With the estate tax laws currently in effect, coupled with historically low interest rates and distressed asset values, it is important to review estate planning and consider whether to take advantage of planning opportunities that are now available, which, if not utilized before Dec. 31, may be lost forever.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) brought the applicable exclusion amount (the amount that can be transferred free of estate and gift tax) progressively to $5.12 million in 2012 ($10.240 million for married couples). Current legislation has reduced the tax rates from a maximum rate of 55 percent down to 35 percent in 2012. Unless Congress takes action, the current law is set to sunset beginning on Jan. 1, 2013, and revert back to levels in effect in year 2002, specifically a $1 million applicable exclusion amount and maximum tax rate of 55 percent.

As the end of 2012 approaches, we can only speculate as to what Congress may do in the months ahead. It is uncertain whether the applicable exclusion amount will be $1 million, $3.5 million, $5 million or some other amount decided by Congress. But, regardless of what action Congress might take, time is quickly winding down to advise clients to take advantage of the $5.12 million applicable exclusion amount and the maximum gift tax rate of 35 percent. Below are a few estate planning opportunities to consider.

Lifetime Gifting

The easiest way to take advantage of the current higher exemption amount and lower tax rate is by making lifetime gifts. An individual who has not utilized his or her lifetime gift tax exemption may gift up to $5.12 million (or $10.24 million per married couple) without incurring federal gift tax. An individual who has previously used his or her $1 million lifetime gift-tax exemption now has the opportunity to make an additional gift of $4.12 million (or $8.24 million per married couple) without incurring federal gift tax.

It is possible that there will be a "clawback" of the prior tax benefit if the applicable exclusion amount is reduced below the amount gifted. But, even assuming a clawback applies, any appreciation of the gifted asset would escape wealth transfer taxation even if the gifts themselves are subject to clawback. Leveraging the gifts through some of the vehicles discussed in this article could enable donors to transfer appreciation on assets in excess of the $512 million exemption.

Currently, the maximum gift-tax rate is only 35 percent. It is best to gift assets that have the potential to appreciate in the future so that the appreciation is removed from the donor's estate for estate tax purposes. Also, gifting assets that have declined in value, such as real estate, may potentially provide more bang for the buck.

Opportunities also exist for lifetime gifting to grandchildren or great grandchildren. The generation skipping tax (GST) is a separate tax that is imposed on transfers to grandchildren or younger generations. In 2012, the GST exemption increased to $5.12 million per donor. Therefore, a grandparent may wish to consider making gifts to grandchildren or great-grandchildren to take advantage of the current increased exemption while it is still available. In a properly drafted and structured GST trust, any future income and appreciation could effectively be shielded from future estate or GST tax for generations.

Qualified Personal Residence Trust (QPRT)

Here, a grantor transfers his or her residence (primary residence or vacation property) to a trust in which the grantor retains the right to use and occupy such residence for a fixed number of years, with the remainder interest passing to the children or other beneficiaries. The grantor is able to transfer the full value of the residence, valued at the date of transfer, but only bears a transfer tax cost equal to the present value of the remainder interest. The currently low real estate values have minimized the transfer tax costs associated with the QPRT. Assuming the grantor survives the term of the trust, the value of the entire residence, as well as all future appreciation, is removed from the grantor's estate for estate tax purposes.

GRATs and GRUTs

Grantor retained annuity trusts (GRATs) and grantor retained unitrusts (GRUTs) are useful for freezing asset values that are likely to appreciate in value. Here, a grantor transfers property (typically a portfolio of stocks and bonds, investment real estate or an interest in a closely-held family business) to an irrevocable trust, while retaining the right to receive a fixed percentage return from the transferred property for a fixed term of years. When the term of years expires, the property passes to the remainder beneficiaries of the trust (i.e., the grantor's children). The transfer tax advantage of the GRAT and GRUT lies in the grantor's ability to transfer property to the remainder beneficiaries at a significantly reduced gift-tax cost, since the actuarial value of the grantor's retained interest is subtracted from the value of the property placed in trust in order to determine the value of the transfer for gift-tax purposes. The currently depressed asset prices and low interest rate environment have minimized the transfer costs associated with the GRAT or GRUT. If the grantor survives the term of the trust, the value of the trust property, including any appreciation, is removed from the grantor estate for estate-tax purposes.

Be aware that proposals in Congress may restrict the use of GRATs and GRUTs to a minimum term of 10 years and to disallow GRATs where the transferred amount equals the annuity payment received (a so-called "zero out" GRAT). None of these proposals have made it to law yet, but Congress may put a limit on GRATs at any time.

Instalment Sale to an Intentionally Defective Grantor Trust

Another popular and powerful estate planning strategy is the use of a sale to an intentionally defective grantor trust (IDGT). Here, the grantor creates an irrevocable trust which purchases an asset with high growth potential from the grantor in exchange for an installment note. The note must include an interest rate equal to at least the monthly Applicable Federal Rate (AFR) in effect at the time of funding. For additional leverage, the grantor can sell interests in a family limited liability company or family limited partnership that may qualify for valuation discounts as high 35-40 percent for lack of control and marketability. If the assets in the IDGT grow at a rate higher than the AFR used, then the excess appreciation can pass to the beneficiaries of the IDGT without any further transfer tax. If the grantor dies during the term of the note, then only the fair market value of the note (to the extent the loan has not been repaid) is included in the grantor's estate. The IDGT is a grantor trust for income tax purposes and the grantor does not recognize gain or loss on the sale of assets to the IDGT, and he or she is not taxed on the annual interest payments received from the note. Because current interest rates are so low, it may be possible to shift substantial appreciation to beneficiaries at a relatively low transfer-tax cost.

Conclusion

In light of the quickly approaching expiration of EGTRRA, and the potential for less favorable changes to the current estate and gift tax laws, it is now exceedingly important to review estate plans to insure that all estate planning opportunities are explored before it is too late. As noted above, the increased estate, gift and GST exemption amounts, as well as the decreased gift-tax rate in 2012, allow for significant family wealth transfer opportunities at minimal or reduced transfer-tax costs. Planning opportunities other than those described herein also may be applicable to your circumstances.

Previously published by New Jersey Law Journal, November 19, 2012.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.