using discounts. President Obama’s 2012 budget proposal would eliminate discounts.

The Republican House of Representatives may be able to resist having some of these new restrictive estate tax provisions enacted, but what will the trade-off be for raising the estate tax exemption above $1,000,000 per taxpayer? President Obama’s February 2012 budget called for a $3,500,000 per taxpayer estate tax exclusion and did not make mention of what the gifting exclusion would be. Since many affluent families have probably used their $5,120,000 gifting exemption during 2011 and 2012, we may not see significant resistance to allowing the gift tax exemption to go down to $1,000,000.

It is a stressful time for individuals who have a net worth of well over $1,000,000 and may find themselves wondering whether living until after December 31, 2012, will cause significant additional estate tax. The situation that we have been fearing since December 2010 is now almost upon us.

So what do you do between now and December 31, 2012?

If you fail to plan then you are planning to fail.

If In Doubt, Gift It Out! Many clients with net worths in the $2,000,000 to $4,000,000 range have stopped annual gifting in the hopes that the $5,120,000 exemption will continue.

Since that now seems highly unlikely, it may be a good idea to complete normal 2012 year-end gifting to make maximum use of the $13,000 per person annual exclusion ($14,000 per person beginning in 2013).

Also, do not forget that the Obama budget proposals would largely curtail grantor retained annuity trust planning by requiring a minimum 10-year term and a positive remainder interest.

Please contact us as quickly as possible if you have any questions or if we can be of assistance between now and year end.

*Special thanks to Alan Gassman for his contribution of material to this Client Alert.

Jeffrey M. Verdon, Esq.

Jeffrey M. Verdon Law Group, LLP

It’s Not Over Til It’s Over – How to Capture the Expiring $5.12M Gift Tax Exclusion Even if You’ve Waited Until the 11th Hour (or Month)

Dear Clients, Colleagues, and Friends,

There are only two months remaining before the $5.12M gift tax exclusion law will sunset taking us back to the pre-2011 $1M gift tax exclusion. For those taxpayers who haven’t yet jumped on the bandwagon (to take advantage of what is arguably the “greatest tax benefit” in the history of our Union) time is running short–not because the appropriate trust can’t be timely formed, but because of the extraordinary length of time it is taking the appraisers and valuation discount experts to determine the values of the intended gifts. If this has been holding you back, we have a solution for you.

At Jeffrey M. Verdon Law Group, LLP, we see obstacles not as impediments but as opportunities. For most of our clients who have engaged in the gift planning, we are using the flexible design of the HYCET Trust® (about which we have written in previous issues of our Client Alerts). The HYCET Trust allows you the flexibility of creating a multi-generation dynasty trust capturing the expiring $5.12M gift tax exclusion wherein the donor of the gift may become a discretionary beneficiary of the HYCET Trust, permitting one to retrieve the gift if he or she later develops a case of Donor’s Remorse, or later needs or wants the gift back. Under previous IRS rulings, a gift transfer to a trust established in a qualifying jurisdiction with these characteristics has been treated as a “completed gift” for Federal gift tax purposes. Whether the assets will be excluded from the donor’s taxable estate at his or her death will depend on whether the independent trustee acted in an “independent” manner during the donor’s lifetime. If the donor attempts to exert undue influence over the trustee risks the IRS disregarding the efficacy of the trust. The donor should exhaust his or her personal assets before seeking to recapture the gifts from the HYCET Trust.

If you are just now considering year-end tax exclusion gifts but the type of assets to be the subject of the gift take an extended period of time to appraise or value, such as your closely held business, investment real estate or their entities, your private equity investments, or other assets without a ready market value, no problem. Form your trust and, before year end, simply make a gift of your other assets where the values can be readily determined, like cash, bonds, marketable securities, residential real property or life insurance policies, up to the $5.12M per spouse gift tax exclusion. Then when the appraisals and valuation discounts are completed in 2013, and using the “substitution of assets” clause we insert in our trusts, simply substitute the appraised assets with those assets you originally transferred to the trust in 2012.

So IT’S NOT OVER ‘TIL IT’S OVER using this approach to benefit from this never-to-be-seen again opportunity to capture the gift tax exclusion benefits. We plan to be in the office and working right up until midnight on the 31st of December as we accommodate our clients and their gift planning strategies. If your advisors are telling you it’s too late to do the planning for 2012, we would be happy to work with them to see that you can join the millions of American taxpayers taking advantage of this soon-to-expire tax windfall.

We hope this helps.

Jeffrey M. Verdon, Esq.

Jeffrey M. Verdon Law Group, LLP